10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2008
	OR
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to         

Commission file number 0-15366

ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

New York	16-1276885
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
120 Madison Street, Tower II, 18th Floor, Syracuse, NY 13202	13202
(Address of principal executive offices)	(ZIP Code)

Registrant’s telephone number including area code: (315) 475-2100

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class: Common Stock, $1.00 par value per share

Name of each exchange on which registered: The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes                                                                     No  X  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes                                                                     No  X  

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.

Yes  X                                                               No        

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.

    Large Accelerated Filer [  ]            Accelerated Filer [X]                     Non-accelerated filer [  ]        Smaller Reporting Company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes                    No  X  

As of June 30, 2008, the aggregate market value of the voting stock held by non-affiliates of the registrant was $89.3 million based on the closing sale price as reported on the NASDAQ Global Market.

The number of outstanding shares of the Registrant’s common stock, $1 par value per share, on January 22, 2009 was 4,578,910 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the 2009 annual shareholders meeting (the “Proxy Statement”) are incorporated by reference in Part III of this Annual Report on Form 10-K.

Exhibit index is located on page 77 of 79.

TABLE OF CONTENTS

FORM 10-K ANNUAL REPORT

FOR THE YEAR ENDED

DECEMBER 31, 2008

ALLIANCE FINANCIAL CORPORATION

			Page
PART I
	Item 1.	Business	1
	Item 1A.	Risk Factors	7
	Item 1B.	Unresolved Staff Comments	11
	Item 2.	Properties	11
	Item 3.	Legal Proceedings	11
	Item 4.	Submission of Matters to a Vote of Security Holders	11
PART II
	Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	12
	Item 6.	Selected Financial Data	14
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	33
	Item 8.	Financial Statements and Supplementary Data	35
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	75
	Item 9A.	Controls and Procedures	75
	Item 9B.	Other Information	75
PART III
	Item 10.	Directors and Executive Officers of the Registrant and Corporate Governance	76
	Item 11.	Executive Compensation	76
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	76
	Item 13.	Certain Relationships, Related Transactions and Director Independence	76
	Item 14.	Principal Accountant Fees and Services	76
PART IV
	Item 15.	Exhibits and Financial Statement Schedules	77

PART I

This Annual Report on Form 10-K contains certain forward-looking statements with respect to the financial condition, results of operations and business of Alliance Financial Corporation and its subsidiaries. These forward-looking statements include: statements of our goals, intentions and expectations; statements regarding our business plans and prospects and growth and operating strategies; estimates of our risks and future costs and benefits. These forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: an increase in competitive pressure in the banking industry; changes in the interest rate environment which may reduce margins; changes in the regulatory environment; general economic conditions, both nationally and regionally, resulting, among other things, in a deterioration in credit quality; changes in business conditions and inflation; changes in the securities markets; changes in technology used in the banking business; the possibility that current and potential future restrictions under the Emergency Economic Stabilization Act (as amended) on the Company’s executive compensation plans will impair its ability to attract and retain key personnel; the possibility that evolving government intervention into the financial markets negatively impacts the Company’s operations; our ability to maintain and increase market share and control expenses; and other factors detailed from time to time in our SEC filings. See Item 1A of this Form 10-K.

Item 1 —Business

Available Information

The Company files annual reports, quarterly reports, proxy statements and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files with the SEC at www.sec.gov.

The Company also makes available free of charge through its website (www.alliancebankna.com) the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC.

General

Alliance Financial Corporation (the “Company” or “Alliance”) is a New York corporation and a registered financial holding company formed on November 25, 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc., which were incorporated May 30, 1986 and October 31, 1984, respectively. The Company is the holding company of Alliance Bank, N.A. (the “Bank”), which was formed as the result of the merger of First National Bank of Cortland and Oneida Valley National Bank in 1999.

The Bank provides financial services from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, trust and investment management services. The Bank has a substantially wholly-owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly-owned subsidiary, Alliance Leasing, Inc.

The Company’s administrative offices are located on the 18^th Floor, AXA Tower II, 120 Madison St., Syracuse, New York. Banking services are provided at the administrative offices as well as at the Company’s 29 customer service facilities.

On February 18, 2005, the Bank acquired a portfolio of personal trust accounts and related assets under management from HSBC, USA, N.A. The Bank assumed the successor trustee role from HSBC on approximately 1,800 personal trust accounts and further assumed approximately $560 million in assets under management. Combined with its existing trust business the Bank now manages approximately $726 million of related investment assets at December 31, 2008.

On October 6, 2006, Alliance completed its acquisition of Bridge Street Financial, Inc. (“Bridge Street”) and its wholly-owned subsidiaries, Oswego County National Bank (“OCNB”) and Ladd’s Agency Inc. (“Ladd’s”), an insurance agency. In connection with the acquisition, Alliance issued approximately 1,292,000 shares of common stock valued at $38.1 million, and paid cash of $13.2 million for total merger consideration of $51.3 million. At the time of the acquisition, Bridge Street had $219.3 million in assets, $148.3 million in gross loans, and $169.2 million in deposits. In the acquisition, Bridge Street was merged into Alliance, Ladd’s became a wholly-owned subsidiary of Alliance, and Oswego County National Bank was merged into the Bank.

The Company formed Alliance Financial Capital Trust I and Alliance Financial Capital Trust II (collectively “Capital Trusts”) for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company.

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In December 2008, the Company entered into a Letter Agreement (the “Purchase Agreement”), with the United States Department of the Treasury (“Treasury Department”) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total price of $26,918,000 (ii) and a warrant (the “Warrant”) to purchase 173,069 shares of the Company’s common stock at an exercise price per share of $23.33.

In addition, under the Certificate of Designations, the Company’s ability to declare or pay dividends or repurchase its common stock or other equity or capital securities will be subject to restrictions in the event that it fails to declare and pay (or set aside for payment) full dividends on the Series A Preferred Stock.

At December 31, 2008, the Company had 334 full-time equivalent employees. The Company’s employees are not represented by any collective bargaining group. The Company considers its employee relations to be good.

The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System, and its deposits are insured by the Federal Deposit Insurance Corporation up to applicable limits.

Services

The Company offers full-service banking with a broad range of financial products to meet the needs of its commercial, retail, government, and investment management customers. Depository account services include interest and non-interest-bearing checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. The Company’s lending activities include the making of residential and commercial mortgage loans, business lines of credit, working capital facilities and business term loans, as well as installment loans, home equity loans, and personal lines of credit to individuals. Trust and investment management services include personal trust, employee benefit trust, investment management, custodial, and financial planning. Through UVEST Financial Services, member NASD/SIPC, the Bank provides financial counseling and brokerage services. The Company also offers safe deposit boxes, wire transfers, collection services, drive-up banking facilities, 24-hour night depositories, automated teller machines, 24-hour telephone banking, and on-line internet banking. Personal and commercial insurance products are offered on an agency basis through Ladd’s Agency, Inc., a multi-line insurance agency.

Competition

The Company’s business is extremely competitive. The Company competes not only with other commercial banks but also with other financial institutions such as thrifts, credit unions, money market and mutual funds, insurance agencies and companies, brokerage firms, and a variety of other financial services companies.

Supervision and Regulation

The following discussion summarizes some of the laws and regulations applicable to bank holding companies and national banks and provides certain specific information relevant to the Company. This regulatory framework primarily is intended for the protection of depositors and the deposit insurance funds that insure bank deposits, and not for the protection of shareholders or creditors of bank holding companies and banks. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Moreover, Congress, state legislatures and regulatory agencies frequently propose changes to the law and regulations affecting the banking industry. The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to accurately predict. A change in the statutes, regulations, or regulatory policies applicable to the Company or its subsidiaries may have a material adverse effect on their business. As a participant in the Capital Purchase Program (“CPP”) under the United States Treasury Department’s Troubled Asset Relief Program (“TARP”), Alliance is subject to certain restrictions and reporting requirements relative to executive compensation and lending activities that do not apply to financial institutions which do not participate in the TARP.

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and elected to become a financial holding company on June 21, 2006. As such, it is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Bank Holding Company Act and other federal laws subject bank and financial holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. A bank holding company that qualifies as a financial holding company can expand into a wide variety of services that are financial in nature, if its subsidiary depository institution is well-managed, well-capitalized and has received at least a “satisfactory” rating on its last CRA examination. Services that have been deemed to be financial in nature include securities underwriting, dealing and market making, sponsoring mutual funds and investment companies, insurance underwriting and agency activities and merchant banking. The Bank Holding Company Act requires every financial holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by financial holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the financial holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a financial holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. In addition, any entity is required to obtain the approval of the Federal

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Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of the Company’s outstanding common stock, or otherwise obtaining control or a “controlling influence” over the Company.

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis. Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Under Federal Reserve Board policy, a holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. The Federal Reserve Board may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of the subsidiary bank.

The Company’s ability to pay dividends to its shareholders is primarily dependent on the ability of the Bank, the Company’s bank subsidiary, to pay dividends to the Company. The ability of both the Company and the Bank to pay dividends is limited by federal statutes, regulations and policies. For example, it is the policy of the Federal Reserve Board that holding companies should pay cash dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the holding company’s expected future needs and financial condition. The policy provides that holding companies should not maintain a level of cash dividends that undermines the holding company’s ability to serve as a source of strength to its banking subsidiaries. Furthermore, the Bank must obtain regulatory approval for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank’s net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. The Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

The Federal Reserve Board has established risk-based capital guidelines that are applicable to financial holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes, and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill (“Tier 1 capital”). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization’s particular circumstances warrant. The remainder (“Tier 2 capital”) may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.” The Company’s Tier 1 and total risk-based capital ratios as of December 31, 2008 were 14.1% and 15.1%, respectively.

In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier 1 capital to quarterly average assets less goodwill (“Tier 1 leverage ratio”) of 3.00% for financial holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other financial holding companies are required to maintain a Tier 1 leverage ratio of 3.00% plus an additional layer of at least 100 to 200 basis points. The Company’s Tier 1 leverage ratio as of December 31, 2008 was 9.6%, which exceeded its regulatory requirement of 4.00%. The guidelines provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

The Gramm-Leach-Bliley Act (“Gramm-Leach”) permits, subject to certain conditions, combinations among banks, securities firms and insurance companies. Under Gramm-Leach, bank holding companies are permitted to offer their customers virtually any type of financial service including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking. In order to engage in these additional financial activities, a financial holding company must qualify and register with the Federal Reserve Board, as the Company has, as a “financial holding company” by meeting certain higher standards for capital adequacy and management, with heavy penalties for noncompliance. Gramm-Leach establishes that the federal banking agencies will regulate the banking activities of financial holding companies and banks’ financial subsidiaries, the U.S. Securities and Exchange Commission will regulate their securities activities and state insurance regulators will regulate their insurance activities. Bank holding companies that wish to engage in expanded activities but do not wish to become financial holding companies may elect to establish “financial subsidiaries,” which are subsidiaries of national banks with expanded powers. Gramm-Leach permits financial subsidiaries to engage in the same types of activities permissible for nonbank subsidiaries of financial holding companies, with the exception of merchant banking, insurance and annuity underwriting and real estate investment and development. Merchant banking may be permitted after a five-year waiting period under certain regulatory circumstances. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers’ nonpublic, personal information.

Transactions between the holding company and its subsidiary bank are subject to Section 23A of the Federal Reserve Act and to the requirements of Regulation W. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of the Company or its subsidiaries. Affiliate transactions are also subject to Section 23B of the Federal Reserve Act and to the

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requirements of Regulation W, which generally require that certain transactions between the holding company and its affiliates be on terms substantially the same, or at least as favorable to the banks, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

As a national bank, the Bank is subject to primary supervision, regulation, and examination by the Office of the Comptroller of the Currency (“OCC”) and secondary regulation by the FDIC and the Federal Reserve Board. The Bank is subject to federal statutes and regulations that significantly affect its business and activities. The Bank must file reports with its regulators concerning its activities and financial condition and obtain regulatory approval to enter into certain transactions. Other applicable statutes and regulations relate to insurance of deposits, allowable investments, loans, acceptance of deposits, trust activities, mergers, consolidations, payment of dividends, capital requirements, reserves against deposits, establishment of branches and certain other facilities, limitations on loans to one borrower and loans to affiliated persons, and other aspects of the business of banks. In addition, federal legislation has instructed federal agencies to adopt standards or guidelines governing banks’ internal controls, information systems, loan documentation, retail and commercial loan underwriting, interest rate exposure, asset growth, compensation and benefits, asset quality, earnings and capital, and other matters. Regulatory authorities have broad flexibility to initiate proceedings designed to prohibit banks from engaging in unsafe and unsound banking practices.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) substantially revised the depository institution regulatory and funding provisions of the Federal Deposit Insurance Act and made revisions to several other federal banking statutes. Among other things, federal banking regulators are required to take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. FDICIA identifies the following capital categories for financial institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Rules adopted by the federal banking agencies under FDICIA provide that an institution is deemed to be well capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific level for any capital measure. FDICIA imposes progressively more restrictive constraints on operation, management, and capital distributions, depending on the capital category in which an institution is classified. At December 31, 2008, the Company and the Bank were in the well-capitalized category, based on the ratios and guidelines noted above.

The Bank must pay assessments to the FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by FDICIA. Under this system, FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications pay assessments at higher rates than institutions that pose a lower risk. An institution’s risk classification is assigned based on its capital level and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances. Under FDIC regulations, no FDIC-insured bank can accept brokered deposits unless it is well-capitalized, or is adequately capitalized and receives a waiver from the FDIC. In addition, these regulations prohibit any bank that is not well-capitalized from paying an interest rate on brokered deposits in excess of three-quarters of one percentage point over certain prevailing market rates.

The Federal Deposit Insurance Reform Act of 2005 was signed into law on February 8, 2006, and gives the FDIC increased flexibility in assessing premiums on banks and savings associations, including the Bank, to pay for deposit insurance and in managing its deposit insurance reserves. The reform legislation provides a credit to all insured institutions, based on the amount of their insured deposits at year-end 1996, to offset the premiums that they may be assessed; combines the BIF and SAIF to form a single Deposit Insurance Fund; increase deposit insurance to $250,000 for Individual Retirement Accounts; and authorizes inflation-based increases in deposit insurance on other accounts every 5 years, beginning in 2011. The FDIC also is directed to conduct studies regarding further deposit insurance reform.

On February 27, 2009, the FDIC adopted an interim rule, with request for comment, which would institute a one-time special assessment of 20 cents per $100 of domestic deposits on FDIC insured institutions. If approved, the Company estimates that the special assessment would total approximately $2 million for the Bank. The assessment would be payable on September 30, 2009. In addition, the FDIC can levy an additional 10 cents per $100 assessment (approximately $1 million for the Bank) in any quarter in the future as needed to maintain the insurance fund at an appropriate level.

The Community Reinvestment Act of 1977 (“CRA”) and the regulations issued thereunder are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide for regulatory assessment of a bank’s record in meeting the needs of its service area when considering applications regarding establishing branches, mergers or other bank or branch acquisitions. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 requires federal banking agencies to make public a rating of a bank’s performance under the CRA. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction.

The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in

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which financial institutions must deal with customers when taking deposits or making loans to such customers. The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations. The Check Clearing for the 21^st Century Act (“Check 21 Act” or “the Act”), which became effective on October 28, 2004, creates a new negotiable instrument, called a “substitute check,” which banks are required to accept as the legal equivalent of a paper check if it meets the requirements of the Act. The Act is designed to facilitate check truncation, to foster innovation in the check payment system, and to improve the payment system by shortening processing times and reducing the volume of paper checks.

The earnings of the Company are significantly affected by the monetary and fiscal policies of governmental authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. Government securities and federal funds, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect that they may have on the Company’s business and earnings.

Pursuant to Title V of Gramm-Leach, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. Under these rules, financial institutions must provide: initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates, annual notices of their privacy policies to current customers, and a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

As part of the USA Patriot Act of 2001, signed into law on October 26, 2001, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). IMLAFATA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies, or other financial institutions. Pursuant to this statute, the Department of the Treasury has issued a number of regulations relating to enhanced recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions. Covered financial institutions also are barred from dealing with foreign “shell” banks. In addition, IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours. These regulations were also adopted during 2002 to implement minimum standards to verify customer identity, to encourage cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, to prohibit the anonymous use of “concentration accounts,” and to require all covered financial institutions to have in place a Bank Secrecy Act compliance program. IMLAFATA also amends the Bank Holding Company Act and the Bank Merger Act to require federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these acts.

The Bank has in place a comprehensive Bank Secrecy Act compliance program. In 2008, the Bank engaged in a very limited number of transactions covered by the Bank Secrecy Act of any kind with foreign financial institutions or foreign persons.

On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the “Act”), implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board that enforces auditing, quality control and independence standards and is funded by fees from all publicly traded companies, the law restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client require pre-approval by the issuer’s audit committee members. In addition, the audit partners must be rotated. The Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Act, legal counsel is required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief financial officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the Board of Directors or the Board itself.

Longer prison terms and increased penalties are also applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company’s financial statements are subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted. The Act accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company’s securities within two business days of the change.

The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company’s financial statements for the purpose of rendering the financial statement’s materially misleading. The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders. In addition, the Act requires that each financial report required to be prepared in accordance with (or reconciled to) accounting principles

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generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a “registered public accounting firm” in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC.

As directed by Section 302(a) of the Act, the Company’s chief executive officer and chief financial officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The Act imposes several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal controls; they have made certain disclosures to the Company’s auditors and the audit committee of the Board of Directors about the Company’s internal controls; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls during the last quarter.

In 1970, the U. S. Congress enacted the Fair Credit Reporting Act (the “FCRA”) in order to ensure the confidentiality, accuracy, relevancy and proper utilization of consumer credit report information. Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system. The information contained in that broad system is used by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions. Employers and law enforcement agencies have also made wide use of the information collected and maintained in databases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, and the requirements on credit bureaus to reinvestigate the contents of reports in response to consumer complaints, among others. By its terms, the preemption provisions of the FCRA were to terminate as of December 31, 2003. With the enactment of the Fair and Accurate Transactions Act (FACT Act) in late 2003, the preemption provisions of FCRA were extended, although the FACT Act imposes additional requirements on entities that gather and share consumer credit information. The FACT Act required the Federal Reserve Board and the Federal Trade Commission to issue final regulations within nine months of the effective date of the Act. A series of regulations and announcements have been promulgated, including a joint FTC/FRB announcement of effective dates for FCRA amendments, the FTC’s “Free Credit Report” rule, revisions to the FTC’s FACT Act Rules, the FTC’s final rules on identity theft and proof of identity, the FTC’s final regulation on consumer information and records disposal, the FTC’s final summaries and notices and a final rule on prescreen notices.

On March 1, 2005 the Federal Reserve Board issued a final rule that allows the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies. Trust preferred securities, however, will be subject to stricter quantitative limits. The rule provides that trust preferred securities, together with other “restricted core capital elements,” can be included in a bank holding company’s Tier 1 capital up to one-third of the sum of core capital elements, including “restricted core capital elements,” as defined in the rule. At December 31, 2008, the Company’s trust preferred securities comprised 20.0% of the sum of the Company’s Tier 1 capital.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law as part of a broad initiative to stabilize U.S. financial markets and provide liquidity. EESA enables the federal government, under terms and conditions to be developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA includes, among other provisions: (a) the $700 billion Troubled Assets Relief Program (TARP), under which the Secretary of the Treasury is authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before March 14, 2008; and (b) an increase in the amount of deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC).

Under the TARP, the Department of Treasury authorized a voluntary capital purchase program (CPP) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. Participating companies must adopt certain standards for executive compensation, including (a) prohibiting “golden parachute” payments as defined in EESA to senior Executive Officers; (b) requiring recovery of any compensation paid to senior Executive Officers based on criteria that is later proven to be materially inaccurate; and (c) prohibiting incentive compensation that encourages unnecessary and excessive risks that threaten the value of the financial institution. The terms of the CPP also limit certain uses of capital by the issuer, including repurchases of company stock, and increases in dividends.

EESA temporarily raised the limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. Separate from EESA, in October 2008, the FDIC also announced the Temporary Liquidity Guarantee Program. Under one component of this program, the FDIC temporarily provides unlimited coverage for noninterest bearing transaction deposit accounts through December 31, 2009. The limits are scheduled to return to $100,000 on January 1, 2010.

On February 10, 2009, the Financial Stability Plan (FSP) was announced by the U.S. Treasury Department. The FSP is a comprehensive set of measures intended to shore up the financial system. The core elements of the plan include making bank capital injections, creating a public-private investment fund to buy troubled assets, establishing guidelines for loan modification programs and expanding the Federal Reserve lending program. The U.S. Treasury Department has indicated more details regarding the FSP are to be announced on a newly created government website, FinancialStability.gov, in the next several weeks.

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was enacted. ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure. The new law also includes numerous non-economic recovery related items, including a limitation on executive compensation in federally-aided banks.

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Under ARRA, an institution will be subject to the following restrictions and standards throughout the period in which any obligation arising from financial assistance provided under TARP remains outstanding:

¡ Limits on compensation incentives for risk-taking by senior executive officers.

¡ Requirement of recovery of any compensation paid based on inaccurate financial information.

¡ Prohibition on “Golden Parachute Payments”.

¡ Prohibition on compensation plans that would encourage manipulation of reported earnings to enhance the compensation of employees.

¡ Publicly registered TARP recipients must establish a board compensation committee comprised entirely of independent directors, for the purpose of reviewing employee compensation plans.

¡ Prohibition on bonus, retention award, or incentive compensation, except for payments of long term restricted stock.

¡ Limitation on luxury expenditures.

¡ TARP recipients are required to permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the SEC’s compensation disclosure rules.

¡ The chief executive officer and chief financial officer of each TARP recipient will be required to provide a written certification of compliance with these standards to the SEC.

On February 18, 2009, the Homeowner Affordability and Stability Plan (HASP) was announced by the President of the United States. HASP is intended to support a recovery in the housing market and ensure that workers can continue to pay off their mortgages through the following elements:

¡ Provide access to low-cost refinancing for responsible homeowners suffering from falling home prices.

¡ A $75 billion homeowner stability initiative to prevent foreclosure and help responsible families stay in their homes.

¡ Support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.

Item 1A — Risk Factors

There are risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected.

The Company is Subject to Interest Rate Risk

The Company’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic and credit market conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of the Company’s mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Company’s results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Net Interest Income” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A, Quantitative and Qualitative Disclosure About Market Risk located elsewhere in this report for further discussion related to the Company’s management of interest rate risk.

The Company is Subject to Lending Risk

There are inherent risks associated with the Company’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic or credit market conditions in the markets where the Company operates as well as the State of New York and the entire United States. Increases in interest rates and/or weakening economic or credit market conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Company.

As of December 31, 2008, approximately 35% of the Company’s loan and lease portfolio consisted of commercial loans and leases net of unearned income. These types of loans are generally viewed as having more risk of default than conventional residential real estate loans or most consumer loans. Commercial loans are also typically larger than residential real estate loans and consumer loans. Because the Company’s loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of one or a

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few of these loans could cause a significant increase in non-performing loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for credit losses and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Loans and Leases” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial loans and leases.

The Company’s Allowance for Credit Losses May Be Insufficient

The Company maintains an allowance for credit losses, which is a reserve established through a provision for credit losses charged to expense, that represents management’s best estimate of probable losses incurred within the existing portfolio of loans and leases. The allowance is necessary to provide for estimated credit losses and risks inherent in the loan and lease portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan and lease portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for credit losses inherently involves a significant degree of subjectivity and requires the Company to make estimates of current credit risks, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review the Company’s allowance for credit losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for credit losses, the Company will need additional provisions to increase the allowance for credit losses. These increases in the allowance for credit losses will result in a decrease in net income and, possibly, capital, and may have a material adverse affect on the Company’s financial condition and results of operations. See the section captioned “Asset Quality and the Allowance for Credit Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for credit losses.

The Company’s Profitability Depends Significantly on Economic Conditions in Central New York

The Company’s success depends significantly on the general economic conditions of Central New York and the specific local markets in which the Company operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the Central New York counties of Cortland, Erie, Madison, Oneida, Onondaga and Oswego. The local economic conditions in these areas have a significant impact on the demand for the Company’s products and services as well as the ability of the Company’s customers to repay loans, the value of the collateral securing loans and the stability of the Company’s deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Company’s financial condition and results of operations.

The Company Operates In a Highly Competitive Industry and Market Area

The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets where the Company operates. The Company also faces competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Company’s competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Company can. The Company’s ability to compete successfully depends on a number of factors, including, among other things:

¡ The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets.

¡ The ability to expand the Company’s market position.

¡ The scope, relevance and pricing of products and services offered to meet customer needs and demands.

¡ The rate at which the Company introduces new products and services relative to its competitors.

¡ Customer satisfaction with the Company’s level of service.

¡ Industry and general economic trends.

¡ The ability of the company to upgrade and acquire technology and information systems to support the sales and service of deposit and loan products.

Failure to perform in any of these areas could significantly weaken the Company’s competitive position, which could adversely affect the Company’s growth and profitability, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

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The Company Is Subject To Extensive Government Regulation and Supervision

The Company, primarily through its subsidiary bank, is subject to extensive federal regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned “Supervision and Regulation” in Item 1. Business, which is located elsewhere in this report.

In December 2008, the Company entered into a Letter Agreement (the “Purchase Agreement”), with the United States Department of the Treasury (“Treasury Department”) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, (ii) and a warrant (the “Warrant”) to purchase 173,069 shares of the Company’s common stock. Section 5.3 of the Purchase Agreement grants the Treasury Department the ability to unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes after the date of the Purchase Agreement in applicable federal statutes. The ability of the Treasury Department to unilaterally amend any provision of the Purchase Agreement presents risks and uncertainties that the Company cannot predict.

The Company is Subject to Additional Government Oversight and Greater Regulatory Uncertainty Through its Participation in the Capital Purchase Program than Financial Institutions Which Do Not Participate in the Program

For as long as the Company has any obligations outstanding under the U.S. Treasury’s CPP, Alliance is subject to certain restrictions and reporting requirements relative to executive compensation which are significantly more restrictive than financial institutions which do not participate in the CPP. The most significant restriction, among others, prohibits the payment of incentive compensation and the vesting of equity securities to the Company’s five highest paid officers. Currently, the restrictions apply to the Company’s CEO, CFO, Executive Vice-President, Executive Vice-President Credit Administration and Senior Vice President Retail Banking Sales and Service. The Company’s inability to pay incentive compensation to its executive officers and other restrictions places it at a significant competitive disadvantage to financial institutions which do not participate in the CPP, and exposes the Company to a heightened risk of an inability to retain or attract executive officers.

The Soundness of Other Financial Services Institutions May Adversely Affect Our Credit Risk

We rely on other financial services institutions through trading, clearing, counterparty, and other relationships. We maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or counterparties. These losses could adversely affect our results of operations and financial condition.

Increases in FDIC Insurance Premiums May Cause Our Earnings to Decrease

The EESA temporarily increased the limit on FDIC coverage to $250,000 for all accounts through December 31, 2009. In addition, we have enrolled in the Temporary Liquidity Guarantee Program for non-interest bearing transaction deposit accounts. This, along with the full utilization or our assessment credit in early 2009 will cause the premiums assessed by the FDIC to increase. These actions will significantly increase the Company’s non-interest expense in 2009 and in future years as long as the increased premiums are in place.

Certain of Our Intangible Assets May Become Impaired in the Future

Intangible assets are tested for impairment on a periodic basis. Impairment testing incorporates the current market price of the Company’s common stock, the estimated fair value of our assets and liabilities, and certain information of similar companies. It is possible that future impairment testing could result in a decline in value of our intangibles which may be less than the carrying value, which may adversely affect our financial condition. If we determine an impairment exists at a given point in time, our earnings and the book value of the related intangibles will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on our intangible assets have no impact on our tangible book value or regulatory capital levels.

9

The Company’s Controls and Procedures May Fail or Be Circumvented

Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.

New Lines of Business or New Products and Services May Subject the Company to Additional Risks

From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company Relies on Dividends from Its Subsidiary for Most of Its Revenue

The Company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on the Company’s common stock and interest and principal on the Company’s debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. Also, the Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations or pay dividends on the Company’s common and preferred stock.

The inability to receive dividends from the Bank could have a material adverse affect on the Company’s business, financial condition and results of operations. See the section captioned “Supervision and Regulation” in Item 1. Business and Note 16 – Dividends and Restrictions in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.

The Company May Not Be Able To Attract and Retain Skilled People

The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense and the Company may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because of their skills, knowledge of the Company’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

The Company’s Information Systems May Experience an Interruption Or Breach In Security

The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company’s information systems could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.

The Company Continually Encounters Technological Change

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological enhancements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.

10

Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events Could Significantly Impact the Company’s Business

Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on the Company’s ability to conduct business. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

The Company’s Articles of Incorporation, By-Laws and Shareholder Rights Plan As Well As Certain Banking Laws May Have an Anti-Takeover Effect

Provisions of the Company’s articles of incorporation and by-laws, federal banking laws, including regulatory approval requirements, and the Company’s stock purchase rights plan could make it more difficult for a third party to acquire the Company, even if doing so would be perceived to be beneficial to the Company’s stockholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of the Company’s common stock.

Item 1B. – Unresolved Staff Comments

Not applicable.

Item 2 — Properties

The Company conducts business in Central New York State through 29 banking offices and two administrative centers. The Company leases its corporate administrative center, located in Syracuse, NY. Eleven banking offices and one of the administrative centers are subject to leases and/or land leases. The other banking offices and administrative center are owned.

Item 3 — Legal Proceedings

In December 1998, the Oneida Indian Nation (“The Nation”) and the U.S. Justice Department filed a motion to amend a long-standing land claim against the State of New York to include a class of 20,000 unnamed defendants who own real property in Madison County and Oneida County. An additional motion sought to include the Company as a representative of a class of landowners. On September 25, 2000, the United States District Court of the Northern District of New York rendered a decision denying the motion to include the landowners as a group, and thus, excluding the Company and many of its borrowers from the litigation. The State of New York, the County of Madison and the County of Oneida remain as defendants in the litigation. This ruling may be appealed by The Nation, and does not prevent The Nation from suing landowners individually, in which case the litigation could involve assets of the Company. On May 21, 2007, the U.S. District Court issued a decision dismissing the possessory land claims. The Court’s decision has been appealed by the Nation. Although management cannot predict the timing of the resolution of this matter, it continues to believe that this matter will be resolved without adversely affecting the Company.

The Company and its subsidiaries are subject to various claims, legal proceedings and matters that arise in the ordinary course of business. In management’s opinion, no pending action, if adversely decided, would materially affect the Company’s financial condition.

Item 4 — Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of the Company’s security holders during the fourth quarter of the year ended December 31, 2008.

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PART II

Item 5 — Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock Data

The common stock of the Company is listed on the NASDAQ Global Market under the symbol “ALNC.” Market makers for the stock include Keefe, Bruyette & Woods, Inc. and Sandler O’Neill & Partners, L.P. There were 961 shareholders of record as of December 31, 2008. The following table presents stock prices for the Company for 2008 and 2007. Stock prices below are based on daily high and low closing prices for the quarter, as reported on the NASDAQ Global Market.

	2008			2007
	High	Low	Dividend Declared	High	Low	Dividend Declared
1st Quarter	$26.70	$23.25	$0.24	$32.27	$28.43	$0.22
2nd Quarter	$27.27	$21.03	$0.24	$30.55	$26.30	$0.22
3rd Quarter	$25.00	$19.56	$0.26	$26.50	$24.07	$0.22
4th Quarter	$24.54	$20.00	$0.26	$26.10	$23.06	$0.24

Registrar and Transfer Agent

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Automatic Dividend Reinvestment Plan

The Company has an automatic dividend reinvestment plan. This plan is administered by American Stock Transfer and Trust Company, as agent. It offers a convenient way for shareholders to increase their investment in the Company. The plan enables certain shareholders to reinvest cash dividends on all or part of their common stock in additional shares of the Company’s common stock without paying brokerage commissions or service charges. Shareholders who are interested in this program may receive a Plan Prospectus and enrollment card by calling ASTC Dividend Reinvestment at 1-800-278-4353, or writing to the following address:

Dividend Reinvestment

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Dividends

The Company has historically paid regular quarterly cash dividends on its common stock, and the Board of Directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. However, because substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition and its need for funds. Furthermore, there are a number of federal banking policies and regulations that restrict the Company’s ability to pay dividends. In particular, because the Bank is a depository institution whose deposits are insured by the FDIC, it may not pay dividends or distribute capital assets if it is in default on any assessment due the FDIC. Also, as a national bank, the Bank is subject to OCC regulations which impose certain minimum capital requirements that would affect the amount of cash available for distribution to the Company. In addition, under Federal Reserve policy, the Company is required to maintain adequate regulatory capital, is expected to serve as a source of financial strength to the Bank and to commit resources to support the Bank. These policies and regulations may have the effect of reducing the amount of dividends that the Company can declare to its shareholders.

Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

Stock Repurchases

On November 27, 2007, the Company announced that its Board of Directors had authorized the repurchase of up to 3% of the Company’s outstanding common stock, or approximately 143,500 shares, over a 12-month period. The stock purchase plan was completed in the third quarter of 2008.

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Stock Performance Graph

The graph below matches Alliance Financial Corporation’s cumulative 5-year total shareholder return on common stock with the cumulative total returns of the Russell 3000 index and the SNL Bank NASDAQ index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/2003 to 12/31/2008.

	12/31/03	12/31/04	12/31/05	12/31/06	12/31/07	12/31/08
Alliance Financial Corporation	100.00	98.26	106.26	108.60	91.67	87.37
NASDAQ Composite	100.00	110.08	112.88	126.51	138.13	80.47
Russell 3000	100.00	111.95	118.80	137.47	144.54	90.61
NASDAQ Bank	100.00	111.11	108.64	123.74	97.71	74.73

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Item 6 — Selected Financial Data

Five-Year Comparative Summary

	December 31,
	2008	2007	2006	2005	2004
Selected Financial Condition Data	(In thousands)
Total assets	$1,367,358	$1,307,014	$1,272,967	$   983,256	$   893,934
Loans & leases, net of unearned income	910,755	895,533	881,411	654,086	526,100
Allowance for credit losses	9,161	8,426	7,029	4,960	5,267
Securities available-for-sale	310,993	282,220	261,987	265,494	317,758
Goodwill	32,073	32,187	33,456	—	—
Intangible assets, net	11,528	13,183	14,912	9,671	—
Deposits	937,882	945,230	936,671	739,118	623,121
Borrowings	238,972	200,757	178,575	150,429	181,854
Junior subordinated obligations	25,774	25,774	25,774	10,310	10,310
Shareholders’ equity	144,481	115,560	109,506	69,571	68,896
Common shareholders’ equity	117,563	115,560	109,506	69,571	68,896
Investment assets under management (Market value, not included in total assets)	$   726,019	$   971,078	$   927,674	$   862,504	$   282,281
	Year ended December 31,
	2008	2007	2006	2005	2004
	(In thousands, except share and per share data)
Selected Operating Data
Interest income	$   67,964	$  71,032	$     57,673	$   46,255	$   40,757
Interest expense	30,267	38,550	29,951	19,336	12,684
Net interest income	37,697	32,482	27,722	26,919	28,073
Provision for credit losses	5,502	3,790	2,477	144	984
Net interest income after provision for credit losses	32,195	28,692	25,245	26,775	27,089
Non-interest income	20,360	21,292	17,714	14,238	9,177
Total Operating income	52,555	49,984	42,959	41,013	36,266
Non-interest expense	39,378	37,638	33,886	31,352	27,085
Income before taxes	13,177	12,346	9,073	9,661	9,181
Income tax expense	2,820	2,869	1,762	2,154	1,926
Net Income	$   10,357	$    9,477	$       7,311	$     7,507	$     7,255
Net income available to common shareholders	$   10,310	$    9,477	$      7,311	$    7,507	$    7,255
Stock and Per Share Data
Basic earnings per common share	$       2.27	$      2.01	$         1.92	$       2.09	$       2.03
Diluted earnings per common share	$       2.24	$      1.98	$         1.88	$       2.05	$       2.00
Basic weighted average common shares outstanding	4,542,957	4,710,530	3,804,711	3,593,864	3,565,226
Diluted weighted average common shares outstanding	4,597,624	4,775,883	3,874,484	3,664,684	3,631,806
Cash dividends declared	$       1.00	$      0.90	$         0.88	$       0.84	$       0.84
Dividend payout ratio (1)	44.6%	45.5%	46.8%	41.0%	42.0%
Common book value	$     25.67	$    24.53	$       22.81	$     19.52	$     19.29
Tangible common book value	$     16.15	$    14.90	$       12.74	$     16.80	$     19.29

(1) Cash dividends declared per share divided by diluted earnings per share.

14

	Year ended December 31,
Selected Financial and Other Data (1)	2008	2007	2006	2005	2004
Performance Ratios:
Return on average assets	0.78%	0.74%	0.69%	0.80%	0.84%
Return on average equity	8.73%	8.48%	9.40%	10.75%	10.75%
Return on average common equity	8.80%	8.48%	9.40%	10.75%	10.75%
Non-interest income to total income(2)	34.86%	39.29%	38.99%	34.62%	23.16%
Efficiency Ratio(3)	68.04%	70.35%	74.58%	76.14%	74.14%
Rate/Yield Information:
Yield on earning assets	5.88%	6.36%	6.06%	5.47%	5.26%
Cost of funds	2.87%	3.78%	3.46%	2.48%	1.77%
Net interest rate spread	3.01%	2.58%	2.60%	2.99%	3.49%
Net interest margin (tax equivalent)(4)	3.35%	3.02%	3.02%	3.28%	3.69%

(1) Averages presented are daily averages

(2) Non-interest income (net of realized gains and losses on securities and non-recurring items) divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items)

(3) Non-interest expense divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items)

(4) Tax equivalent net interest income divided by average earning assets

	At or for the Year ended December 31,
	2008	2007	2006	2005	2004
Asset Quality Ratios
Non-performing loans and leases to total loans and leases	0.49%	0.75%	0.30%	0.25%	0.53%
Non-performing assets to total assets	0.38%	0.53%	0.21%	0.17%	0.31%
Allowance for credit losses to non-performing loans and leases	204.6%	125.7%	266.4%	304.7%	191.5%
Allowance for credit losses to total loans and leases	1.01%	0.94%	0.80%	0.76%	1.00%
Net charge-offs to average loans and leases	0.53%	0.27%	0.23%	0.08%	0.36%
Equity Ratios
Average total common shareholders’ equity to average total assets	8.86%	8.74%	7.37%	7.43%	7.82%
Average tangible common equity to average tangible assets	5.69%	5.21%	6.22%	6.61%	7.82%
Regulatory Ratios
Consolidated:
Tier 1 (core) capital	9.59%	7.53%	7.53%	7.42%	8.70%
Tier 1 risk-based capital	14.05%	10.64%	10.42%	10.93%	14.34%
Total risk-based capital	15.08%	11.59%	11.26%	11.72%	15.34%
Bank:
Tier 1 (core) capital	8.97%	7.26%	7.00%	6.75%	7.79%
Tier 1 risk-based capital	13.15%	10.34%	9.65%	9.96%	12.89%
Total risk-based capital	14.19%	11.30%	10.48%	10.78%	13.89%

15

Summarized quarterly financial information for the years ended December 31, 2008 and 2007 is as follows:

	Year ended	Three months ended
	12/31/08	12/31/08	9/30/08	6/30/08	3/31/08
		(Dollars in thousands, except share and per share data)
Total interest income	$     67,964	$ 16,699	$ 16,734	$ 16,980	$ 17,551
Total interest expense	30,267	6,855	7,155	7,473	8,784
Net interest income	37,697	9,844	9,579	9,507	8,767
Provision for credit losses	5,502	1,976	849	1,311	1,366
Non-interest income	20,360	4,754	5,134	5,287	5,185
Non-interest expense	39,378	10,055	9,899	9,630	9,794
Income before income taxes	13,177	2,567	3,965	3,853	2,792
Provision for income taxes	2,820	183	955	966	716
Net Income	$     10,357	$  2,384	$  3,010	$  2,887	$  2,076
Basic earnings per share	$         2.27	$    0.52	$    0.66	$    0.63	$    0.45
Diluted earnings per share	$         2.24	$    0.51	$    0.65	$    0.63	$    0.45
Basic weighted average shares outstanding	4,542,957	4,492,810	4,545,357	4,556,157	4,578,027
Diluted weighted average shares outstanding	4,597,624	4,546,099	4,597,452	4,613,726	4,636,012
Cash dividends declared per share	$         1.00	$    0.26	$    0.26	$    0.24	$    0.24
Net interest margin (tax equivalent)	3.35%	3.43%	3.43%	3.39%	3.15%
Return on average assets	0.78%	0.70%	0.92%	0.87%	0.63%
Return on average equity	8.73%	7.52%	10.42%	9.93%	7.15%
Return on average common equity	8.80%	7.74%	10.42%	9.93%	7.15%
Non-interest income to total income	34.86%	32.55%	34.89%	35.74%	36.32%
Efficiency ratio	68.04%	68.87%	67.28%	65.09%	71.14%

	Year ended	Three months ended
	12/31/07	12/31/07	9/30/07	6/30/07	3/31/07
		(Dollars in thousands, except share and per share data)
Total interest income	$    71,032	$ 17,978	$18,028	$17,649	$17,377
Total interest expense	38,550	9,832	9,822	9,600	9,296
Net interest income	32,482	8,146	8,206	8,049	8,081
Provision for credit losses	3,790	1,200	1,140	700	750
Non-interest income	21,292	5,705	5,432	5,136	5,019
Non-interest expense	37,638	9,496	9,350	9,541	9,251
Income before income taxes	12,346	3,155	3,148	2,944	3,099
Provision for income taxes	2,869	715	738	671	745
Net Income	$9,477	$  2,440	$ 2,410	$ 2,273	$ 2,354
Basic earnings per share	$        2.01	$    0.52	$   0.51	$   0.48	$   0.50
Diluted earnings per share	$        1.98	$    0.51	$   0.51	$   0.48	$   0.49
Basic weighted average shares outstanding	4,710,530	4,699,106	4,709,334	4,709,334	4,724,638
Diluted weighted average shares outstanding	4,775,883	4,752,112	4,756,088	4,771,091	4,799,638
Cash dividends declared per share	$        0.90	$    0.24	$   0.22	$   0.22	$   0.22
Net interest margin (tax equivalent)	3.02%	2.98%	3.04%	3.01%	3.04%
Return on average assets	0.74%	0.75%	0.75%	0.71%	0.75%
Return on average equity	8.48%	8.49%	8.64%	8.22%	8.58%
Return on average common equity	8.48%	8.49%	8.64%	8.22%	8.58%
Non-interest income to total income	39.29%	40.01%	39.83%	38.95%	38.31%
Efficiency ratio	70.35%	69.93%	68.56%	72.36%	70.62%

16

Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following section presents highlight information from management to assist with understanding the consolidated financial condition and results of operations of Alliance Financial Corporation and its subsidiaries (combined, the “Company”), during the year ended December 31, 2008 and the preceding two years. The consolidated financial statements and related notes, included elsewhere in this annual report on Form 10-K should be read in conjunction with the discussions in this section. The matters discussed in this section contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements made that are not historical facts are forward-looking and are based on estimates, forecasts and assumptions involving risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. The risks and uncertainties referred to above include, but are not limited to those described under “Forward-Looking Statements” and “Risk Factors” in Items 1 and 1A, respectively of this Form 10-K.

2008 Highlights and Overview

Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on our loans and leases and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for credit losses, securities and loan sale activities, loan servicing activities, service charges and fees collected on our deposit accounts, income collected from trust and investment advisory services and the income earned on our investment in bank-owned life insurance. Our expenses primarily consist of salaries and employee benefits, occupancy and equipment expense, marketing expense, professional services, technology expense, amortization of intangible assets, other expense and income tax expense. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, inflation, government policies and the actions of regulatory authorities.

17

Average Balance Sheet

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and yield information is adjusted for items exempt from federal income taxes and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.

	Years ended December 31,
			2008					2007					2006
	Avg. Balance		Amt. of Interest		Avg. Yield/ Rate	Avg. Balance		Amt. of Interest		Avg. Yield/ Rate	Avg. Balance		Amt. of Interest		Avg. Yield/ Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Federal funds sold	$	4,856	$	100	2.06%	$	362	$	18	4.97%	$	2,450	$	136	5.55%
Taxable investment securities		189,164		8,796	4.65%		174,719		7,929	4.54%		177,027		7,311	4.13%
Nontaxable investment securities		88,667		5,420	6.11%		84,987		5,252	6.18%		75,384		4,683	6.21%
FHLB and FRB stock		11,063		634	5.73%		8,741		628	7.18%		6,233		346	5.55%
Residential real estate loans		294,829		17,442	5.92%		263,180		15,914	6.05%		204,946		12,438	6.07%
Commercial loans		207,931		14,068	6.77%		211,964		17,058	8.05%		170,919		13,459	7.87%
Non-taxable commercial loans		8,618		565	6.56%		8,527		606	7.11%		6,998		476	6.80%
Taxable leases (net of unearned income)		103,726		6,436	6.20%		111,182		7,559	6.80%		72,597		5,091	7.01%
Nontaxable leases (net of unearned income)		16,284		1,020	6.26%		19,259		1,152	5.98%		17,907		1,038	5.80%
Indirect auto loans		179,762		10,180	5.66%		180,688		9,983	5.52%		179,552		9,123	5.08%
Consumer loans		90,675		5,685	6.27%		91,502		7,317	8.00%		72,450		5,680	7.84%
Total interest-earning assets		1,195,575		70,346	5.88%	$	1,155,111	$	73,416	6.36%	$	986,463	$	59,781	6.06%
Non-interest-earning assets:
Other assets		133,780					132,431					77,155
Allowance for credit losses		(8,686)					(7,656)					(5,518)
Net unrealized gains (losses) on available-for-sale securities		1,867					(1,712)					(3,227)
Total	$	1,322,536				$	1,278,174				$	1,054,873
Liabilities and Shareholders’ Equity:
Demand deposits	$	107,204	$	733	0.68%	$	97,740	$	911	0.93%	$	87,221	$	519	0.60%
Savings deposits		86,239		492	0.57%		84,764		474	0.56%		62,640		343	0.55%
MMDA deposits		225,590		4,732	2.10%		197,079		6,322	3.21%		176,811		5,141	2.91%
Time deposits		385,275		15,277	3.97%		432,652		20,547	4.75%		378,382		16,161	4.27%
Borrowings		223,230		7,634	3.42%		182,051		8,336	4.58%		144,932		6,648	4.59%
Junior subordinated obligations issued to unconsolidated subsidiary trusts		25,774		1,399	5.43%		25,774		1,960	7.60%		14,606		1,139	7.80%
Total interest-bearing liabilities	$	1,053,312		30,267	2.87%	$	1,020,060	$	38,550	3.78%	$	864,592	$	29,951	3.46%
Non-interest-bearing liabilities:
Demand deposits		133,997					126,698					101,266
Other liabilities		17,138					19,688					11,239
Shareholders’ equity		118,089					111,728					77,776
Total	$	1,322,536				$	1,278,174				$	1,054,873
Net interest income (tax equivalent)			$	40,079				$	34,866				$	29,830
Net interest rate spread					3.01%					2.58%					2.60%
Net interest margin (tax equivalent)					3.35%					3.02%					3.02%
Federal tax exemption on nontaxable investment securities, loans and leases included in interest income			$	2,382				$	2,384				$	2,108
Net interest income			$	37,697				$	32,482				$	27,722

18

Rate/Volume Analysis

The following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of earning assets and interest-bearing liabilities, and from changes in rates. Volume changes are computed by multiplying the volume difference by the prior year’s rate. Rate changes are computed by multiplying the rate difference by the prior year’s balance. The change in interest due to both rate and volume has been allocated proportionally between the volume and rate variances.

	2008 Compared to 2007						2007 Compared to 2006
	Increase (decrease) due to						Increase (decrease) due to
	Volume		Rate		Net Change		Volume		Rate		Net Change
	(In thousands)
Federal funds sold	$	98	$	(16)	$	82	$	(105)	$	(13)	$	(118)
Taxable investment securities		668		199		867		(96)		714		618
Non-taxable investment securities		226		(58)		168		594		(25)		569
FHLB and FRB stock		148		(142)		6		163		119		282
Residential real estate loans		1,869		(341)		1,528		3,521		(45)		3,476
Commercial loans		(319)		(2,671)		(2,990)		3.297		302		3,599
Non-taxable commercial loans		6		(47)		(41)		108		22		130
Taxable leases, net of unearned income		(488)		(635)		(1,123)		2,628		(160)		2,468
Non-taxable leases, net of unearned income		(184)		52		(132)		81		33		114
Indirect loans		(51)		248		197		58		802		860
Consumer loans		(66)		(1,566)		(1,632)		1,521		116		1,637
Total interest-earning assets	$	1,907	$	(4,977)	$	(3,070)	$	11,770	$	1,865	$	13,635
Interest-bearing demand deposits		82		(260)		(178)		69		323		392
Savings deposits		9		9		18		125		6		131
MMDA deposits		821		(2,411)		(1,590)		621		560		1,181
Time deposits		(2,102)		(3,168)		(5,270)		2,464		1,922		4,386
Borrowings		1,662		(2,364)		(702)		1,703		(15)		1,688
Junior subordinated obligations issued to unconsolidated subsidiary trusts		—		(561)		(561)		850		(29)		821
Total interest-bearing liabilities	$	472	$	(8,755)	$	(8,283)	$	5,832	$	2,767	$	8,599
Net interest income (tax equivalent)	$	1,435	$	3,778	$	5,213	$	5,938	$	(902)	$	5,036

Comparison of Operating Results for the Years Ended December 31, 2008 and 2007

General

Net income available to common shareholders for 2008 was $10.3 million, an increase of $833,000, or 8.8%, compared to net income of $9.5 million in 2007. Diluted earnings per share were $2.24 in 2008, an increase of 13.1%, or $0.26 per share, compared to $1.98 per share in 2007.

Net Interest Income

Net interest income for the year ended December 31, 2008 totaled $37.7 million, an increase of $5.2 million or 16.1% compared with $32.5 million in 2007. The increase in net interest income resulted from a combination of earning asset growth and a higher net interest margin. Average earning assets increased $40.5 million in 2008 compared with 2007, due primarily to growth in the residential loan and securities portfolios. The tax-equivalent net interest margin was 3.35% in 2008, compared with 3.02% in 2007. The net interest margin growth in 2008 is primarily the result of the Company’s ongoing balance sheet management and deposit pricing strategies and the effects of those strategies in the low interest rate environment of the past year. The rate of growth in the Company’s net interest margin slowed in the second half of 2008 as interest rates on a substantial component of the Company’s interest-bearing liabilities have adjusted to the lower rates in effect during the period.

The Company experienced a decrease of 48 basis points in its tax-equivalent earning assets yield in 2008 compared with 2007, which was more than offset by a 91 basis point decrease in its cost of funds over the same period. The yield on the Company’s interest-earning assets was 5.88% in 2008, compared with 6.36% in 2007. The Company’s cost of funds was 2.87% in 2008, compared with 3.78% in 2007.

Since September 2007, the Federal Reserve has reduced its target fed funds rate from 5.25% to between zero and 0.25%. Over this same time period, a sharp drop in equity markets, economic recession and federal government monetary and economic stimulus efforts have contributed to a sharp decline in the yields on U.S. Treasury securities. As a result of these factors, the yields on two-year, five-year and ten-year treasury securities dropped 339 basis points, 272 basis points and 230 basis points, respectively from August 31, 2007 to December 31, 2008. Yields on commercial loans and consumer loans were most affected by these conditions in 2008, with yields on these assets down 128 basis points and 173 basis points, respectively, in 2008 compared with 2007. These asset types are more sensitive than the Company’s other interest-bearing assets to changes in market interest rates due to the variable rate characteristics of a portion of these portfolios and to the high levels of annual amortization in the portfolios as a result of their relatively shorter duration.

19

Loans and leases comprised 75.4% of average earning assets in 2008, compared with 76.7% in 2007. The slightly lower proportion of earning assets in loan and leases resulted largely from the Company’s previously announced planned wind-down of the Company’s lease portfolio in the third quarter of 2008, which was also a contributing factor to the lower earning-assets yield in 2008.

The Company’s cost of funds declined markedly in 2008 in all interest-bearing liability categories except savings accounts. The average yield of money market and time deposits dropped 111 basis points and 78 basis points, respectively in 2008 as a result of the lower rate environment and the Company’s deposit pricing strategies. Our wholesale funding costs also dropped significantly in 2008, with the average cost of our borrowings down 115 basis points. At the same time the Company was lowering its borrowing costs due to the lower rates in 2008, it took the opportunity to lower its overall liability-sensitive position by extending the maturity on new or renewed borrowings. The weighted average maturity of the Company’s borrowings was 2.7 years at December 31, 2008 compared with 1.1 years at December 31, 2007.

The average cost on the Company’s junior subordinated obligations decreased 217 basis points in 2008 due to the decline in the three-month Libor index to which these variable rate obligations are tied.

The Company’s liability mix changed favorably during 2008 as the Company continued to focus on growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain retail time accounts. The aggregate average balance of transaction accounts was $553.0 million in 2008, which was an increase of $47.6 million or 9.4% from the aggregate average balances of $505.5 million in 2007. Average transaction account balances comprised 58.9% of total average deposits in 2008, compared with 53.9% in 2007. Average time account balances in 2008 were $385.3 million or 41.1% of total average deposits in 2008, compared with $432.7 million or 46.1% in 2007. The decrease in average time account balances occurred largely in the first half of 2008 as the Company’s de-emphasis on higher promotional rates allowed the Company to reduce its reliance on highly rate sensitive, short-term retail time accounts.

Non-Interest Income

The Company’s non-interest income is comprised of service charges on deposits, fees from investment management and brokerage services, mortgage banking operations that include gains from sales and income from servicing, and other recurring operating income fees from normal banking operations, along with non-core components that primarily consist of net gains or losses from sales of investment securities.

The following table sets forth certain information on non-interest income for the years indicated:

	Years ended December 31,
	2008		2007		Change
	(In thousands)
Investment management income	$	8,670	$	9,180	$	(510)	(5.6)%
Service charges on deposit accounts		5,164		5,296		(132)	(2.5)%
Card-related fees		2,106		1,942		164	8.4%
Insurance agency income		1,583		1,855		(272)	(17.2)%
Income from bank-owned life insurance		856		635		221	34.8%
Gain on sale of loans		252		192		60	31.3%
Gains (losses) on sale of securities available-for-sale		137		(12)		149	1,241.7%
Other operating income		1,592		2,204		(612)	(27.8)%
Total non-interest income	$	20,360	$	21,292	$	(932)	(4.4)%

Total non-interest income decreased $932,000 or 4.4% in 2008, with lower investment management fees and fewer non-recurring income items in 2008 as compared to 2007 contributing to the decrease. The largest single non-recurring item in 2007 was a $283,000 gain on the prepayment of certain equipment leases which is included in other non-interest income in 2007.

Investment management income decreased by $510,000 or 5.6% in 2008 as a result of the impact of declines in equity markets on the investment management portfolio under management. The S&P 500 Index and the Dow Jones Industrial Average were down 39% and 34%, respectively in 2008. These market declines were the primary factors in a 25% decline in the levels and values of assets managed by the Company, and on the fees generated from these managed assets. Despite this, the Company’s account retention rates remain at levels consistent with our historical norms.

Non-interest income comprised 34.9% of total revenue (non-interest income, net of realized gains and losses on securities and non-recurring items, and net interest income) in 2008 compared with 39.3% in 2007.

20

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:

	Years ended December 31
	2008		2007		Change
	(In thousands)
Salaries and employee benefits	$	19,823	$	18,281	$	1,542	8.4%
Occupancy and equipment expenses		7,032		6,765		267	3.9%
Communication expense		791		827		(36)	(4.4)%
Office supplies and postage expense		1,137		1,236		(99)	(8.0)%
Marketing expense		1,090		1,237		(147)	(11.9)%
Amortization of intangible assets		1,622		1,729		(107)	(6.2)%
Professional fees		2,661		2,845		(184)	(6.5)%
Other non-interest expense		5,222		4,718		504	10.7%
Total non-interest expenses	$	39,378	$	37,638	$	1,740	4.6%

Total non-interest expense increased $1.7 million or 4.6% in 2008. Salaries and benefits increased $1.5 million or 8.4% due primarily to the absence of incentive compensation accruals in 2007, and increased participation in the Company’s 401(k) plan, higher medical insurance costs and normal salary increases in 2008.

The Company’s efficiency ratio was 68.0% in 2008, compared with 70.4% in 2007.

Income Tax Expense

The Company’s effective tax rate was 21.4% in 2008 and 23.2% in 2007. The decrease in the effective tax rate in 2008 primarily reflects an increase in the percentage of non-taxable income to pre-tax income.

Comparison of Operating Results for the Years Ended December 31, 2007 and 2006

General

Net income for 2007 was $9.5 million, an increase of $2.2 million, or 29.6%, compared to net income of $7.3 million in 2006. Diluted earnings per share were $1.98 in 2007, an increase of 5.3%, or $0.10 per share, compared to $1.88 per share in 2006.

The increases in net income and diluted earnings per share are due largely to the impact of the acquisition of Bridge Street in October 2006. The acquisition was also the primary factor behind increases in net interest income, non-interest income and non-interest expense. The provision for credit losses increased in 2007 due primarily to increases in charge-offs, delinquencies and a general softening of economic and credit conditions in 2007.

Net Interest Income

Net interest income increased $4.8 million or 17.2% due primarily to a $168.6 million increase in average interest earning assets. The increase in average earning assets resulted primarily from the Bridge Street acquisition and secondarily from organic growth, particularly in our lease portfolio.

The net interest margin on a tax-equivalent basis was 3.02% in 2007 and 2006, as an increase in the Company’s cost of funds of 32 basis points in 2007 was substantially offset by a 30 basis point increase in tax-equivalent earning asset yields.

Loans and leases comprised 76.7% of average earning assets in 2007, compared with 73.5% in 2006. The higher proportion of earning assets in loans and leases, combined with general upward repricing of the Company’s earning-assets in the higher interest rate environment of much of 2007, contributed to an increase in the Company’s tax-equivalent earning asset yield to 6.36% in 2007, compared with 6.06% in 2006.

The Company’s cost of funds was 3.78% in 2007, compared with 3.46% in 2006 due to generally higher market interest rates in 2007 and to the effect of significant competition for deposits in our market, which increased the cost of retaining existing deposits and attracting new deposits.

Reductions in the federal funds rate late in 2007 by the Federal Reserve along with a weakening of national economic conditions contributed to a decline in short-term market interest rates late in 2007. Both the Company’s earning-assets yields and its cost of funds began to decline in the fourth quarter of 2007 as a result.

21

Non-Interest Income

The following table sets forth certain information on non-interest income for the years indicated:

	Years ended December 31,
	2007		2006		Change
	(In thousands)
Investment management income	$	9,180	$	8,895	$	285	3.2%
Service charges on deposit accounts		5,296		4,316		980	22.7%
Card-related fees		1,942		1,291		651	50.4%
Insurance agency income		1,855		615		1,240	201.6%
Income from bank-owned life insurance		635		455		180	39.6%
Gain on sale of loans		192		126		66	52.4%
Losses on sale of securities available-for-sale		(12)		(2)		(10)	(500.0)%
Other operating income		2,204		2,018		186	9.2%
Total non-interest income	$	21,292	$	17,714	$	3,578	20.2%

Total non-interest income increased $3.6 million or 20.2% in 2007 due primarily to the effect of the full-year impact in 2007 of the Bridge Street acquisition. In addition, organic growth in customer service charges and transaction fees, due in large part to increased customer transaction volumes and greater utilization of debit cards for consumer purchases contributed to the increases in service charges on deposit accounts and card related fees.

Investment management income increased in 2007 due to an increase in assets under management resulting from generally higher equity market returns in 2007 and the acquisition of new customers and related assets under management. Rental income from operating leases decreased due to the Company’s planned reduction of operating lease activity.

Approximately 60% of the increase in other non-interest income was comprised of non-recurring items, including a $283,000 gain on a prepayment of certain equipment leases and an increase in other non-interest income resulted primarily from increases in mortgage servicing fees and miscellaneous customer fees. These increases were partly offset by a decrease in rental income from operating leases.

Non-interest income comprised 39.3% of total revenue (non-interest income, net of realized gains and losses on securities and lease prepayment, and net interest income) in 2007 compared with 39.0% in 2006.

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:

	Years ended December 31
	2007		2006		Change
	(In thousands)
Salaries and employee benefits	$	18,281	$	16,607	$	1,674	10.1%
Occupancy and equipment expenses		6,765		6,460		305	4.7%
Communication expense		827		744		83	11.2%
Office supplies and postage expense		1,236		1,079		157	14.6%
Marketing expense		1,237		1,128		109	9.7%
Amortization of intangible assets		1,729		797		932	116.9%
Professional fees		2,845		3,239		(394)	(12.2)%
Other non-interest expense		4,718		3,832		886	23.1%
Total non-interest expenses	$	37,638	$	33,886	$	3,752	11.1%

Total non-interest expenses increased $3.8 million or 11.1% in 2007, with increases in all categories, except marketing, resulting primarily from the incremental costs associated with the operation of the Bridge Street branches and the Ladd’s insurance agency, the costs associated with processing the increased volume of customer transactions due to the Bridge Street acquisition and amortization of intangible assets recorded in connection with the acquisition.

Non-interest expenses in 2006 included integration and closing costs of the acquisition totaling approximately $1.1 million, including salaries and benefits of approximately $350,000, stationery expense of $130,000, and professional fees of $585,000.

The Company’s efficiency ratio was 70.4% in 2007, compared with 74.6% in 2006.

Income Tax Expense

The Company’s effective tax rate was 23.2% in 2007 and 19.4% in 2006. The increase in the effective tax rate in 2007 compared with 2006 is primarily attributable to lower non-taxable interest and life insurance income relative to total pre-tax income.

22

Comparison of Financial Condition at December 31, 2008 and December 31, 2007

General

Total assets increased $60.3 million or 4.6% in 2008, to $1.4 billion at December 31, 2008.

Federal funds sold increased $26.9 million in 2008 upon receipt of proceeds from the issuance of preferred stock and common stock warrants in December 2008 in connection with the Company’s voluntary participation in the Department of the Treasury’s Capital Purchase Program (CPP). These funds will be used, along with the Company’s other funding sources and cash flows, to meet the financing needs of credit worthy retail and commercial borrowers in our markets. . The proceeds from the CPP will continue to be segregated from the Company’s general corporate funds during the time that they are drawn down to fund new loan originations.

Securities available-for-sale increased $26.4 million or 9.7%, and total loans and leases, net of unearned income, increased $15.2 million or 1.7% in 2008.

Securities

The securities portfolio is designed to provide a favorable total return utilizing low-risk, high-quality securities while at the same time assisting in meeting the liquidity needs of the Bank’s loan and deposit operations, and supporting the Company’s interest risk objectives. Our securities portfolio is predominately comprised of investment grade mortgage-backed securities, securities issued by U.S. government sponsored corporations and municipal securities. The Company classifies the majority of its securities as available-for-sale. The Company does not engage in securities trading or derivatives activities in carrying out its investment strategies.

The following table sets forth the amortized cost and market value for the Company’s available-for-sale securities portfolio:

	Years ended December 31,
	2008				2007				2006
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)
Securities available for sale:
Debt securities:
U.S. Treasury obligations	$	101	$	102	$	100	$	101	$	6,839	$	6,420
Obligations of U.S. government-sponsored corporations		34,489		35,143		60,902		60,942		62,178		61,452
Obligations of states and political subdivisions		89,154		91,033		87,028		88,580		86,299		87,388
Mortgage-backed securities		167,753		169,960		120,258		120,155		97,908		96,163
Total debt securities	$	291,497	$	296,238	$	268,288	$	269,778	$	253,224	$	251,423
Stock investments:
Equity securities		1,958		1,923		1,934		1,946		1,942		2,111
Mutual funds		1,000		988		1,000		989		500		468
Total stock investments		2,958		2,911		2,934		2,935		2,442		2,579
Total available for sale		294,455		299,149		271,222		272,713		255,666		254,002
Net unrealized gains (losses) on available-for-sale securities		4,694				1,491				(1,664)
Total carrying value	$	299,149			$	272,713			$	254,002

The Company’s investment securities portfolio totaled $299.1 million at December 31, 2008, compared with $272.7 million at December 31, 2007. The Company’s portfolio is comprised entirely of investment grade securities, the majority of which are rated “AAA” by one or more of the nationally recognized rating agencies. The breakdown of our securities portfolio at December 31, 2008 is 57% guaranteed mortgage-backed securities, 30% municipal securities and 12% obligations of U.S. Government sponsored corporations. Mortgage-backed securities, which totaled $170.0 million at December 31, 2008, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the full faith and credit of the federal government. The Company does not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. The Company also does not hold any preferred stock, corporate debt or trust preferred securities in its investment portfolio.

The Company had net unrealized gains of approximately $4.7 million in its securities portfolio at December 31, 2008, compared with net unrealized gains of $1.5 million at December 31, 2007. The increase in unrealized gains in 2008 resulted primarily from the changes in market interest rates and the levels of risk premiums sought by market participants during 2008.

23

The following table sets forth as of December 31, 2008, the maturities and the weighted-average yields of the Company’s debt securities, which have been calculated on the basis of the amortized cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:

	At December 31, 2008
	Amount   Maturing Within One Year or Less		Amount   Maturing After   One Year but Within Five Years		Amount Maturing After Five Years but   Within Ten Years		Amount   Maturing After   Ten Years		Total Cost
	(In thousands)
U.S. Treasury obligations	$	—	$	101	$	—	$	—	$	101
Obligations of U.S. government-sponsored corporations		14,877		19,612		—		—		34,489
Obligations of states and political subdivisions		12,590		48,216		24,374		3,974		89,154
Mortgage-backed securities		48,139		82,965		23,022		13,627		167,753
Total debt securities available-for-sale	$	75,606	$	150,894	$	47,396	$	17,601	$	291,497
Weighted average yield at year end(1)		4.32%		4.72%		5.30%		4.88%		4.72%

(1) Weighted average yields on the tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a marginal federal tax rate of 34%. These yields are an arithmetic computation of interest income divided by average balance and may differ from the yield to maturity, which considers the time value of money.

Loans and Leases

The loan and lease portfolio is the largest component of the Bank’s earning assets and accounts for the greatest portion of total interest income. The Bank provides a full range of credit products through its branch network and its commercial department. Consistent with the focus on providing community banking services, the Bank generally does not attempt to diversify geographically by making a significant amount of loans to borrowers outside of the primary service area. Loans are internally generated and the majority of the lending activity takes place in the New York State counties of Cortland, Madison, Onondaga, Oneida, and Oswego. In addition, the Bank originates indirect auto loans in the western counties of New York State. In connection with the Company’s ongoing strategic review and balance sheet management processes, Alliance Leasing, Inc. ceased origination of new transactions in the third quarter of 2008. The operations of Alliance Leasing are currently limited to servicing the existing lease portfolio. As a result, the lease portfolio is projected to amortize at the rate of approximately $9 million per quarter over the next year.

Total loans and leases, net of unearned income and deferred costs, increased $15.2 million or 1.7% in 2008.

Residential mortgages increased $40.6 million or 14.8% in 2008, and reached an all-time high of $314.0 million at December 31, 2008. Residential mortgage origination volume increased $29.9 million or 40.8% in 2008 compared with 2007, reaching an all-time high for the Company of $103.2 million in 2008. Alliance has increased its market share due largely to its focused expansion of and investment in the Company’s mortgage business in Central New York over the past two years. Substantially all of the Company’s residential mortgage originations are conventional mortgages originated in its local markets. The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages.

Commercial loans outstanding decreased $2.8 million or 1.3% in 2008, reflecting in part, the difficulty in expanding this portfolio in the perennially low-growth markets in which we operate. Until recently, opportunities for growing our commercial loan portfolio were further limited by aggressive competition predominantly from the larger commercial banks and non-bank lenders operating in our markets, some of whom had offered credit terms (such as non-recourse and high loan-to-values) against which we chose not to compete. As a result, Alliance declined many potential commercial lending opportunities due to underwriting concessions it was unwilling to make. The more recent credit market turmoil and difficulties experienced by some of the larger lenders with whom we compete is anticipated to present opportunities for Alliance to compete more effectively for sound commercial credits without compromising our long-standing underwriting standards. As one of the largest community banks headquartered in Central New York, Alliance expects to play a more prominent role in meeting the financing needs of credit worthy commercial customers with terms that are sound and within our standards. In 2008, originations of commercial loans (excluding lines of credit), totaled approximately $40 million, compared with approximately $43 million in 2007.

Leases (net of unearned income) decreased $26.6 million or 20.3% in 2008 due to the sale of a $10.8 million segment of the portfolio in the second quarter of 2008 and as a result of the Company’s previously announced decision to cease new lease originations in the third quarter of 2008. As noted above, the lease portfolio is expected to continue to run-off at the rate of approximately $9 million per quarter over the next year.

Indirect auto loans increased $6.7 million or 3.8% in 2008, though the portfolio growth was slightly negative in the fourth quarter due to normal seasonal sales declines which have been exacerbated by the widespread drop in consumer automobile purchases. The Company originated $94.8 million of indirect auto loans in 2008, of which $55.7 million were new vehicles and $39.1 million were late model pre-owned vehicles. Alliance originates auto loans through a network of reputable, well established automobile dealers located in Central and Western New York. Applications received through the Company’s indirect lending program are subject to the same comprehensive underwriting criteria and procedures as in its direct lending program.

24

The following table sets forth the composition of the Bank’s loan and lease portfolio at the dates indicated:

	Years ended December 31,
	2008			2007			2006			2005			2004
	Amount		Percent	Amount		Percent	Amount		Percent	Amount		Percent	Amount		Percent
	(Dollars in thousands)
Residential real estate	$	314,039	34.6%	$	273,465	30.6%	$	252,134	28.7%	$	185,760	28.5%	$	175,851	33.6%
Commercial loans		214,315	23.6%		217,136	24.4%		223,600	25.4%		162,408	24.8%		154,188	29.4%
Leases, net of unearned Income		104,655	11.6%		131,300	14.7%		131,048	14.9%		65,172	10.0%		13,762	2.6%
Indirect auto loans		182,807	20.2%		176,115	19.7%		181,929	20.7%		172,113	26.4%		117,623	22.4%
Other consumer loans		90,906	10.0%		94,246	10.6%		90,438	10.3%		66,981	10.3%		62,956	12.0%
		906,722	100.0%		892,262	100.0%		879,149	100.0%		652,434	100.0%		524,380	100.0%
Net deferred loan costs		4,033			3,271			2,262			1,652			1,720
Total loans and leases		910,755			895,533			881,411			654,086			526,100
Allowance for credit losses		(9,161)			(8,426)			(7,029)			(4,960)			(5,267)
Net Loans and Leases	$	901,594		$	887,107		$	874,382		$	649,126		$	520,833

The following table shows the amount of loans and leases outstanding as of December 31, 2008, which, based on remaining scheduled payments of principal, are due in the periods indicated:

	Maturing within     one year or less	Maturing after one but     within five years	Maturing after     five but within ten years	Maturing     after ten years	Total
	(In thousands)
Residential real estate	$    15,550	$    59,217	$    83,420	$  155,852	$  314,039
Commercial loans	64,938	74,305	39,898	35,174	214,315
Leases, net of unearned income	31,072	61,003	10,699	1,881	104,655
Indirect auto loans	59,569	121,416	1,822	–	182,807
Other consumer loans	20,029	42,632	22,359	5,886	90,906
Total loans & leases, net of unearned income	$  191,158	$  358,573	$  158,198	$  198,793	$  906,722

The following table sets forth the sensitivity to changes in interest rates as of December 31, 2008:

	Fixed Rate		Variable Rate		Total
	(In thousands)
Due after one year, but within five years	$	280,810	$	77,763	$	358,573
Due after five years		175,100		181,891		356,991

Asset Quality and the Allowance for Credit Losses

The following table represents a summary of delinquent loans and leases grouped by the number of days delinquent at the dates indicated:

Delinquent loans and leases	December 31, 2008			December 31, 2007
	$		%(1)	$		%(1)
	(Dollars in thousands)
30 days past due	$	11,124	1.22%	$	8,633	0.97%
60 days past due		4,736	0.52%		1,042	0.12%
90 days past due and still accruing		126	0.01%		39	—
Non-accrual		4,352	0.48%		6,667	0.75%
Total	$	20,338	2.23%	$	16,381	1.84%

(1) As a percentage of total loans and leases, excluding deferred costs

Weaknesses in the local, state and national economies contributed, in part, to an increase in delinquent loans and leases in the fourth quarter and full year of 2008. Loans and leases past due 30 days or more totaled $20.3 million or 2.23% of total loans and leases at December 31, 2008, compared with $10.9 million or 1.20% at September 30, 2008 and $16.4 million or 1.84% at December 31, 2007. Approximately 55% of all delinquent loans and leases at the end of 2008 were past due for one payment, and 23% were two payments past due. The largest increase in delinquencies was in the Company’s lease portfolio, with $6.7 million past due 30 days or more at December 31, 2008, compared with $1.1 million at September 30, 2008 and $1.6 million at December 31, 2007. Residential mortgages past due 30 days or more totaled $6.7 million at December 31, 2008, compared with $4.9 million at September 30, 2008 and $5.9 million at December 31, 2007. Commercial loans past due 30 days or more totaled $5.5 million at December 31, 2008, compared with $3.9 million at September 30, 2008 and $7.0 million at December 31, 2007.

25

The following table represents information concerning the aggregate amount of non-performing assets:

	December 31,
	2008		2007		2006		2005		2004
	(In thousands)
Non-accrual loans and leases:
Residential real estate	$	1,506	$	1,118	$	298	$	12	$	168
Commercial		1,997		4,988		1,248		1,103		2,116
Leases		595		320		99		—		—
Indirect auto		101		83		63		74		90
Consumer		153		158		141		169		60
Total non-accrual loans and leases		4,352		6,667		1,849		1,358		2,434
Accruing loans and leases past due 90 days or more		126		39		790		270		317
Total non-performing loans		4,478		6,706		2,639		1,628		2,751
Other real estate owned and other repossessed assets		657		229		-		6		53
Total non-performing assets	$	5,135	$	6,935	$	2,639	$	1,634	$	2,804
Total non-performing loans and leases to total loans and leases		0.49%		0.75%		0.30%		0.25%		0.53%
Total non-performing assets to total assets		0.38%		0.53%		0.21%		0.17%		0.31%
Allowance for credit losses to non-performing loans and leases		204.6%		125.7%		266.4%		304.7%		191.5%
Allowance for credit losses to total loans and leases		1.01%		0.94%		0.80%		0.76%		1.00%

Non-performing assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and other repossessed assets were $5.1 million or 0.38% of total assets at December 31, 2008, compared with $6.9 million or 0.53% of total assets at December 31, 2007. Conventional residential mortgages comprised $1.5 million (22 loans) or 33.6% of nonperforming loans and leases at December 31, 2008. Commercial loans on nonaccrual status decreased $3.0 million in 2008, and totaled $2.0 million (16 loans) or 44.6% of nonperforming loans and leases at the end of 2008. The decrease in nonaccrual commercial loans in 2008 is due primarily to principal pay downs (including $600,000 in cash collected in the fourth quarter of 2008), collateral liquidation and charge-offs with respect to the two largest nonperforming loans (totaling $2.8 million) at the end of 2007.

As a recurring part of its portfolio management program, the Company has identified approximately $13.3 million in potential problem loans at December 31, 2008, as compared to $5.4 million at December 31, 2007. The average balance of such potential problem loans was $333,000 and $208,000 at December 31, 2008 and December 31, 2007, respectively. Potential problem loans are loans that are currently performing, but where the borrower’s operating performance or other relevant factors could result in potential credit problems, and are typically classified by our loan rating system as “substandard.” At December 31, 2008, potential problem loans primarily consisted of commercial loans and commercial real estate . There can be no assurance that additional loans will not become nonperforming, require restructuring, or require increased provision for loan losses.

The Bank has a loan and lease monitoring program that it believes appropriately evaluates non-performing loans and leases and the loan and lease portfolio in general. The loan and lease review program continually audits the loan and lease portfolio to confirm management’s loan and lease risk rating system, and systematically tracks problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses.

The Bank’s policy is to place a loan or lease on non-accrual status and recognize income on a cash basis when a loan or lease is more than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The impact of interest not recognized on non-accrual loans and leases was $264,000 in 2008, $202,000 in 2007, and $40,000 in 2006. The Bank considers a loan or lease impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. As of December 31, 2008, there was $1.1 million in impaired loans for which $193,000 in related allowance for credit losses was allocated. There was $4.2 million in impaired loans for which $1.3 million in related allowance for credit losses was allocated as of December 31, 2007.

The allowance for credit losses represents management’s best estimate of probable incurred credit losses in the Bank’s loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred credit losses within each product class. The Bank uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates an allowance for each pool based on the average loss rate for the time period that includes the current year and two full prior years. The average loss rate is adjusted to reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan and lease pools, the Bank establishes a specific allocation for all loans and leases in excess of $250,000 which are considered to be impaired and which have been risk rated under the Bank’s risk rating system as substandard, doubtful or loss. The specific allocation is based on the most recent valuation of the loan or lease collateral. For all other commercial loans and leases, the Bank uses the general allocation methodology that estimates the probable incurred loss for each risk rating category. The general allocation methodology for commercial loans and leases considers the same qualitative factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects management’s best estimate of the probable incurred credit losses in the Bank’s loan and lease portfolio.

26

Loans and leases are charged against the allowance for credit losses, in accordance with the Bank’s loan and lease policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for probable incurred losses, a direct charge to operating income is recorded.

The following table summarizes changes in the allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense.

	Years ended December 31,
	2008		2007		2006		2005		2004
	(In thousands)
Balance at beginning of year	$	8,426	$	7,029	$	4,960	$	5,267	$	6,069
Loans and leases charged-off:
Residential real estate		276		103		33		39		123
Commercial loans		1,940		545		689		393		1,271
Leases		1,844		881		560		—		—
Indirect auto		295		211		195		296		531
Consumer		1,284		1,487		913		360		265
Total loans and leases charged off		5,639		3,227		2,390		1,088		2,190
Recoveries of loans and leases previously charged off:
Residential real estate		32		1		1		45		10
Commercial loans		113		48		59		209		52
Leases		40		13		—		—		—
Indirect auto		91		119		213		191		218
Consumer		596		653		412		192		124
Total recoveries		872		834		685		637		404
Net loans and leases charged off		4,767		2,393		1,705		451		1,786
Provision for credit losses		5,502		3,790		2,477		144		984
Allowance acquired from Bridge Street Financial Inc.		—		—		1,297		—		—
Balance at end of year	$	9,161	$	8,426	$	7,029	$	4,960	$	5,267

The provision for credit losses was $5.5 million in 2008, compared with $3.8 million in 2007. Net charge-offs were $4.8 million in 2008, compared with $2.4 million in 2007. Total charge-offs in 2008 were impacted by comprehensive liquidation strategies implemented in the first quarter on the two largest non-performing commercial relationships at that time, which resulted in charge-offs of $1.2 million or 65% of the first quarter’s total gross charge-offs. Net charge-offs in the fourth quarter of 2008 were $1.7 million compared with $637,000 in the fourth quarter of 2007. The increase in charge-offs in the fourth quarter related largely to deterioration in specific segments of the Company’s equipment lease portfolio. In the fourth quarter of 2008, the Company took aggressive action to address the challenges in these segments, including charge downs and repossession of leased equipment. The net outstanding balance of the affected segments of the portfolio was approximately $10 million at December 31, 2008.

The Company’s increased level of credit loss provisions in 2008 is a reflection of generally higher levels of loan delinquencies and charge-offs in 2008, a higher level of classified loans, and management’s assessment of the potential impact on the Company’s portfolio of macroeconomic factors and credit market conditions affecting the financial institutions sector generally.

Net charge-offs equaled 0.53% of average loans and leases in 2008 (0.74% annualized rate in the fourth quarter of 2008), compared with 0.27% in 2007 (0.29% annualized rate in the fourth quarter of 2007). The provision for credit losses as a percentage of net charge-offs was 115.4% in 2008, compared with 158.4% in 2007. The decrease in the ratio of the provision for credit losses to net charge-offs in 2008 was largely the result of provision recorded by the Company in 2007 on impaired loans which were charged down to their estimated collectible amounts in the first quarter of 2008.

The allowance for credit losses was $9.2 million at December 31, 2008, compared with $8.4 million at December 31, 2007. The ratio of the allowance for credit losses to total loans and leases was 1.01% at December 31, 2008, compared with 0.94% at December 31, 2007. The ratio of the allowance for credit losses to nonperforming loans and leases was 204.6% at December 31, 2008, compared with 125.7% at December 31, 2007.

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The allowance for credit losses has been allocated within the following categories of loans and leases at the dates indicated with the corresponding percent of loans to total loans for each category (dollars in thousands):

	December 31,
	2008		2007		2006		2005		2004
	Amount of Allowance	Percent of Loans to Total Loans	Amount of Allowance	Percent of Loans to Total Loans	Amount of Allowance	Percent of Loans to Total Loans	Amount of Allowance	Percent of Loans to Total Loans	Amount of Allowance	Percent of Loans to Total Loans
Residential real estate	$     850	34.6%	$     978	30.6%	$     969	28.7%	$     653	28.5%	$    689	33.6%
Commercial	3,988	23.6%	4,097	24.4%	3,143	25.4%	2,521	24.8%	2,714	29.4%
Leases	2,673	11.6%	1,951	14.7%	1,468	14.9%	385	10.0%	51	2.6%
Indirect auto	879	20.2%	685	19.7%	785	20.7%	1,099	26.4%	1,447	22.4%
Consumer	771	10.0%	715	10.6%	664	10.3%	302	10.3%	366	12.0%
Total	$  9,161	100.0%	$  8,426	100.0%	$  7,029	100.0%	$  4,960	100.00%	$  5,267	100.00%

The allowance for credit losses is allocated according to the amount deemed to be reasonably necessary to provide for the probable incurred losses within each category of loans and leases. Increases in the amount allocated to the commercial and lease portfolios reflect the higher outstanding balances of these portfolios coupled with the higher inherent risk of these portfolios compared with residential and consumer lending.

Deposits

The Bank’s deposits are the Company’s primary source of funds. The deposit base is comprised of demand deposit, savings and money market accounts, and time deposits that are primarily provided by individuals, businesses, and local governments within the communities served. The Bank continuously monitors market pricing, competitors’ rates, and internal interest rate spreads to maintain and promote growth and profitability.

The following table sets forth the composition of the Company’s deposits by business line at year-end (dollars in thousands):

	December 31, 2008							December 31, 2007
	Retail		Commercial	Municipal	Total		Percent	Retail		Commercial	Municipal	Total		Percent
Non-interest checking	$	35,685	$101,423	$3,737	$	140,845	15.0%	$	35,133	$100,598	$     2,960	$	138,691	14.6%
Interest checking		82,096	11,134	13,062		106,292	11.3%		77,368	9,636	14,789		101,793	10.8%
Total checking		117,781	112,557	16,799		247,137	26.3%		112,501	110,234	17,749		240,484	25.4%
Savings		76,811	8,049	3,382		88,242	9.4%		74,283	6,498	1,545		82,326	8.7%
Money market		74,597	45,471	127,324		247,392	26.4%		70,684	43,565	88,826		203,075	21.5%
Time deposits		296,381	20,189	38,541		355,111	37.9%		352,760	22,897	43,688		419,345	44.4%
Total deposits	$	565,570	$186,266	$186,046	$	937,882	100.0%	$	610,228	$183,194	$151,808	$	945,230	100.0%

Total deposits decreased $7.3 million or 0.8% in 2008 as a decrease in high-rate, short-term time accounts resulting from the Company’s de-emphasis of these types of accounts was substantially offset by growth in lower rate checking, savings and money market accounts. The Company’s liability mix changed favorably during 2008 as it continued to focus on growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain retail time accounts. Transaction accounts increased $56.9 million in 2008 and comprised 62.1% of total deposits at the end of 2008, compared with 55.6% at December 31, 2007. During 2008, the Company added a net 4,400 in new transaction accounts, due largely to business development efforts focusing on these lower cost accounts and to a greater awareness of the Alliance brand in our markets. These increases largely offset decreases in time accounts of $64.2 million in 2008 as the Company actively managed its deposit pricing and promotional rate structure in order to reduce its reliance on high-rate, short-term retail time accounts.

Time deposits in excess of $100,000, which tend to be more volatile and sensitive to interest rates, totaled $102.0 million at December 31, 2008, representing 28.7% of total time deposits and 10.9% of total deposits. These deposits totaled $117.0 million, representing 27.9% of total time deposits and 12.4% of total deposits at year-end 2007.

The following table schedules the amount of the Company’s time deposits of $100,000 or more by time remaining until maturity as of December 31, 2008 (in thousands):

Less than three months	$	17,981
Three months to six months		28,994
Six months to one year		33,949
Over one year		21,045
Total	$	101,969

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Borrowings

The Bank offers retail repurchase agreements primarily to its larger business customers. Under the terms of the agreements, the Bank sells investment portfolio securities to the customer and agrees to repurchase the securities on the next business day. The Bank uses this arrangement as a deposit alternative for its business customers. As of December 31, 2008, retail repurchase agreement balances amounted to $40.5 million compared to balances of $52.8 million at December 31, 2007.

During 2008, the Bank utilized collateralized repurchase agreements with various brokers and advances from the Federal Home Loan Bank of New York (FHLB) as alternative sources of funding and as a liability management tool. At December 31, 2008, the combination of repurchase agreements and FHLB advances were $198.5 million, compared to $148.0 million at December 31, 2007. Detailed information regarding the Company’s borrowings is included in Note 7 in the consolidated financial statements section of this report.

Capital

Shareholders’ equity was $144.5 million at December 31, 2008, compared with $115.6 million at December 31, 2007. In December 2008, the Company received $26.9 million from its voluntary participation in the CPP. In the transaction, the Treasury Department purchased 26,918 shares of newly issued, non-voting senior preferred stock for $26.9 million, with an initial annual dividend rate of 5%. The U.S. Treasury also received a warrant to purchase 173,069 shares of the Company’s common stock with an exercise price of $23.33 per share representing an aggregate market price of $4.0 million or 15% of the preferred stock investment. In addition to this transaction, shareholders’ equity increased $5.8 million in 2008 from net income of $10.4 million which was partially offset by dividends declared of $4.6 million. In 2008 the Company purchased 143,900 shares of its stock for a total of $3.4 million, or an average price per share of $23.84 per share.

The Company’s Tier 1 leverage ratio was 9.6% and its total risk-based capital ratio was 15.1% at the end of the fourth quarter, both of which exceeded the regulatory thresholds required to be classified as a well-capitalized institution, which are 5.0% and 10.0%, respectively.

The Company’s goal is to maintain a strong capital position, consistent with the risk profile of the Bank, that supports growth and expansion activities while at the same time exceeding regulatory standards. Capital adequacy in the banking industry is evaluated primarily by the use of ratios which measure capital against total assets, as well as against total assets that are weighted based on defined risk characteristics. At December 31, 2008, the Company exceeded all regulatory required minimum capital ratios and met the regulatory definition of a “well-capitalized institution.” A more comprehensive analysis of regulatory capital requirements, including ratios for the Company, is included in Note 18 of the consolidated financial statements.

Liquidity and Capital Resources

The Company’s liquidity is primarily measured by the Bank’s ability to provide funds to meet loan and lease requests, to accommodate possible outflows of deposits, and to take advantage of market interest rate opportunities. Funding of loan and lease commitments, providing for liability outflows, and management of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and leases, and investments with specific types of deposits and borrowings. Liquidity is normally considered in terms of the nature and mix of the Bank’s sources and uses of funds. The Asset Liability Management Committee (ALCO) of the Bank is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. Management believes, as of December 31, 2008, that liquidity as measured by the Bank is in compliance with its policy guidelines.

The Bank’s principal sources of funds for operations are cash flows generated from earnings, deposits, securities, loan and lease repayments, borrowings from the FHLB, and securities sold under repurchase agreements. During the year ended December 31, 2008, cash and cash equivalents increased by $17.4 million as net cash provided by operating activities and financing activities of $82.0 million exceeded the net cash used in investing activities of $64.7 million. Net cash provided by financing activities reflects the $26.9 million in proceeds from the issuance of preferred stock and a net increase in borrowings of $38.2 million, partly offset by a $7.3 million net decrease in deposits, treasury stock purchases of $3.4 million and cash dividends paid of $4.6 million. Net cash used in investing activities primarily results from a net increase in loans and leases of $31.5 million, a net increase in investment securities of $23.3 million, and a $7.0 million purchase of bank-owned life insurance.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of December 31, 2008, the Bank’s credit limit with the FHLB was $245.9 million with outstanding borrowings in the amount of $175.7 million.

The Company had a $151.8 million line of credit at December 31, 2008 with the Federal Reserve Bank of New York through its Discount Window. The Company has pledged indirect loans and securities totaling $183.4 million and $5.2 million, respectively, at December 31, 2008. The Company did not draw any funds on this line of credit in 2008. At December 31, 2008 and 2007, the Company also had available $35.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2008 and 2007, respectively.

In December 2003, the Company formed Alliance Financial Capital Trust I, a wholly-owned subsidiary of the Company. The trust was formed for the purpose of issuing $10.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital

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securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 285 basis points (6.32% at December 31, 2008). The capital securities have a 30-year maturity and are redeemable at par beginning in January 2009.

In September 2006, the Company formed Alliance Financial Capital Trust II, a wholly-owned subsidiary of the Company. The trust was formed for the purpose of issuing $15.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 165 basis points (3.65% at December 31, 2008). The capital securities have a 30-year maturity and are redeemable at par in September 2011 and any time thereafter.

In December 2008, the Company entered into a Purchase Agreement with the Treasury Department pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Series A Preferred Stock, having a liquidation amount per share equal to $1,000, for a total price of $26,918,000 (ii) and a Warrant to purchase 173,069 shares of the Company’s common stock at an exercise price per share of $23.33.

The Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. The Company may not redeem the Series A Preferred Stock during the first three years except with the proceeds from a “qualified equity offering”. After three years, the Company may, at its option, redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is generally non-voting. The ARRA now provides an opportunity for TARP recipients to immediately repay a TARP financing assistance without first needing to raise any funds, subject to the consultation by the Treasury Department with the appropriate federal banking agency. The nature of the consultation process is not defined under the ARRA, and banking regulators might seek to require a withdrawing TARP recipient to raise additional funds from third parties if the regulators determine that there are not otherwise sufficient capital reserves. Under repayment, the Treasury Department is required to liquidate any warrants it received from the Company.

Future federal statutes may contain retroactive restrictions which may adversely affect our ability to comply with the terms of the Purchase Agreement or effectively manage our business, and therefore, we may choose to redeem the preferred shares issued under the CPP.

Prior to December 19, 2011, and unless the Company has redeemed all of the Series A Preferred Stock or the Treasury Department has transferred all of the Series A Preferred Stock to a third party, the approval of the Treasury Department will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement.

The Warrant has a ten year term and is immediately exercisable. The Warrant provides for the adjustment of the exercise price and the number of shares of the Company’s common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Company’s common stock, and upon certain issuances of the Company’s common stock at or below a specified price relative to the then current market price of the Company’s common stock. If, on or prior to December 31, 2009, the Company receives aggregate gross cash proceeds of not less than the purchase price of the Series A Preferred Stock from one or more “qualified equity offerings,” the number of shares of common stock issuable pursuant to the Warrant will be reduced by one-half of the original number of shares, taking into account all adjustments. Pursuant to the Purchase Agreement, the Treasury Department has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

Both the Series A Preferred Stock and Warrant will be accounted for as components of the Company’s Tier 1 capital.

The Series A Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register for resale the Series A Preferred Stock, the Warrant and the shares of common stock underlying the Warrant (the “Warrant Shares”), as soon as practicable after the date of the issuance of the Series A Preferred Stock and the Warrant. Neither the Series A Preferred Stock nor the Warrant will be subject to any contractual restrictions on transfer, except that the Treasury Department may only transfer or exercise an aggregate of one-half of the Warrant Shares prior to the earlier of the date on which the Company receives aggregate gross cash proceeds of not less than the purchase price of the Series A Preferred Stock from one or more “qualified equity offerings” and December 31, 2009.

Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

In addition, under the Certificate of Designations, the Company’s ability to declare or pay dividends or repurchase its common stock or other equity or capital securities will be subject to restrictions in the event that it fails to declare and pay (or set aside for payment) full dividends on the Series A Preferred Stock.

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Contractual Obligations, Commitments, and Off-Balance Sheet Arrangements

Contractual Obligations

The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents as of December 31, 2008, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.

		Payments Due In
	Note   Reference	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
		(Dollars in thousands)
Time deposits*	6	$	255,645	$	69,148	$	30,318	$	—	$	355,111
Borrowings*	7		108,972		65,000		25,000		40,000		238,972
Junior subordinated obligations issued to unconsolidated subsidiaries*	8		—		—		—		25,774		25,774
Operating leases	15		1,113		1,912		1,005		3,033		7,063
Purchase obligations	15		172		344		344		1,708		2,568
Total		$	365,902	$	136,404	$	56,667	$	70,515	$	629,488

*Excludes interest

The Company has obligations under its pension, post-retirement plan, directors’ retirement and supplemental executive retirement plans as described in Note 12 to the consolidated financial statements. The supplemental executive retirement, pension and postretirement benefit and directors’ retirement payments represent actuarially determined future benefit payments to eligible plan participants.

As of December 31, 2008, the liability for uncertain tax positions, excluding associated interest and penalties, was $180,000 pursuant to FASB Interpretation No. 48. This liability represents an estimate of tax positions that the Company has taken in its tax returns which may ultimately not be sustained upon examination by the tax authorities. Since the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty, this estimated liability has been excluded from the contractual obligations table.

Commitments and Off-Balance Sheet Arrangements

In the normal course of business, to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates, the Bank is party to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument, for loan commitments and standby letters of credit, is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet loans. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Commitments to originate loans, unused lines of credit, and un-advanced portions of construction loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

The following table details the amounts and expected maturities of significant commitments and off-balance sheet arrangements as of December 31, 2008. Further discussion of these commitments and off-balance sheet arrangements is included in Note 15 to the consolidated financial statements.

Commitments to extend credit:	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
	(Dollars in thousands)
Residential real estate	$	14,670	$	—	$	—	$	—	$	14,670
Commercial loans and leases		26,197		4,861		513		35,061		66,632
Revolving home equity lines		2,867		4,678		13,022		30,336		50,903
Consumer revolving credit		30,395		—		—		—		30,395
Standby letters of credit		1,572		—		—		—		1,572
Total	$	75,701	$	9,539	$	13,535	$	65,397	$	164,172

Application of Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different

31

estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management.

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses, accrued income taxes, pensions and post-retirement obligations and the fair value analysis of goodwill and intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates.

The allowance for credit losses represents management’s estimate of probable incurred loan and lease losses inherent in the loan and lease portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses, and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report.

The Company estimates its tax expense based on the amount it expects to owe the respective tax authorities. Taxes are discussed in more detail in Note 10 to the consolidated financial statements section of this report. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of the Corporation’s tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

The Company utilizes significant estimates and assumptions in determining the fair value of its goodwill and intangible assets for purposes of impairment testing. The valuation requires the use of assumptions, including, among others, discount rates, rates of return on assets, account attrition rates and costs of servicing. Impairment testing for goodwill requires that the fair value of each of our reporting units be compared to the carrying amount of its net assets, including goodwill. Determining the fair value of a reporting unit requires us to use a high degree of subjective judgment. The Company utilizes both market-based valuation multiples and discounted cash flow valuation models that incorporate such variables as revenue growth rates, expense trends, interest rates and terminal values. Based upon an evaluation of key data and market factors, we select the specific variables to be incorporated into the valuation model. Future changes in the economic environment or operations of our reporting units could cause changes to these variables, which could result in impairment being identified.

The valuation of the Company’s obligations associated with pension, post-retirement, directors’ retirement and supplemental executive retirement plans utilize various actuarial assumptions. These assumptions include discount rate, rate of future compensation increases and expected return on plan assets. Specific discussion of the assumptions used by management is discussed in Note 12 to the consolidated financial statements section of this report.

New Accounting Pronouncements

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The impact of adoption was a cumulative adjustment to retained earnings of $462,000 to record the future death benefit obligation at January 1, 2008.

The FAS issued FASB Staff Position (“FSP”) FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13”, and FSP FAS 157-2, “Effective Date of FASB Statement No. 157.” FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, “Accounting for Leases”, from the scope of Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, “Fair Value Measurements”, for one year (January 1, 2009 for the Company) for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The impact this will have on the Company’s current practice of measuring fair value for these assets will not have a material effect on the financial statements.

In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) “Business Combinations.” Statement 141R will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all

32

the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R also includes a substantial number of new disclosure requirements. The Company will be required to apply Statement 141R to any business acquisitions completed on or after January 1, 2009.

In October 2008, the FASB released Staff Position (“FSP”) 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” to clarify the application of SFAS No. 157, “Fair Value Measurements,” in a market that is not active and to provide an example that illustrates key considerations in determining the fair value of a financial asset when the market for that asset is not active. The impact of adoption was not material.

Item 7A — Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company’s market risk arises principally from interest rate risk in its lending, deposit and borrowing activities. Other types of market risks do not arise in the normal course of the Company’s business activities.

The Bank’s Asset Liability Management Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The policies and guidelines established by the ALCO are reviewed and approved by the Company’s Board of Directors.

Interest rate risk is monitored primarily through the use of two complementary measures: earnings simulation modeling and net present value estimation. Both measures are highly assumption dependent and change regularly as the balance sheet and business mix evolve; however, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. The key assumptions employed by these measures are analyzed regularly and reviewed by the ALCO.

Earnings Simulation Modeling

Net interest income is affected by changes in the amounts and composition of the Company’s interest earning assets and non-interest and interest bearing funding and by changes in the absolute level of interest rates and by changes in the shape of the yield curve. In general, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and funding rates, while a steepening of the yield curve would result in increased earnings as investment margins widen. The model requires management to make assumptions about how the balance sheet is likely to evolve through time in different interest rate environments. Loan and deposit growth rate assumptions are derived from historical analysis and management’s outlook, as are the assumptions used to project yields and rates for new loans and deposits. Securities portfolio maturities and prepayments are assumed to be reinvested in similar instruments. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds in conjunction with the historical prepayment performance of the Bank’s loans. Non-contractual deposit growth rates and pricing are modeled on historical patterns. Interest rates of the various assets and liabilities on the balance sheet are assumed to change proportionally, based on their historic relationship to short-term rates. The Bank’s guidelines for risk management call for preventative measures to be taken if the simulation modeling demonstrates that a gradual increase or decrease in short-term rates of no more than 2% over the next 12 months would adversely affect net interest income over the same period by more than 15% when compared to the stable rate scenario.

The following table sets forth the results of our net interest income simulation model assuming that management does not take action to alter the outcome as of December 31:

Change in interest rates in basis points	First year percentage change in net interest income
	2008	2007
-200	N/A	6.3%
-100	-2.1%	N/A
+200	-2.1%	13.3%

The Company periodically changes the interest rate environment assumptions used in its earnings simulation modeling based on the absolute levels of interest rates and the Company’s perceived probability of a hypothetical interest rate environment occurring. At December 31, 2008, the Company suspended the modeling of an interest rate environment which assumed rates dropped by 200 basis points because the historically low level of interest rates at that time rendered this scenario not meaningful.

Net interest income is estimated to decrease 2.1% over twelve months in both interest rate scenarios modeled at December 31, 2008 due to the effect of interest rate floors on certain interest-bearing liabilities. If interest rates decrease 100 basis points, the rates on many of our deposit accounts cannot or are not likely to drop the full 100 basis points because of their already low rates. As a result, the expected decrease in the Company’s asset yields could exceed the decrease in our cost of funds in such a rate scenario. If interest rates were to increase 200 basis points, the Company’s net interest income would also be expected to decrease 2.1% as a result of our slightly liability-sensitive position, which would result in the rates on our interest-bearing liabilities adjusting upward more quickly than our interest-earning assets.

The large change in the expected net interest income from 2007 to 2008 in the up 200 basis point scenario is due primarily to a combination of changes in the asset/liability mix, the level of absolute interest rates and the change in the period of time over which the change in rates are assumed to occur.

33

Net Present Value Estimation

The Net Present Value of Equity (NPV) measure is used for discerning levels of risk present in the balance sheet that might not be taken into account in the earnings simulation model due to the shorter time horizon used by the earnings simulation model. The NPV of the balance sheet, at a point in time, is defined as the discounted present value of the asset cash flows minus the discounted value of liability cash flows. Interest rate risk analysis using NPV involves changing the interest rates used in determining the cash flows and in discounting the cash flows. The Company’s NPV analysis models both an instantaneous 2% increasing and 2% decreasing interest rate scenario comparing the NPV in each scenario to the NPV in the current rate scenario. The resulting percentage change in NPV is an indication of the longer-term repricing risk and options risk embedded in the balance sheet. The NPV measure assumes a static balance sheet versus the growth assumptions that are incorporated into the earnings simulation measure, and an unlimited time horizon instead of the one-year horizon applied in the earnings simulation model. As with earnings simulation modeling, assumptions about the timing and the variability of balance sheet cash flows are critical in NPV analysis. Particularly important are assumptions driving mortgage prepayments in both the loan and investment portfolios, and changes in the non-contractual deposit portfolios. These assumptions are applied consistently in both models The Company’s policy guidelines limit the amount of the estimated decrease or increase in NPV to 25% in a 2% rate change scenario.

The following table sets forth the results of NPV simulation model assuming that management does not take action to alter the outcome as of December 31:

Change in interest rates in basis points	Change in net present value
	2008	2007
-200	-0.7%	7.3%
+200	0.0%	1.4%

The variances in the NPV simulation results from 2007 to 2008 are attributable to the same factors affecting the net interest income simulation model identified above.

34

Item 8 — Financial Statements and Supplementary Data

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with Unites States generally accepted accounting principles.

Under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under that framework, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2008. In addition, based on our assessment, management has determined that there were no material weaknesses in the Company’s internal controls over financial reporting.

The Company’s internal control over financial reporting as of December 31, 2008 has been audited by Crowe Horwath LLP, an independent registered public accounting firm, as stated in their report appearing herein, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008.

/s/ Jack H. Webb	/s/ J. Daniel Mohr
Jack H. Webb	J. Daniel Mohr
Chairman, President & CEO	Chief Financial Officer & Treasurer
Syracuse, New York
March 13, 2009

35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM ON INTERNAL CONTROL

We have audited Alliance Financial Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Alliance Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Alliance Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Alliance Financial Corporation as of December 31, 2008 and 2007 and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for the years then ended and our report dated March 12, 2009 expressed an unqualified opinion on those consolidated financial statements.

/s/ Crowe Horwath LLP

Crowe Horwath LLP

Livingston, New Jersey

March 12, 2009

36

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM ON FINANCIAL STATEMENTS

Board of Directors and Shareholders

Alliance Financial Corporation

Syracuse, New York

We have audited the accompanying consolidated balance sheets of Alliance Financial Corporation as of December 31, 2008 and 2007 and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for each of the two years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alliance Financial Corporation as of December 31, 2008 and 2007 and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2008 in conformity with. accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alliance Financial Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 12, 2009 expressed an unqualified opinion thereon.

/s/ Crowe Horwath LLP

Crowe Horwath LLP

Livingston, New Jersey

March 12, 2009

37

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Alliance Financial Corporation:

In our opinion, the accompanying consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for the year ended December 31, 2006 present fairly, in all material respects, the results of operations and cash flows of Alliance Financial Corporation and its subsidiaries for the year ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts

March 13, 2007

38

Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets

December 31, 2008 and 2007

	2008		2007
Assets	(Dollars in thousands)
Cash and due from banks	$	21,172	$	30,704
Federal funds sold		26,918		–
Securities available-for-sale		299,149		272,713
Federal Home Loan Bank of NY(“FHLB”) and Federal Reserve Bank (“FRB”) Stock		11,844		9,507
Loans held for sale		875		3,163
Loans and leases, net of unearned income		910,755		895,533
Less allowance for credit losses		9,161		8,426
Net loans and leases		901,594		887,107
Premises and equipment, net		21,202		21,560
Accrued interest receivable		4,218		4,501
Bank-owned life insurance		24,940		17,084
Goodwill		32,073		32,187
Intangible assets, net		11,528		13,183
Other assets		11,845		15,305
Total assets	$	1,367,358	$	1,307,014
Liabilities and shareholders’ equity
Liabilities:
Deposits
Non-interest bearing	$	140,845	$	138,691
Interest bearing		797,037		806,539
Total deposits		937,882		945,230
Borrowings		238,972		200,757
Accrued interest payable		3,037		3,903
Other liabilities		17,212		15,790
Junior subordinated obligations issued to unconsolidated subsidiary trusts		25,774		25,774
Total liabilities		1,222,877		1,191,454
Commitments and contingent liabilities (Note 16)		–		—
Shareholders’ equity: Preferred stock – par value $1.00 a share; 1,000,000 shares authorized, Series A, cumulative perpetual preferred stock, $1,000 liquidation value, 26,918 issued and outstanding in 2008		26,331		—
Common stock – par value $1.00 a share; 10,000,000 shares authorized, 4,901,222 and 4,889,297 shares issued, and 4,578,910 and 4,710,885 shares outstanding for 2008 and 2007, respectively		4,901		4,889
Surplus		41,922		38,847
Undivided profits		81,110		75,844
Accumulated other comprehensive income		971		1,205
Directors’ stock-based deferred compensation plan: 85,510 shares		(2,098)		–
Treasury stock, at cost: 322,312 and 178,412 shares, respectively		(8,656)		(5,225)
Total Shareholders’ Equity		144,481		115,560
Total Liabilities and Shareholders’ Equity	$	1,367,358	$	1,307,014

The accompanying notes are an integral part of the consolidated financial statements.

39

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Income

Years Ended December 31, 2008, 2007 and 2006

	2008		2007		2006
Interest Income	(In thousands, except per share data)
Interest and fees on loans and leases	$	54,857	$	58,992	$	46,790
Federal funds sold and interest bearing deposits		100		28		148
Interest and dividends on taxable securities		9,430		8,546		7,644
Interest and dividends on nontaxable securities		3,577		3,466		3,091
Total Interest Income		67,964		71,032		57,673
Interest Expense
Deposits:
Savings accounts		492		474		343
Money market accounts		4,732		6,322		5,141
Time accounts		15,277		20,547		16,161
NOW accounts		733		911		519
Total		21,234		28,254		22,164
Borrowings:
Repurchase agreements		1,584		2,790		2,596
FHLB advances		6,050		5,546		4,052
Junior subordinated obligations		1,399		1,960		1,139
Total interest expense		30,267		38,550		29,951
Net interest income		37,697		32,482		27,722
Provision for credit losses		5,502		3,790		2,477
Net interest income after provision for credit losses		32,195		28,692		25,245
Non-interest income:
Investment management income		8,670		9,180		8,895
Service charges on deposit accounts		5,164		5,296		4,316
Card-related fees		2,106		1,942		1,291
Insurance agency income		1,583		1,855		615
Income from bank-owned life insurance		856		635		455
Gain on the sale of loans		252		192		126
Gain (loss) on sale of securities available-for-sale		137		(12)		(2)
Other non-interest income		1,592		2,204		2,018
Total non-interest income		20,360		21,292		17,714
Non-interest expense:
Salaries and employee benefits		19,823		18,281		16,607
Occupancy and equipment expense		7,032		6,765		6,460
Communication expense		791		827		744
Office supplies and postage expense		1,137		1,236		1,079
Marketing expense		1,090		1,237		1,128
Amortization of intangible assets		1,622		1,729		797
Professional fees		2,661		2,845		3,239
Other non-interest expense		5,222		4,718		3,832
Total non-interest expenses		39,378		37,638		33,886
Income before income tax expense		13,177		12,346		9,073
Income tax expense		2,820		2,869		1,762
Net income	$	10,357	$	9,477	$	7,311
Dividends and accretion of discount on preferred stock		47		—		—
Net income available to common shareholders	$	10,310	$	9,477	$	7,311
Earnings Per Common Share
Basic	$	2.27	$	2.01	$	1.92
Diluted	$	2.24	$	1.98	$	1.88

The accompanying notes are an integral part of the consolidated financial statements.

40

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

Years Ended December 31, 2008, 2007 and 2006

	Issued and Outstanding Common Shares	Preferred Stock	Common Stock	Surplus	Unamortized Value of Restricted Stock	Undivided Profits	Accumulated Other Comprehensive Income (Loss)	Treasury Stock	Directors’ Deferred Stock	Total
	(In thousands, except per share data)
Balance at December 31, 2005	3,565,012	$      —	$  3,979	$    11,185	$  (1,453)	$  66,740	$  (1,700)	$  (9,180)	$      —	$  69,571
Comprehensive income:
Net income	—	—	—	—	—	7,311	—	—	—	7,311
Other comprehensive income, net of taxes	—	—	—	—	—	—	572	—	—	572
Total comprehensive income	—	—	—	—	—	—	—	—	—	7,883
Cumulative effect of change in accounting for adoption of SFAS No. 158	—	—	—	—	—	—	(994)	—	—	(994)
Shares issued in purchase of Bridge Street Financial Inc.	1,291,812	—	863	27,518	—	—	—	9,676	—	38,057
Issuance of restricted stock	26,500	—	27	789	(816)	—	—	—	—	—
Forfeiture of restricted stock	(19,995)	—	(21)	(594)	503	—	—	—	—	(112)
Amortization of restricted stock	—	—	—	—	332	—	—	—	—	332
Stock options exercised	47,032	—	47	1,080	—	—	—	—	—	1,127
Tax benefit of stock-based compensation	—	—	—	442	—	22	—	—	—	464
Cash dividends $0.88 per share	—	—	—	—	—	(3,415)	—	—	—	(3,415)
Treasury stock purchased	(109,849)	—	—	—	—	—	—	(3,407)	—	(3,407)
Reclassification of unearned restricted stock awards to surplus in accordance with SFAS No. 123R (67,375 shares)	—	—	—	(1,434)	1,434	—	—	—	—	—
Balance at December 31, 2006	4,800,512	—	4,895	38,986	—	70,658	(2,122)	(2,911)	—	109,506
Comprehensive income:
Net income	—	—	—	—	—	9,477	—	—	—	9,477
Other comprehensive income, net of taxes	—	—	—	—	—	—	3,327	—	—	3,327
Total comprehensive income	—	—	—	—	—	—	—	—	—	12,804
Issuance of restricted stock	16,950	—	17	(17)	—	—	—	—	—	—
Forfeiture of restricted stock	(10,150)	—	(10)	(80)	—	—	—	—	—	(90)
Amortization of restricted stock	—	—	—	330	—	—	—	—	—	330
Stock options exercised	8,027	—	8	170	—	—	—	—	—	178
Tax benefit of stock-based compensation	—	—	—	97	—	—	—	—	—	97
Retirement of common stock	(20,524)	—	(21)	(639)	—	—	—	—	—	(660)
Cash dividend $0.90 per share	—	—	—	—	—	(4,291)	—	—	—	(4,291)
Treasury stock purchased	(83,930)	—	—	—	—	—	—	(2,314)	—	(2,314)
Balance at December 31, 2007	4,710,885	—	4,889	38,847	—	75,844	1,205	(5,225)	—	115,560
Comprehensive income:
Net income	—	—	—	—	—	10,357	—	—	—	10,357
Other comprehensive loss, net of taxes	—	—	—	—	—	—	(195)	—	—	(195)
Total comprehensive income										10,162
Cumulative effect of change in pension measurement date	—	—	—	—	—	44	(39)	—	—	5
Cumulative effect of change in accounting for adoption of EITF06-4	—	—	—	—	—	(462)	—	—	—	(462)
Issuance of preferred stock and warrants	—	26,325	—	593	—	—	—	—	—	26,918
Accretion of preferred stock discount	—	6	—	—	—	(6)	—	—	—	—
Issuance of restricted stock	15,500	—	16	(16)	—	—	—	—	—	—
Forfeiture of restricted stock	(3,575)	—	(4)	(11)	—	—	—	—	—	(15)

41

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity (cont’d)

Years Ended December 31, 2008, 2007 and 2006

	Issued and Outstanding Common Shares	Preferred Stock	Common Stock	Surplus	Unamortized Value of Restricted Stock	Undivided Profits	Accumulated Other Comprehensive Income (Loss)	Treasury Stock	Directors’ Deferred Stock	Total
Amortization of restricted stock	—	—	—	374	—	—	—	—	—	374
Tax benefit of stock-based compensation	—	—	—	37	—	—	—	—	—	37
Cash dividend $1.00 per common share	—	—	—	—	—	(4,626)	—	—	—	(4,626)
Preferred stock dividend	—	—	—	—	—	(41)	—	—	—	(41)
Treasury stock purchased	(143,900)	—	—	—	—	—	—	(3,431)	—	(3,431)
Directors’ deferred stock plan purchase	—	—	—	2,098	—	—	—	—	(2,098)	—
Balance at December 31, 2008	4,578,910	$  26,331	$  4,901	$  41,922	$      —	$  81,110	$  971	$  (8,656)	$  (2,098)	$  144,481

The accompanying notes are an integral part of the consolidated financial statements

42

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2008, 2007 and 2006

	2008	2007	2006
	(In thousands)
Net income	$  10,357	$    9,477	$  7,311
Other comprehensive income (loss) net of tax:
Net unrealized gains for the period, net of tax expense of $1,275 in 2008, $1,222 in 2007, and $445 in 2006	2,021	1,924	645
Reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit) of $53 in 2008, $(5) in 2007, and $(1) in 2006	(84)	7	1
Change in minimum pension liability	–	–	(74)
Change in accumulated unrealized loss and prior service costs for pension and other post- retirement benefits, net of tax (benefit) expense of $(1,371) in 2008 and $310 in 2007	(2,132)	569	–
Post-retirement plan amendment net of tax benefit of $(521)	–	827	–
Total other comprehensive income (loss)	(195)	3,327	572
Comprehensive income	$  10,162	$  12,804	$  7,883

The accompanying notes are an integral part of the consolidated financial statements.

43

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended December 31, 2008, 2007 and 2006

	2008	2007	2006
Operating Activities:	(In thousands)
Net income	$    10,357	$      9,477	$      7,311
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses	5,502	3,790	2,477
Depreciation expense	2,516	2,456	2,837
Increase in surrender value of life insurance	(856)	(635)	(455)
Deferred income tax benefit (expense)	37	534	(1,353)
Amortization (accretion) of investment security discounts and premiums, net	189	(38)	(195)
Net (gain) loss on sale of securities available-for-sale	(137)	12	2
Net (gain) loss on sale of premises and equipment	–	(10)	22
Impairment write-down on premises	–	–	174
Proceeds from the sale of loans and leases held-for-sale	25,281	13,043	7,889
Origination of loans held-for-sale	(12,223)	(14,973)	(8,918)
Net gains on sale of loans and leases	(252)	(192)	(126)
Write-down of leases transferred to held-for-sale	160	–	–
Gain on lease prepayment	–	(286)	–
Gain on sale of assets held-for-sale	(99)	–	–
(Gain) loss on foreclosed real estate-owned	(71)	43	–
Amortization of capitalized servicing rights	272	296	104
Amortization of intangible assets	1,622	1,729	797
Restricted stock expense	359	240	220
Change in other assets and liabilities	1,665	(787)	11,728
Net cash provided by operating activities	34,322	14,699	22,514
Investing Activities:
Proceeds from maturities, redemptions, calls and principal repayments of investment securities, available-for-sale	84,456	79,347	60,725
Proceeds from sales of investment securities available-for-sale	6,299	6,975	9,718
Purchase of investment securities available-for-sale	(114,040)	(101,852)	(27,128)
Purchase of FRB and FHLB stock	(22,466)	(26,197)	(14,579)
Redemption of FRB and FHLB stock	20,129	24,675	14,845
Net increase in loans and leases	(31,468)	(16,670)	(86,403)
Purchases of premises and equipment	(1,553)	(2,596)	(1,994)
Proceeds from the sale of premises and equipment	119	174	16
Proceeds from disposition of assets held-for-sale	176	107	–
Proceeds from disposition of foreclosed assets	689	–	–
Purchase of bank-owned life insurance	(7,000)	–	–
Acquisitions	–	–	(13,171)
Net cash used in investing activities	(64,659)	(36,037)	(57,971)
Financing Activities:
Net increase (decrease) in demand deposits, NOW, money market and savings accounts	56,886	26,306	(20,530)
Net (decrease) increase in time deposits	(64,234)	(17,689)	44,456
Net increase (decrease) in short-term borrowings	5,215	(12,021)	27,264
Payments on long-term borrowings	(17,000)	(15,700)	(46,750)
Proceeds from long-term borrowings	50,000	50,000	25,000
Net increase in junior subordinated obligations	–	–	15,464
Proceeds from the exercise of stock options	–	178	1,127
Treasury stock purchased	(3,431)	(2,314)	(3,407)
Purchase of shares for directors’ deferred stock-based plan	(2,098)	–	–
Tax benefit of stock-based compensation	37	97	464
Issuance of preferred stock and warrants	26,918	–	–
Cash dividends	(4,570)	(4,213)	(3,111)
Net cash provided by financing activities	47,723	24,644	39,977
Net increase in cash and cash equivalents	17,386	3,306	4,520
Cash and cash equivalents at beginning of year	30,704	27,398	22,878
Cash and cash equivalents at end of year	$    48,090	$    30,704	$    27,398

44

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (cont’d)

Years Ended December 31, 2008, 2007 and 2006

	2008	2007	2006
Supplemental Disclosures of Cash Flow Information:
Interest received during the year	$    68,336	$    71,136	$      57,083
Interest paid during the year	31,113	37,300	29,561
Income taxes paid	1,377	2,971	2,455
Non-cash investing activities:
Change in unrealized loss on securities available-for-sale	3,203	3,155	1,090
Fair value of assets acquired in acquisition	–	–	252,182
Fair value of liabilities assumed in acquisition	–	–	200,954
Transfer between premises and equipment and assets held-for-sale	724	(1,459)	118
Transfer of loans to foreclosed real estate	660	441	–
Transfer of leases to held-for-sale	10,819	–	–
Non-cash financing activities:
Dividends declared and unpaid	1,232	1,135	1,057
Common stock issued in acquisition	–	–	38,057

The accompanying notes are an integral part of the consolidated financial statements.

45

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Nature of Operations

Alliance Financial Corporation (the “Company”) is a financial holding company which owns and operates Alliance Bank, N.A. (the “Bank”), Alliance Financial Capital Trust I, Alliance Financial Capital Trust II (collectively the “Capital Trusts”) and Ladd’s Agency, Inc., a multi-line insurance agency. The Company provides financial services through its Bank subsidiary from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, and investment management services. The Capital Trusts were formed for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The Bank has a substantially wholly-owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly-owned subsidiary, Alliance Leasing, Inc., which was engaged in commercial equipment financing activity in over thirty states until the third quarter of 2008, at which time Alliance Leasing, Inc. ceased the origination of new leases.

1. Basis of Presentation and Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Alliance Bank, N.A. and Ladd’s Agency, Inc., after elimination of intercompany accounts and transactions. The Company’s wholly-owned subsidiaries, Alliance Financial Capital Trust I and II, qualify as variable interest entities under FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” However, the Company is not the primary beneficiary and therefore has not consolidated the accounts of Alliance Financial Capital Trust I and II in its consolidated financial statements.

Critical Accounting Estimates and Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management has identified the allowance for credit losses, income taxes, and the carrying value of goodwill and intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates.

Risk and Uncertainties

In the normal course of its business, the Company encounters economic and regulatory risks. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, from its interest-earning assets. The Company’s primary credit risk is the risk of default on the Company’s loan and lease portfolio that results from the borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects potential changes in the value of collateral underlying loans, the fair value of investment securities, and the value of loans held for sale.

The Company is subject to regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loan and lease loss allowances, and operating restrictions resulting from the regulators’ judgments based on information available to them at the time of their examinations.

In December 2008, the Company entered into a Letter Agreement (the “Purchase Agreement”), with the United States Department of the Treasury (“Treasury Department”) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, (ii) and a warrant (the “Warrant”) to purchase 173,069 shares of the Company’s common stock. Section 5.3 of the Purchase Agreement grants the Treasury Department the ability to unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes after the date of the Purchase Agreement in applicable federal statutes. The ability of the Treasury Department to unilaterally amend any provision of the Purchase Agreement presents risks and uncertainties that the Company cannot predict.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and highly liquid investments with original maturities less than ninety days.

46

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1.  Basis of Presentation and Significant Accounting Policies (cont’d.)

Securities

The Company classifies securities as held-to-maturity or available-for-sale at the time of purchase. Held-to-maturity securities are those that the Company has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Securities not classified as held-to-maturity are classified as available-for-sale and are reported at fair value, with net unrealized gains and losses reflected as a separate component of accumulated other comprehensive income, net of taxes. None of the Company’s securities have been classified as trading securities or held-to-maturity.

Gains and losses on the sale of securities are based on the specific identification method. Premiums and discounts on securities are amortized and accreted into income using the interest method over the life of the security. Securities are reviewed regularly for other than temporary impairment. In estimating other-than-temporary losses, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. The cost basis of individual securities is written down to estimated fair value through a charge to earnings when declines in value below amortized cost are considered to be other than temporary. Purchases and sales of securities are recognized on a trade-date basis.

Federal Home Loan Bank of New York and Federal Reserve Bank Stock

As a member of the Federal Home Loan Bank of New York (“FHLB”) and Federal Reserve Bank (“FRB”), the Company is required to hold stock in based on ultimate recovery of par value.

Securities Sold under Agreements to Repurchase

Repurchase agreements are accounted for as collateralized borrowings, and the obligations to repurchase securities sold are reflected as a liability in the balance sheet, since the Company maintains effective control over the transferred securities. The securities underlying the agreements remain in the Company’s securities portfolio. The fair value of the collateral provided to a third party is continually monitored, and additional collateral is provided to the third party, or surplus collateral is returned to the Company as deemed appropriate.

Loans Held for Sale and Mortgage Servicing Rights

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are charged to earnings.

Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Mortgage servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sale of loans. Fair value is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Servicing fee income which is reported on the income statement as other non-interest income is recorded for fees earned for servicing loans and recorded as income when earned. The amortization of mortgage servicing rights is netted against loans servicing fee income.

47

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1.  Basis of Presentation and Significant Accounting Policies (cont’d.)

Loans and Leases

Loans and leases are stated at unpaid principal balances less the allowance for credit losses, unearned interest income and net deferred loan origination fees and costs. Interest on loans is based upon the principal amount outstanding. Interest on loans is accrued except when in management’s opinion the collectibility of interest is doubtful, at which time the accrual of interest on the loan is discontinued. Loan and lease origination fees and certain direct origination costs are deferred and the net amount is amortized as a yield adjustment over the life of the loan or lease.

Operating leases are stated at cost of the equipment less scheduled depreciation. Equipment on operating leases is depreciated on a straight-line basis to its estimated residual value over the lease term. Operating lease income is recognized on a straight-line basis over the term of the lease. Lease financings, included in portfolio loans on the consolidated balance sheet consist of direct financing leases of commercial equipment, primarily computers and office equipment, manufacturing equipment, commercial truck and trailers, and medical equipment. Income attributable to finance leases is initially recorded as unearned income and subsequently recognized as finance income at level rates of return over the term of the leases. The recorded residual values of the Company’s leased assets are estimated at the inception of the lease to be the expected fair market value of the assets at the end of the lease term. The Company reviews commercial lease residual values at least annually and recognizes residual value impairments deemed to be other than temporary. In accordance with U.S. generally accepted accounting principles, anticipated increases in specific future residual values are not recognized before realization.

Allowance for Credit Losses

The allowance for credit losses represents management’s best estimate of probable incurred credit losses in the Company’s loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease type, or pool, of similar loans and leases. The Company uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates an allowance for each pool based on the average loss rate for the time period that includes the current year and two full prior years. The average loss rate is adjusted to reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan and lease pools, the Company establishes a specific allocation for all loans and leases classified as being impaired in excess of $250,000, which have been risk rated under the Company’s risk rating system as substandard, doubtful, or loss. For all other commercial loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. The general allocation methodology for commercial loans and leases considers the same factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects management’s best estimate of the probable incurred credit losses in the Company’s loan and lease portfolio.

A loan or lease is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans less than $250,000, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

Loans are charged off when they are considered a loss regardless of the delinquency status. From a delinquency standpoint, the policy of the Company is to charge off loans when they are 120 days past due unless extenuating circumstances are documented that attest to the ability to collect the loan. In special circumstances loans and leases will be charged off no later than 90 days of discovery or 120 days delinquent, whichever is shorter. In lieu of charging off the entire loan balance, loans with collateral may be written down to the value of the collateral, less cost to sell, if foreclosure or repossession of collateral is assured and is in process.

Income Recognition on Impaired and Non-accrual Loans and Leases

Loans and leases, including impaired loans or leases, are generally classified as non-accrual if they are past due as to maturity of payment of principal or interest for a period of more than 90 days unless they are well secured and are in the process of collection. While a loan or lease is classified as non-accrual and the future collectibility of the recorded loan or lease balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding.

48

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1.  Basis of Presentation and Significant Accounting Policies (cont’d.)

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of net assets acquired for transactions accounted for under the purchase method of accounting for business combinations. Goodwill is not being amortized, but is evaluated at least annually for impairment. Intangible assets resulting from the acquisition of Bridge Street Financial, Inc. in 2006 include core deposit intangibles, customer relationship intangibles and a covenant to not compete. The core deposit intangible and customer list intangible are being amortized over 10 years using an accelerated method. The non-compete covenant is being amortized on a straight-line basis over a period of 3 years based on the agreement. The investment management intangible related to the purchase of certain trust accounts and related assets under management from HSBC, USA, N.A. in 2005 is being amortized over the expected useful life of the relationships acquired. These intangibles are tested for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable.

Premises, Furniture, and Equipment

Land is carried at cost. Bank premises, furniture, and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets. Useful lives range from one year to 10 years for furniture, fixtures and equipment; three to five years for software, hardware, and data handling equipment; and 10 to 39 years for buildings and building improvements. Leasehold improvements are amortized over the term of the respective lease. Maintenance and repairs are charged to operating expenses as incurred. The asset cost and accumulated depreciation are removed from the accounts for assets sold or retired and any resulting gain or loss is included in the determination of the income.

Long-Term Assets

Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Bank-Owned Life Insurance

The Bank has purchased life insurance policies on certain employees, key executives and directors. In accordance with Emerging Issues Task Force (“EITF”) No. 06-5, Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Foreclosed Assets

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.

Loan Commitments and Related Financial Instruments

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Retirement Plans

Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Employee 401(k) and profit sharing plan expense is the amount of matching contributions and employer fixed and discretionary contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.

Stock-Based Compensation

Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

Directors Stock-Based Deferral Plan

In accordance with EITF Number 97-14, as affected by FAS 123R the stock held in the trust is classified in equity similar to the manner in which treasury stock is classified.

49

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1.  Basis of Presentation and Significant Accounting Policies (cont’d.)

Earnings Per Common Share

Basic earnings per common share are net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, restricted stock awards and warrants.

Loss Contingencies

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale and changes in funded status of the pension plan, post-retirement medical plan and supplemental executive retirement plans which are also recognized as separate components of equity.

Income Taxes

Provision for income taxes is based on taxes currently payable or refundable and deferred income taxes on temporary differences between the tax basis of assets and liabilities and their reported amount in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no affect on the Company’s financial statements. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.

Dividend Restriction

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the holding company or by the holding company to shareholders. The Company received capital in the form of preferred stock from the U.S. Treasury Department under the Capital Purchase Program. Until the earlier of December 19, 2011 and the date the Treasury no longer holds any preferred stock, without U.S. Treasury’s consent, the Company is restricted from increasing the quarterly common dividend above $0.26 per share.

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting

The Company’s operations are solely in the financial services industry and include providing to its customers traditional banking, equipment leasing and other financial services including investment management services. The Company operates primarily in the geographical regions of Cortland, Madison, Oneida, Onondaga, and Oswego counties of New York State, and from a Trust Administration Center in Buffalo, NY. In addition, Alliance Leasing conducts business in over thirty states. While the Company’s chief decision-makers monitor the revenue streams of the various Company products and services, the segments that could be separated from the Company’s primary business of banking do not meet the criteria for separate disclosure. Accordingly, all of the Company’s financial service operations are considered by management to be combined in one reportable operating segment.

Investment Assets Under Management

Assets held in fiduciary or agency capacities for customers are not included in the accompanying consolidated statements of condition, since such items are not assets of the Company. Fees associated with providing investment management services are recorded using a method that approximates the accrual basis.

50

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1.  Basis of Presentation and Significant Accounting Policies (cont’d.)

Reclassification

Reclassifications are made to prior years’ consolidated financial statements, when necessary, to conform to the current year’s presentation. These reclassifications have no effect on net income as previously reported.

New Accounting Pronouncements

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The impact of adoption was a cumulative adjustment to retained earnings of $462,000 to record the future death benefit obligation at January 1, 2008.

The FAS issued FASB Staff Position (“FSP”) FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13”, and FSP FAS 157-2, “Effective Date of FASB Statement No. 157.” FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, “Accounting for Leases”, from the scope of Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, “Fair Value Measurements”, for one year (January 1, 2009 for the Company) for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company is currently evaluating the impact this will have on the Company’s current practice of measuring fair value for these assets and does not anticipate a material effect on the financial statements.

In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) “Business Combinations.” Statement 141R will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R also includes a substantial number of new disclosure requirements. The Company will be required to apply Statement 141R to any business acquisitions completed on or after January 1, 2009.

In October 2008, the FASB released Staff Position (“FSP”) 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” to clarify the application of SFAS No. 157, “Fair Value Measurements,” in a market that is not active and to provide an example that illustrates key considerations in determining the fair value of a financial asset when the market for that asset is not active. The impact of adoption was not material.

51

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

2. Securities

The amortized cost and estimated fair value of securities at December 31 are as follows (in thousands):

	December 31, 2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Debt Securities:
U.S. Treasury obligations	$	101	$	1	$	—	$	102
Obligations of U.S. government-sponsored corporations		34,489		654		—		35,143
Obligations of states and political subdivisions		89,154		2,148		269		91,033
Mortgage-backed securities		167,753		2,521		314		169,960
Total debt securities		291,497		5,324		583		296,238
Stock Investments:
Equity securities		1,958		—		35		1,923
Mutual Funds		1,000		14		26		988
Total stock investments		2,958		14		61		2,911
Total available-for-sale	$	294,455	$	5,338	$	644	$	299,149

Mortgage-backed securities, which totaled $170.0 million at December 31, 2008, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the full faith and credit of the federal government. The Company does not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. The Company also does not hold any preferred stock, corporate debt or trust preferred securities in its investment portfolio.

	December 31, 2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Debt Securities:
U.S. Treasury obligations	$	100	$	1	$	—	$	101
Obligations of U.S. government-sponsored corporations		60,902		162		122		60,942
Obligations of states and political subdivisions		87,028		1,657		105		88,580
Mortgage-backed securities		120,258		675		778		120,155
Total debt securities		268,288		2,495		1,005		269,778
Stock Investments:
Equity securities		1,934		12		—		1,946
Mutual Funds		1,000		15		26		989
Total stock investments		2,934		27		26		2,935
Total available-for-sale	$	271,222	$	2,522	$	1,031	$	272,713

The carrying value and estimated fair value of debt securities at December 31, 2008, by contractual maturity, are shown below (in thousands). The maturities of mortgage-backed securities are based on average life of the security. All other expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Estimated Fair Value
Due in one year or less	$	75,606	$	76,391
Due after one year through five years		150,894		153,745
Due after five years through ten years		47,396		48,413
Due after ten years		17,601		17,689
Total debt securities	$	291,497	$	296,238

At December 31, 2008 and 2007, securities with a carrying value of $293.1 million and $262.3 million, respectively, were pledged as collateral for certain deposits and other purposes as required or permitted by law.

The Company recognized gross gains on sales of securities of $137,000, $0, and $8,000, for 2008, 2007, and 2006, respectively, and gross losses of $0, $12,000, and $10,000, for 2008, 2007, and 2006, respectively. The tax provision (benefit) related to these net realized gains and losses was $53,000, $(5,000) and $(1,000), respectively.

52

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

2.  Securities (cont’d.)

The following table shows the securities with unrealized losses at year end, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated (in thousands):

	December 31, 2008
	Less than 12 Months				12 Months or Longer				Total
Type of Security	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
Obligations of states and political subdivisions	$	8,342	$	269	$	—	$	—	$	8,342	$	269
Mortgage-backed securities		22,804		164		5,636		150		28,440		314
Subtotal, debt securities		31,146		433		5,636		150		36,782		583
Equity securities		1,923		35		—		—		1,923		35
Mutual Funds		—		—		474		26		474		26
Total temporarily impaired Securities	$	33,069	$	468	$	6,110	$	176	$	39,179	$	644
	December 31, 2007
	Less than 12 Months				12 Months or Longer				Total
Type of Security	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
Obligations of U.S. government-sponsored corporations	$	7,063	$	4	$	24,332	$	118	$	31,395	$	122
Obligations of states and political subdivisions		2,147		33		10,387		72		12,534		105
Mortgage-backed securities		8,436		56		49,589		722		58,025		778
Subtotal, debt securities		17,646		93		84,308		912		101,954		1,005
Mutual Funds		—		—		474		26		474		26
Total temporarily impaired Securities	$	17,646	$	93	$	84,782	$	938	$	102,428	$	1,031

Management does not believe any individual unrealized loss as of December 31, 2008 represents an other-than-temporary impairment. A total of 82 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 8 securities for 12 months or longer. The unrealized losses relate primarily to debt securities issued by FNMA, GNMA, FHLMC, FHLB, the State of New York, and various political subdivisions within the State of New York. These unrealized losses are primarily attributable to changes in interest rates and individually were 10% or less of their respective amortized cost basis. The Company has both the intent and ability to hold the securities contained in the previous table for a time necessary to recover the amortized cost.

3. Loans and Leases

Major classifications of loans and leases at December 31 are as follows (in thousands):

	2008		2007
Residential real estate	$	314,039	$	273,465
Commercial loans		214,315		217,136
Leases		117,691		150,933
Indirect auto loans		182,807		176,115
Other consumer loans		90,906		94,246
Total		919,758		911,895
Unearned income		(13,036)		(19,633)
Net deferred loan costs		4,033		3,271
Total loans and leases		910,755		895,533
Allowance for credit losses		(9,161)		(8,426)
Net loans & leases	$	901,594	$	887,107

53

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

3. Loans and Leases (cont’d.)

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of mortgage loans serviced for others were $135.3 million and $139.5 million at December 31, 2008 and 2007, respectively. Servicing fee income, net of mortgage servicing rights amortization, totaled $82,000, $75,000 and $51,000 for the years ended December 31, 2008, 2007 and 2006.

The following table summarizes the changes in the carrying value of mortgage servicing rights (in thousands):

	2008		2007                                         2006
Balance at January 1	$	976	$	1,158	$	304
Additions		141		114		65
Amortization		(272)		(296)		(104)
Acquired from Bridge Street Financial, Inc.		—		—		893
Balance at December 31	$	845	$	976	$	1,158

The fair value of mortgage servicing rights was $1.0 million at December 31, 2008. Fair value at December 31, 2008 was determined using a discount rate of 8.50%, prepayment speed assumptions (PSA) ranging from 319% in the first year to 218% in the third year and servicing cost per loan of $55.

The estimated residual value of leased assets was $581,000 and $1.3 million at December 31, 2008 and 2007, respectively.

At December 31, 2008, the minimum future lease payments to be received from lease financings were as follows (in thousands):

Year ending December 31:
2009	$	38,898
2010		28,223
2011		20,064
2012		13,722
2013		5,813
Thereafter		10,971

Nonperforming loans and leases at December 31 are as follows (in thousands):

	2008		2007
Loans and leases 90 days past due and still accruing	$	126	$	39
Non-accrual loans and leases		4,352		6,667
Total nonperforming loans and leases	$	4,478	$	6,706

As of December 31, 2008 and 2007, impaired loans and leases totaled approximately $1.4 million and $4.2 million, respectively. The recorded investment in loans considered impaired for which there was a related valuation allowance for impairment included in the allowance for credit losses and the amount of such impairment allowance were $217,000 and $193,000, respectively, at December 31, 2008 and $4.2 million and $1.3 million, respectively, at December 31, 2007. The recorded investment in loans considered impaired for which there was no related valuation allowance for impairment was $1.2 million at December 31, 2008. The average recorded investment in impaired loans for 2008 and 2007 totaled $2.1 million and $4.7 million, respectively. During 2008 and 2007, there was no interest recognized on impaired loans while they were considered to be impaired. There were no loans that were considered to be impaired in 2006.

Changes in the allowance for credit losses for the years ended December 31 are summarized as follows (in thousands):

	2008		2007		2006
Balance at beginning of year	$	8,426	$	7,029	$	4,960
Loans and leases charged off		(5,639)		(3,227)		(2,390)
Recoveries		872		834		685
Provision for credit losses		5,502		3,790		2,477
Allowance acquired from Bridge Street Financial, Inc.		—		—		1,297
Balance at end of year	$	9,161	$	8,426	$	7,029

Directors and executive officers of the Company and their affiliated companies were customers of, and had other transactions with, the Company in the ordinary course of business during 2008. Loan transactions with related parties are summarized as follows (in thousands):

	2008
Balance at beginning of year	$	3,935
New loans and advances		851
Loan payments		(1,202)
Balance at end of year	$	3,584

54

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

4. Bank Premises, Furniture, and Equipment

Bank premises, furniture, and equipment at December 31 consist of the following (in thousands):

	2008		2007
Land	$	3,168	$	2,911
Bank premises		19,804		19,151
Furniture and equipment		24,218		26,184
Total cost		47,190		48,246
Less: Accumulated depreciation		25,988		26,686
	$	21,202	$	21,560

At December 31, 2008 and 2007, furniture and equipment included $1.3 million and $1.4 million, respectively, in equipment leased to others under operating leases and the related accumulated depreciation of $351,000 and $137,000 at December 31, 2008 and 2007, respectively. Depreciation expense on equipment leased to others totaled $226,000, $93,000 and $832,000 in 2008, 2007 and 2006, respectively.

At December 31, 2008, the minimum future lease payments to be received from equipment leased to others were as follows (in thousands):

Year ending December 31:
2009	$	248
2010		205
2011		255
2012		229
2013		245
Thereafter		51

5. Goodwill and Other Intangible Assets

The carrying value of goodwill was $32.1 million and $32.2 million at December 31, 2008 and 2007, respectively. The change in the carrying amount of goodwill is associated with purchase accounting adjustments. No goodwill impairment adjustments were recognized in 2008 or 2007. The carrying value of intangible assets decreased by $33,000 in 2008 due to the sale of a segment of the insurance agency customer list.

The following table summarizes the company’s intangible assets that are subject to amortization (in thousands):

	December 31, 2008
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Intangible Assets
Core deposit intangible	$	4,202	$	1,604	$	2,598
Non-compete covenant		894		670		224
Investment management intangible		10,089		1,932		8,157
Insurance agency customer intangible		909		360		549
Total	$	16,094	$	4,566	$	11,528
	December 31, 2007
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Intangible Assets
Core deposit intangible	$	4,202	$	936	$	3,266
Non-compete covenant		894		372		522
Investment management intangible		10,089		1,427		8,662
Insurance agency customer intangible		942		209		733
Total	$	16,127	$	2,944	$	13,183

55

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

5.  Goodwill and Other Intangible Assets (cont’d.)

Amortization expense for intangible assets for the next five years is estimated as follows (in thousands):

	Core Deposit     Intangible		Non-compete     Covenant		Investment     Management     Intangible		Insurance Agency     Customer Intangible	Total
2009	$	592	$	224	$	504	$    133	$	1,453
2010		516		—		504	116		1,136
2011		439		—		504	99		1,042
2012		363		—		504	81		948
2013		287		—		504	64		855
Thereafter		401		—		5,637	56		6,094

6. Deposits

Deposits consisted of the following at December 31 (in thousands):

	2008		2007
Non-interest-bearing checking	$	140,845	$	138,691
Interest-bearing checking		106,292		101,793
Savings accounts		88,242		82,326
Money market accounts		247,392		203,075
Time deposits		355,111		419,345
Total deposits	$	937,882	$	945,230

The following table indicates the maturities of the Company’s time deposits at December 31 (in thousands):

	2008		2007
Due in one year	$	255,645	$	314,436
Due in two years		59,391		76,093
Due in three years		9,757		19,653
Due in four years		18,082		3,120
Due in five years or more		12,236		6,044
Total time deposits	$	355,111	$	419,346

Total time deposits in excess of $100,000 as of December 31, 2008 and 2007 were $102.0 million and $117.0 million, respectively. Time deposits include $67.9 million and $89.2 million in accounts acquired through third party brokers at December 31, 2008 and 2007, respectively.

7. Borrowings

The following is a summary of borrowings outstanding at December 31 (in thousands):

	2008		2007
Short-term:
Federal Home Loan Bank (“FHLB”) overnight advances	$	34,700	$	15,500
FHLB advances		—		—
Repurchase agreements		40,495		52,780
Total short-term borrowings		75,195		68,280
Long-term:
FHLB advances		141,000		107,700
Repurchase agreements		22,777		24,777
Total long-term borrowings		163,777		132,477
Total borrowings	$	238,972	$	200,757

56

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

7.  Borrowings (cont’d.)

The following table sets forth certain information with respect to the overnight lines of credit, federal funds purchased and short term repurchase agreements (dollars in thousands):

	2008		2007		2006
FHLB overnight advances and short-term advances:
Maximum month-end balance	$	48,900	$	49,700	$	38,300
Balance at end of year		34,700		15,500		38,300
Average balance during the year		19,284		29,459		11,040
Weighted average interest rate at end of year		0.44%		4.11%		5.44%
Weighted average interest rate during the year		2.02%		5.26%		5.46%
Repurchase agreements:
Maximum month-end balance	$	45,667	$	58,617	$	46,152
Balance at end of year		40,495		52,780		41,998
Average balance during the year		43,400		49,456		38,898
Weighted average interest rate at end of year		0.15%		2.74%		3.95%
Weighted average interest rate during the year		1.34%		3.84%		4.47%

As of the dates indicated, the contractual amounts of FHLB long term advances mature as follows (dollars in thousands):

	December 31, 2008			December 31, 2007
Maturing	Amount		Weighted Average Rate	Amount		Weighted Average Rate
2008	$	—	—	$	16,700	4.72%
2009		31,000	4.10%		31,000	5.07%
2010		50,000	4.18%		40,000	4.53%
2011		15,000	3.47%		—	—
2012		10,000	3.54%		—	—
2013		15,000	4.08%		—	—
Thereafter		20,000	3.75%		20,000	3.75%
Total FHLB term advances	$	141,000	3.97%	$	107,700	4.57%

As of the dates indicated, the contractual amounts of long-term repurchase agreements mature as follows (in thousands):

	December 31, 2008			December 31, 2007
Maturing	Amount		Weighted Average Rate	Amount		Weighted Average Rate
2008	$	—	—	$	2,000	3.80%
2009		2,777	3.99%		2,777	3.99%
2010		—	—		—	—
2011		—	—		—	—
2012		—	—		—	—
2013		—	—		—	—
Thereafter		20,000	4.01%		20,000	4.01%
Total repurchase agreements	$	22,777	4.01%	$	24,777	3.99%

The Company has access to various credit facilities through the FHLB, including an overnight line of credit, a one-month line of credit, and a Term Advance Program, under which it can borrow at various terms and interest rates. All of the credit facilities are subject to meeting certain collateral requirements of the FHLB. In addition to pledging securities, the Company has also pledged, under a blanket collateral agreement, certain residential mortgage loans with balances at December 31, 2008 of $245.9 million. At December 31, 2008, the Company had borrowed $175.7 million against the pledged mortgages. At December 31, 2008, the Company had $70.2 million available under its various credit facilities with the FHLB.

The Company had a $151.8 million line of credit at December 31, 2008 with the Federal Reserve Bank of New York through its Discount Window. The Company has pledged indirect loans and securities totaling $183.4 million and $5.2 million, respectively, at December 31, 2008. At December 31, 2008 and 2007, the Company also had available $35.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2008 and 2007, respectively.

The Company offers retail repurchase agreements primarily to its larger business customers. Under the terms of the agreement, the Company sells investment portfolio securities to such customers agreeing to repurchase the securities on the next business day. The Company views the borrowing as a deposit alternative for its business customers. On December 31, 2008, the Company had securities with a market value of $53.1 million pledged as collateral for these agreements. The Company also has agreements with the Federal Home Loan Bank of New York (FHLB), and Bank approved brokers to sell securities under agreements to repurchase. At December 31, 2008, securities with a market value of $22.9 million were pledged against repurchase agreements in the amount of $22.8 million. All of these repurchase agreements at December 31, 2008 were transacted with the FHLB.

57

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

8. Junior Subordinated Obligations

On September 21, 2006, the Company formed a wholly-owned subsidiary, Alliance Financial Capital Trust II, a Delaware business trust. The Trust issued $15.0 million of 30-year floating rate Company-obligated pooled capital securities. The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest debentures having substantially similar terms. The capital securities mature in 2036, but may be redeemed at the Company’s option on predetermined dates with the first redemption date at par in five years. The capital securities of the trust are a pooled trust preferred fund of Preferred Term Securities XXIV, Ltd., and interest rates on the securities adjust quarterly based on the 3-month LIBOR plus 1.65% (3.65% at December 31, 2008). The Company guarantees all of the securities.

On December 19, 2003, the Company formed a wholly-owned subsidiary, Alliance Financial Capital Trust I, a Delaware business trust. The Trust issued $10.0 million of 30-year floating rate Company-obligated pooled capital securities. The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest debentures having substantially similar terms. The capital securities mature in 2034, but may be redeemed at the Company’s option on predetermined dates with the first redemption date at par in five years. The capital securities of the trust are a pooled trust preferred fund of ALESCO Preferred Funding II, Ltd., and interest rates on the securities adjust quarterly based on the 3-month LIBOR plus 2.85% (6.32% at December 31, 2008). The Company guarantees all of the securities.

The Company had a $310,000 investment in Trust I at December 31, 2008 and 2007 and a $464,000 investment in Trust II at December 31, 2008 and 2007.

The trusts are variable interest entities (“VIE’s”) as defined by FASB Interpretation No. 46 (“FIN 46 R”). The Company is not the primary beneficiary of the VIE’s and as such they are not consolidated in the Company’s financial statements in accordance with FIN 46R. Liabilities owed to the trusts, totaling $25.8 million, were reflected as liabilities in the consolidated balance sheets at December 31, 2008 and 2007, respectively.

9. Earnings Per Common Share

Basic and diluted net income per common share calculations for the years ended December 31 are as follows (in thousands, except share and per share amounts):

	2008		2007		2006
Basic
Net income	$	10,357	$	9,477	$	7,311
Less: Preferred stock dividends and discount accretion		47		—		—
Net income available to common shareholders		10,310		9,477		7,311
Average common shares outstanding		4,542,957		4,710,530		3,804,711
Earnings per common share — basic	$	2.27	$	2.01	$	1.92
Diluted
Net income	$	10,357	$	9,477	$	7,311
Less: Preferred stock dividends and discount accretion		47		—		—
Net income available to common shareholders		10,310		9,477		7,311
Average common shares outstanding		4,542,957		4,710,530		3,804,711
Incremental shares from assumed conversion of stock options and restricted stock		54,667		65,353		69,773
Average common shares outstanding — diluted		4,597,624		4,775,883		3,874,484
Earnings per common share — diluted	$	2.24	$	1.98	$	1.88

Basic earnings per share, after giving effect to preferred stock dividends and discount accretion, are computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding throughout each year. Diluted earnings per share gives the effect to weighted average shares which would be outstanding assuming the exercise of options and warrants using the treasury stock method. For the years ended December 31, 2008 and 2007, 66,055 and 1,000, respectively, anti-dilutive stock options were excluded from the diluted weighted average common share calculations.

58

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

10. Income Taxes

The provision for income taxes for the years ended December 31 is summarized as follows (in thousands):

	2008		2007		2006
Current tax expense
Federal	$	2,236	$	2,882	$	977
State		145		475		51
		2,381		3,357		1,028
Deferred tax (benefit) provision
Federal		422		(373)		491
State		17		(115)		243
		439		(488)		734
Total	$	2,820	$	2,869	$	1,762
A reconciliation between the statutory federal income tax rate and the effective income tax rate for the years indicated is as follows:
	2008		2007		2006
Statutory federal income tax rate		34.0%		34.0%		34.0%
State franchise tax, net of federal tax benefit		0.8%		1.9%		2.1%
Tax exempt interest income		(11.3%)		(11.4%)		(13.2%)
Tax exempt insurance income		(2.2%)		(1.8%)		(1.7%)
Other, net		0.1%		0.5%		(1.8%)
Total		21.4%		23.2%		19.4%

The components of deferred income taxes, included in other assets, at December 31, are as follows (in thousands):

	2008		2007
Assets:
Loans	$	445	$	606
Allowance for credit losses		3,509		3,260
Retirement benefits		1,336		1,468
Deferred compensation		2,616		2,317
Pension costs		1,200		—
Tax attribute carry-forwards		672		1,249
Incentive compensation plans		487		348
Covenant not to compete		255		275
Other		559		350
Total deferred tax assets		11,079		9,873
Liabilities:
Securities		87		178
Premises, furniture and equipment		510		521
Depreciation and leasing		3,319		3,169
Deferred fees		1,045		916
Intangible assets		1,326		1,804
Net unrealized gains on available-for-sale securities		1,813		577
Pension costs		—		170
Other		412		68
Total deferred tax liabilities		8,512		7,403
Net deferred tax asset at year-end	$	2,567	$	2,470

Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of the deferred tax liabilities, the level of historical taxable income, and the projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets will be deductible. Based on its assessment, management determined that no valuation allowance is necessary.

59

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

10.  Income Taxes (cont’d.)

The Company has the following tax attribute carry-forward benefits available as of December 31 (dollars in thousands)

	2008		Year(s) of Expiration
Federal:
Alternative Minimum Tax (AMT) Credit	$	672	None

The utilization of $480,000 of the AMT credit carry-forward is subject to annual limitations imposed by the Internal Revenue Code. The Company believes these limitations will not prevent the tax attribute from being utilized.

The Company has adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) effective January 1, 2007. There was no cumulative effect of adoption of FIN 48. At December 31, 2007 and 2008, the Company had approximately $163,000 and $173,000, respectively, of net unrecognized tax benefits and interest.

A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and the federal income tax benefit of unrecognized state tax benefits) is as follows (in thousands):

	2008		2007
Balance at January 1	$	180	$	134
Additions for tax positions of prior years		—		115
Reductions for tax positions of prior years		—		(69)
Balance at December 31	$	180	$	180

Included in the amount at December 31, 2008 and 2007, is $101,000 and $90,000, respectively, of unrecognized tax benefits and interest which would impact the Company’s effective tax rate, if recognized or reversed. As of December 31, 2008 and 2007, accrued interest related to uncertain tax positions was $27,000 and $17,000, respectively, net of the related tax benefit. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. Federal examination for tax years prior to 2005. The Company is no longer subject to State examination for tax years prior to 2004. The Company’s 2004-2006 New York income tax returns are currently under examination. Management does not anticipate the New York state examination will result in an unfavorable material change to its financial position. The Company does anticipate that a reduction in the unrecognized tax benefits of up to $60,000 may occur over the next twelve months from the settlement of examinations.

60

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

11. Accumulated Other Comprehensive Income (Loss)

A summary of activity in accumulated other comprehensive income (loss) follows (in thousands):

	2008		2007		2006
Effect from unrealized gains (losses) on securities available for sale
Accumulated unrealized gains (losses) on securities available-for-sale at January 1, net of tax	$	933	$	(998)	$	(1,644)
Net unrealized gains for the period, net of tax expense of $1,275 in 2008, $1,222 in 2007, and $445 in 2006		2,021		1,924		645
Reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit) of $53 in 2008, $(5) in 2007, and $(1) in 2006		(84)		7		1
Effect on other comprehensive income for the period		1,937		1,931		646
Accumulated unrealized gains (losses) on securities available-for-sale at December 31, net of tax	$	2,870	$	933	$	(998)
Effect from retirement benefit plans
Accumulated unrealized gains (losses) for retirement benefit plans at January 1, net of tax	$	272	$	(1,124)	$	(56)
Change in minimum pension liability		—		—		(74)
Amortization of prior service costs, net of tax benefit of $(4) in 2008 and $(6) in 2007		6		10		—
Amortization of net (gain) loss, net of tax expense (benefit) of $3 in 2008 and $(12) in 2007		(7)		18		—
Change in accumulated unrealized net (losses) gains for plan benefits, net of tax (benefit) expense of $(1,185) in 2008 and $292 in 2007		(1,839)		541		—
Change in unrecognized prior service cost, net of tax benefit $(185)		(292)		—		—
Post-retirement plan amendment, net of tax benefit $(521)		—		827		—
Effect on other comprehensive income for the period		(2,132)		1,396		(74)
Cumulative effect of change in accounting for pension obligations
Prior service costs, net of tax expense of $126 in 2006		—		—		(190)
Net loss, net of tax benefit of $25 in 2008 and $536 in 2006		(39)		—		(804)
		—		—		(994)
Accumulated unrealized (losses) gains for benefit obligations at December 31, net of tax	$	(1,899)	$	272	$	(1,124)
Accumulated other comprehensive income (loss) at January 1, net of tax		1,205		(2,122)		(1,700)
Other comprehensive (loss) income, net of tax		(195)		3,327		572
Cumulative effect of change in accounting for adoption of SFAS No. 158		(39)		—		(994)
Accumulated other comprehensive income (loss) at December 31, net of tax	$	971	$	1,205	$	(2,122)

12. Employee and Director Benefit Plans

Defined Contribution Plan

The Company provides retirement benefits through a defined contribution 401(k) plan that covers substantially all of its employees and former employees of Bridge Street. The Bridge Street defined contribution 401(k) plan was terminated on October 6, 2006 and all plan assets were transferred to the Company’s plan. Former Bridge Street employees’ service with Bridge Street at the time of the acquisition is deemed to be service with the Company for eligibility and vesting purposes only. Contributions to the Company’s 401(k) plan are determined by the Board of Directors and are based on percentages of compensation for eligible employees. Contributions are funded following the end of the plan (calendar) year. Company contributions to the plan were $484,000, $42,000, and $522,000 in 2008, 2007, and 2006, respectively.

Executive Incentive Retirement Plan

In 2008, the Company established an executive incentive retirement defined contribution plan (“Executive Plan”) which provides certain senior officers of Alliance Bank N.A. the opportunity to earn performance-based deferred cash bonuses, equal to 10% of the participant’s base salary, upon attainment by the Company of certain financial performance targets defined by the Board of Directors annually. The deferred balances earn interest at the Bank’s one-year rate for certificates of deposit. The deferred bonuses vest ratably over a five year period on the anniversary date of the bonus payment. Upon the participant’s separation from service (other than for cause), the Company pays the participant or his or her beneficiary either a lump sum or an annuity based on the amount of the vested benefit. At December 31, 2008, other liabilities included approximately $135,000 accrued under the Executive Plan.

61

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12.  Employee and Director Benefit Plans (cont’d.)

Defined Benefit Plan and Post-Retirement Benefits

The Company has a noncontributory defined benefit pension plan (“Pension Plan”) which it assumed from Bridge Street. The Pension Plan covers substantially all former Bridge Street full-time employees who met eligibility requirements on October 6, 2006, at which time all benefits were frozen. Under the Pension Plan, retirement benefits are primarily a function of both the years of service and the level of compensation. The amount contributed to the Pension Plan is determined annually on the basis of (a) the maximum amount that can be deducted for federal income tax purposes, or (b) the amount certified by an actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974.

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R). This Statement requires that defined benefit plan assets and obligations are to be measured as of the date of the employer’s fiscal year-end, starting in 2008. Through 2007, the Company utilized the early measurement date option available under FASB Statement No. 87 “Employers’ Accounting for Pensions”, and measured the funded status of the defined benefit plan assets and obligations as of October 1 each year. In accordance with the adoption provisions, the net periodic benefit cost for the period between the October 1 measurement date and the 2008 fiscal year end measurement were allocated proportionately between amounts to be recognized as an adjustment to retained earnings and net periodic benefit cost for the fiscal year. As a result of this adoption, the Company reduced January 1, 2008 opening retained earnings by $44,000, increased deferred income taxes by $25,000, increased the pension liability by $20,000 and credited accumulated other comprehensive income for $39,000.

Prior to September 30, 2007, post-retirement medical and life insurance benefits (“Post-Retirement Plan”) were available to full-time employees who had worked 15 years and attained age 55. Subsequent to the acquisition of Bridge Street, benefits for the Bridge Street active participants were converted to those under the Company’s plan. Retirees and certain active employees with more than 20 years of service to the Company continue to receive benefits in accordance with plans that existed at First National Bank of Cortland and Oneida Valley National Bank, prior to the merger of the banks in 1999. At September 30, 2007, the Company settled (the “Settlement”) the post-retirement benefits for certain active participants that met age and service criteria at that time. In addition, a negative plan amendment (“Negative Amendment”) was adopted for all other active participants who did not meet the age and service criteria. The Settlement and the Negative Amendment eliminated post-retirement benefits for all active employees. The only remaining participants in the Post-Retirement Plan after September 30, 2007 are retired participants and their spouses, if applicable.

In connection with the Settlement of the Post-Retirement Plan, the Company recorded a deferred gain of $517,000, representing the difference between the accrued accumulated benefit obligation of $966,000 and the lump sum payments to the qualifying participants of $449,000. This gain was offset against existing unrecognized losses recorded in accumulated other comprehensive income. Unrealized losses in excess of 10% of the accumulated projected benefit obligation are amortized on a straight line basis over the expected future lifetime of the retiree group. No payments were made to participants in connection with the Negative Amendment. The Company reversed the accrued accumulated benefit obligation of $831,000 as of September 30, 2007 through accumulated other comprehensive income. The remaining balance of unrecognized prior service benefit of $651,000 will be amortized on a straight line basis over 15 years.

The following table represents a reconciliation of the change in the benefit obligation, plan assets and funded status of the Pension Plan and Post-Retirement Plan at December 31(using a measurement date of October 1 in 2007 for the Pension Plan and December 31 for the Post-Retirement Plan and the Pension Plan in 2008):

	Pension Plan				Post-Retirement Plan
	2008		2007		2008		2007
Change in benefit obligation:		(In thousands)
Benefit obligation at beginning of year	$	4,192	$	4,150	$	3,935	$	6,060
Service cost		—		—		—		133
Interest cost		257		239		241		322
Actuarial loss (gain)		625		21		240		(462)
Benefits paid		(274)		(218)		(314)		(799)
Participant contributions		—		—		27		29
Adjustment for measurement date change		64		—		—		—
Settlement gain		—		—		—		(517)
Plan amendment		—		—		—		(831)
Benefit obligation at end of year		4,864		4,192		4,129		3,935
Change in plan assets:
Fair value of plan assets at the beginning of the year		4,914		4,524		—		—
Actual return on plan assets		(1,395)		608		—		—
Benefits paid		(274)		(218)		(314)		(799)
Participant contributions		—		—		27		29
Employer contributions		—		—		287		770
Fair value of plan assets at the end of year		3,245		4,914		—		—
Funded status at end of year	$	(1,619)	$	722	$	(4,129)	$	(3,935)

62

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12.  Employee and Director Benefit Plans (cont’d.)

Pre-tax amounts recognized in accumulated other comprehensive income (loss) at December 31 that has not been recognized as components of net periodic benefit or cost consist of:

	Pension Plan				Post-Retirement Plan
	2008		2007		2008		2007
	(In thousands)
Unrecognized actuarial loss (gain)	$	2,372	$	(188)	$	(607)	$	289
Unrecognized prior service cost (benefit)		—		—		529		(651)
	$	2,372	$	(188)	$	(78)	$	(362)

The composition of the plan’s net periodic (benefit) cost for the years ended December 31 is as follows:

	Pension Plan				Post-Retirement Plan
	2008		2007		2008		2007		2006
	(In thousands)
Service cost	$	—	$	—	$	—	$	133	$	121
Interest cost		257		239		241		322		284
Amortization of unrecognized prior service cost		—		—		(44)		6		23
Amortization of unrecognized actuarial loss		—		—		—		30		56
Expected return on assets		(433)		(399)		—		—		—
Total net periodic (benefit) cost	$	(176)	$	(160)	$	197	$	491	$	484

The estimated prior service benefit for the Post-Retirement Plan that is expected to be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $44,000. The estimated unrecognized actuarial loss for the Pension Plan and Post-Retirement Plan that is expected to be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $165,000 and $8,000, respectively.

The following weighted average assumptions were used to determine benefit obligations for these plans:

	Pension Plan		Post-Retirement Plan
	2008	2007	2008	2007
Discount rate	5.87%	6.29%	5.77%	6.38%
Expected return on plan assets	9.00%	9.00%	—	—

The following weighted average assumptions were used to determine net periodic (benefit) cost for the years ended December 31:

	Pension Plan		Post-Retirement Plan
	2008	2007	2008	2007	2006
Discount rate	6.29%	5.90%	6.38%	6.00%	5.50%
Expected return on plan assets	9.00%	9.00%	—	—	—

The discount rates used in determining the benefit obligations for the Pension Plan and Post-Retirement Plan as of December 31, 2008, 2007 and 2006 were based upon the Citibank pension liability index. The Citibank pension liability index was determined to appropriately reflect the rate at which the Pension Plan and Post-Retirement Plan obligations could be effectively settled, based upon the expected duration of each plan.

Pension Plan assets are invested in six diversified investment funds of the RSI Retirement Trust (the “Trust”), a no load series open-ended mutual fund. The investment funds include four equity mutual funds and two bond mutual funds, each with its own investment objectives, investment strategies and risks, as detailed in the Trust’s prospectus. The Trust has been given discretion by the Plan Sponsor to determine the appropriate strategic asset allocation versus plan liabilities, as governed by the Trust’s Statement of Investment Objectives and Guidelines (the “Guidelines”).

The long-term investment objective is to be invested 65% in equity securities (equity mutual funds) and 35% in debt securities (bond mutual funds). If the Pension Plan is underfunded under the Guidelines, the bond fund portion will be temporarily increased to 50% in order to lessen asset value volatility. When the Pension Plan is no longer underfunded, the bond fund portion will be decreased back to 35%. Asset rebalancing is performed at least annually, with interim adjustments made when the investment mix varies more than 10% from the target (i.e., a 20% target range).

The Pension Plan’s investment goal is to achieve investment results that will contribute to the proper funding of the Pension Plan by exceeding the rate of inflation over the long-term. In addition, investment managers for the Trust are expected to provide above average performance when compared to their peer managers. Performance volatility is also monitored. Risk/volatility is further managed by the distinct investment objectives of each of the Trust funds and the diversification within each fund.

63

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12. Employee and Director Benefit Plans (cont’d.)

The Pension Plan’s weighted-average asset allocations by asset category at December 31 are as follows:

Asset Category	2008	2007
Equity securities	59%	70%
Debt Securities (Bond Mutual Funds)	41%	30%
Total	100%	100%

The Pension Plan’s long-term rate-of-return-on-assets assumption was set based on historical returns earned by equities and fixed income securities, adjusted to reflect expectations of future returns as applied to the plan’s target allocation of asset classes. Equities and fixed income securities were assumed to earn real rates of return in the ranges of 5-9% and 2-6%, respectively. The long-term inflation rate was estimated to be 3%. When these overall return expectations are applied to the Pension Plan’s target allocation, the result is an expected rate of return of 7% to 11%.

Due to recent changes in pension funding law and sharp declines in market asset values, a reasonable estimate of expected contributions cannot be determined at this time.

For measurement purposes, with respect to the Post-Retirement Plan, a 10.0% annual rate of increase in the per capita cost of covered health care benefits is assumed for 2008. The rate is assumed to decrease gradually to 4.5% by the year 2016 and remain at that level thereafter.

Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend rates would have the following effects on the Post-Retirement Plan (in thousands):

	One Percentage     Point Increase	One Percentage     Point Decrease
Effect on total of service and interest cost	$    14	$    (12)
Effect on post-retirement benefit obligations	247	(215)

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid from the Pension Plan (in thousands):

Year ending December 31:
2009	$	221
2010		219
2011		255
2012		253
2013		259
Years 2014-2018		1,347

The following healthcare benefits are expected to be paid under the Post-Retirement Plan (in thousands):

Year ending December 31:
2009	$	312
2010		335
2011		348
2012		346
2013		340
Years 2014-2018		1,549

The above benefit payments include expected life insurance claims, rather than the premiums that the Company is paying to provide the life insurance.

Directors Retirement Plan

In 2008, the Company established a noncontributory defined benefit plan for non-employee directors (“Directors Plan”). The Directors Plan provides for a cash benefit equivalent to 35% of their average annual director’s fees, subject to increases based on the directors’ length and extent of service, payable in a number of circumstances, including normal retirement, death or disability and a change in control.

64

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12. Employee and Director Benefit Plans (cont’d.)

The following table represents a reconciliation of the change in the benefit obligations, plan assets and funded status of the Directors Plan at December 31:

	2008
Change in benefit obligation:	(in thousands)
Benefit obligation at beginning of year	$	—
Service cost		27
Interest cost		14
Prior service cost		477
Benefit obligation at end of year	$	518
Plan assets		—
Funded status at end of year	$	(518)

Pre-tax amounts recognized in accumulated other comprehensive income at December 31, 2008 that have not been recognized as components of net periodic benefit or cost consist of:

	2008
	(in thousands)
Unrecognized actuarial (gain) loss	$	—
Unrecognized prior service cost		454
	$	454

The composition of the Directors Plan’s net periodic cost for the year ended December 31 is as follows (in thousands):

	2008
	(in thousands)
Service cost	$	27
Interest cost		14
Amortization of unrecognized prior service cost		24
Total net periodic cost	$	65

The discount rate used in determining the benefit obligation for the Directors Plan as of December 31, 2008 was 5.87%. The discount rate used to determine benefit obligations for the Directors Plan was based upon the Citibank pension liability index. The Citibank pension liability index was determined to appropriately reflect the rate at which the pension liabilities could be effectively settled based upon the expected duration of the Directors Plan. Directors’ fees were assumed to increase at an annual rate of 3.00%.

The following directors’ retirement benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands):

Year ending December 31:
2009	$	—
2010		—
2011		—
2012		33
2013		49
Years 2014-2018		317

In 2009, $46,000 in unrecognized prior service costs are estimated to be amortized from accumulated other comprehensive income into the net periodic cost for the Directors’ Plan.

Supplemental Retirement Plans

The Company has supplemental executive retirement plans (“SRP’s”) for certain current and former employees. Included in other assets, the Company has segregated assets of $174,000 and $332,000 at December 31, 2008 and 2007, respectively, to fund the estimated benefit obligation associated with certain SRP plans.

65

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12.  Employee and Director Benefit Plans (cont’d.)

The following table represents a reconciliation of the change in the benefit obligations, plan assets and funded status of the SRP’s at December 31:

	2008	2007
Change in benefit obligation:	(In thousands)
Benefit obligation at beginning of year	$     3,334	$     3,535
Service cost	61	57
Interest cost	199	192
Actuarial loss (gain)	262	(53)
Benefits paid	(390)	(397)
Benefit obligation at end of year	3,466	3,334
Change in plan assets:
Benefits paid	(390)	(397)
Employer contributions	390	397
Fair value of plan assets at the end of year	—	—
Funded status at end of year	$   (3,466)	$   (3,334)

Pre-tax amounts recognized in accumulated other comprehensive income at December 31, 2008 that has not been recognized as components of net periodic benefit or cost consist of:

	2008	2007
	(In thousands)
Unrecognized actuarial loss (gain)	$    243	$   (10)
Unrecognized prior service cost	111	121
	$    354	$    111

The composition of the SRP’s net periodic cost for the years ended December 31 is as follows (in thousands):

	2008	2007	2006
	(In thousands)
Service cost	$      61	$      57	$      64
Interest cost	199	192	83
Amortization of unrecognized prior service cost	10	10	81
Amortization of unrecognized actuarial loss	9	—	251
Total net periodic cost	$    279	$    259	$    479

The Company amortizes unrecognized gain or losses and prior service costs in the SRP’s on a straight line basis over the future working lifetime of the participant expected to receive benefits under the plan. In the year of a participant’s retirement, any unrecognized gains or losses and prior service costs are fully recognized. Future unrecognized gains or losses arising after retirement are amortized over the participant’s remaining life expectancy. The compensation expense resulting from the full recognition of unrecognized losses and prior service costs totaled $319,000 in 2006. There was no such expense in 2008 and 2007.

The discount rate used in determining the benefit obligation of the SRP’s as of December 31, 2008 and 2007 was 5.77% and 6.38%, respectively. The discount rate used in determining the net periodic benefit cost was 6.38%, 5.80%, and 5.50% for 2008, 2007 and 2006, respectively. The discount rate used to determine benefit obligations for the plans was based upon the Citibank pension liability index. The Citibank pension liability index, less an adjustment of 10 basis points, was determined to appropriately reflect the rate at which the pension liabilities could be effectively settled, based upon the expected duration of the plans. For measurement purposes in 2008 and 2007, with respect to the SRP’s, an 8.5% annual rate was assumed as the investment return on account balances and salaries were assumed to increase at an annual rate of 4.0%.

The following SRP payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands):

Year ending December 31:
2009	$	262
2010		261
2011		251
2012		249
2013		246
Years 2014-2018		1,741

In 2009, $10,000 in unrecognized prior service costs and $10,000 in unrecognized actuarial losses are estimated to be amortized from accumulated other comprehensive income into the net periodic cost for the SRP’s.

66

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

12. Employee and Director Benefit Plans (cont’d.)

The Company assumed a SRP for directors from Bridge Street, providing for extended compensation after retirement. Cash surrender value of these policies approximated $6.9 million and $6.7 million at December 31, 2008 and 2007, respectively. At December 31, 2008 and 2007 other liabilities include approximately $679,000 and $708,000, respectively, accrued under the directors’ SRP from Bridge Street. Deferred compensation expense related to the SRP from Bridge Street for the year ended December 31, 2008 and 2007 approximated $66,000 and $69,000, respectively.

The Company expects to contribute $356,000 to its SRP’s in 2009.

13. Directors’ Deferred Compensation

In March 2008, the Company’s Board of Directors approved a stock-based deferral plan which provides directors and officers designated by the Board of Directors the opportunity to defer receipt of cash compensation and, thereby, accumulate additional shares of the Company’s common stock. The Company contributes the amount of compensation deferred to a trust, which purchases shares of the Company’s common stock, and distributions are made in shares of the Company’s common stock upon such events as are elected by participants. Dividends paid on shares are also converted to common stock. Upon adoption of the plan, certain directors transferred their balances from the prior deferred compensation plan to the stock-based deferral plan. The total amount transferred was $1.9 million which converted into 76,817 shares at an average share price of $24.57. At December 31, 2008, 85,510 shares are held in trust with a cost basis of $2.1 million.

The Company maintained an optional deferred compensation plan for its directors, whereby fees normally received were deferred and paid by the Company upon the retirement of the director. In March 2008, active directors transferred their plan balances into the stock-based deferred compensation plan and the remaining liability consists of the retired directors balances. At December 31, 2008 and 2007, other liabilities included approximately $580,000 and $2.5 million, respectively, relating to deferred compensation. Deferred compensation expense resulting from the earnings on deferred balances for the years ended December 31, 2008, 2007, and 2006 approximated $76,000, $342,000, and $319,000, respectively.

The Company assumed a nonqualified deferred compensation plan for former directors of Bridge Street, under which participants were eligible to elect to defer all or part of their annual director fees. The plan provides that deferred fees are to be invested in mutual funds, as selected by the individual directors. Deferrals under the plan were discontinued effective with the acquisition of Bridge Street. At December 31, 2008 and 2007, deferred director fees included in other liabilities, and the corresponding assets included in other assets, aggregated approximately $485,000 and $767,000, respectively.

14. Stock Based Compensation Plans

The Company has a long-term incentive compensation plan (the “Plan”) authorizing the use of 550,000 shares of authorized but unissued common stock of the Company. The purpose of the Plan is to promote the interests of the Company by providing current and future officers, directors and key employees with an equity or equity-based interest in the Company, so that the interests of such individuals will be closely associated with the interests of shareholders. Pursuant to this Plan, eligible individuals may receive incentive stock options, non-qualified stock options, and/or restricted stock awards.

There were 182,555 options outstanding at December 31, 2008, of which 166,555 of the options were issued with a 10-year term, vesting one year after the issue date, and exercisable based on the Company achieving specified stock prices. 15,000 options were issued with a 10-year term and vest ratably over a three-year period. 1,000 options were issued with a five-year term and vested on issuance. No options were granted during 2008, 2007 and 2006.

Compensation expense recognized for stock options was $1,800 and $28,000 net of a tax benefit of $1,200 and $18,000 during 2008 and 2007. As of December 31, 2008, there was no remaining unrecognized compensation cost related to non-vested stock option awards. The company generally uses authorized but unissued shares to satisfy stock option exercises.

Stock option activity in the plan for the years ended December 31 was as follows:

	2008
	Shares	Weighted Average         Exercise Price
Outstanding at beginning of year	182,555	$    21.77
Granted	—
Vested	—
Exercised	—
Forfeited	—
Outstanding at end of year	182,555	$    21.77

67

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

14. Stock Based Compensation Plans (cont’d)

The following table summarizes the Company’s stock options at December 31, 2008:

	Options Outstanding			Options Exercisable
Range of Exercise                 Prices	Options Outstanding	Weighted Average Exercise Price	Weighted Average Remaining Life (Years)	Options Exercisable	Weighted Average Exercise Price
$17.75 - $19.00	75,500	$18.28	1.3	75,500	$18.28
$21.75 - $23.50	41,000	$23.29	2.7	41,000	$23.29
$24.75 - $28.65	66,055	$24.81	1.1	38,782	$24.85

The total intrinsic value of options exercised during 2007 and 2006 was $66,000 and $408,000, respectively. The aggregate intrinsic value of shares outstanding and exercisable at December 31, 2008 was $426,000. Cash received from options exercised was $178,000 and $1.1 million in 2007 and 2006, respectively. The tax benefit realized from stock option exercised was $26,000 and $120,000 in 2007 and 2006, respectively. No options were exercised in 2008.

Restricted stock awards are recorded as deferred compensation, a component of stockholders’ equity, at fair value at the date of the grant and amortized to compensation expense over the specified vesting periods. These shares become vested at the end of a 7-year period. No shares were vested in 2008. Furthermore, 50% of the shares awarded, to all grantees except the Company’s Chief Executive Officer, become vested on the date, at least three years after the award date, that the Company’s stock price has closed at a price that is at least 160% of the award price for 15 consecutive days. Compensation expense associated with the amortization of the cost of all restricted shares issued for the years ended December 31, 2008, 2007 and 2006 was $359,000, $241,000, and $213,000, respectively. The unrecognized compensation cost for restricted stock awards was $1.3 million at December 31, 2008, which will be recognized as compensation expense over a weighted average period of 4.3 years.

The following is a summary of the Company’s restricted stock activity for the years ended December 31, 2008, 2007 and 2006:

	2008		2007		2006
	Non-vested   Shares	Weighted Average   Grant Price	Non-vested   Shares	Weighted Average   Grant Price	Non-vested   Shares	Weighted Average   Grant Price
Outstanding at beginning of year	74,175	$30.95	67,375	$31.06	62,775	$31.00
Granted	15,500	25.19	16,950	30.88	26,500	30.81
Forfeited	3,575	26.55	10,150	31.44	(19,995)	30.67
Vested	—	—	—	—	(1,905)	30.21
Outstanding at end of year	86,100	$30.32	74,175	$30.95	67,375	$31.06

15. Commitments and Contingent Liabilities

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and letters of credit which involve, to varying degrees, elements of credit risk in excess of amounts recognized in the consolidated statements of condition. The contract amount of those commitments and letters of credit reflects the extent of involvement the Company has in those particular classes of financial instruments. The Company’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of the instruments. The Company uses the same credit policies in making commitments and letters of credit as it does for on-balance-sheet instruments.

Financial instruments whose contract amounts represent credit risk (in thousands):

	Contract Amount
	2008	2007	2006
Commitments to extend credit, variable	$    129,818	$    122,099	$    127,590
Commitments to extend credit, fixed	32,782	30,955	7,587
Standby letters of credit	1,572	1,289	2,663

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payments of a fee. Since some of the commitment amounts are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. Since the

68

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

15. Commitments and Contingent Liabilities (cont’d)

letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. For both commitments to extend credit and standby letters of credit, the amount of collateral obtained, if deemed necessary by the Company upon the extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies, but includes residential and commercial real estate.

The Company leases office space and certain branches under noncancelable operating lease agreements having initial terms which expire at various dates through 2025. Total rental expense was approximately $1.2 million in 2008, $1.0 million in 2007, and $982,000 in 2006.

Minimum rental payments under the initial terms of these leases are summarized as follows (in thousands):

Year ending December 31:
2009	$  1,113
2010	967
2011	945
2012	549
2013	456
Thereafter	3,033
Total minimum lease payments	$  7,063

The Bank entered into an agreement in 2005 with Onondaga County whereby the Bank obtained the naming rights to a sports stadium in Syracuse, NY for a 20-year term. Under the agreement, the Bank paid $152,000 in 2008, $120,000 in 2007, and $75,000 in 2006, and will pay $152,000 annually from 2009 through 2024.

The Company is required to maintain a reserve balance as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 2008 was $600,000.

FASB Interpretation No. 47 (FIN 47) issued in March 2005 clarified that the term conditional retirement obligation as used in FASB Statement No. 143 (FAS 143), Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the Company. The Company is required to recognize a liability for the fair value of a conditional asset retirement obligation when it is incurred, generally upon acquisition, construction, or development and (or) through the normal operation of the asset, and if the fair value of the liability can be reasonably estimated. FAS 143 acknowledges that in some cases sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation. The Company acknowledges that some of its facilities were constructed years ago when asbestos was used for insulation and other construction purposes. Regulations are now in place that require the Company to handle and dispose of asbestos in a special manner if major renovations or demolition of a facility are to be completed. The Company does not believe that it has sufficient information to estimate the fair value of the obligation at this time since any major renovations or demolition of any of its facilities have not been planned and would occur at an unknown future date. Accordingly, the Company has not recognized a liability or a contingent liability in connection with potential future costs to remove and dispose of asbestos from its facilities.

16. Dividends and Restrictions

The primary source of cash to pay dividends to the Company’s shareholders is through dividends from its banking subsidiary. The Federal Reserve Board and the Office of the Comptroller of the Currency are authorized to determine certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank’s capital base could be deemed to constitute such an unsafe or unsound practice. Banking organizations may generally only pay dividends from the combined current year and prior two years’ net income less any dividends previously paid during that period. At December 31, 2008, approximately $13.8 million was available for the declaration of dividends by the Bank. There were no loans or advances from the subsidiary Bank to the Company at December 31, 2008.

Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

69

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

17. Fair Value of Financial Instruments

Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets Measured on a Recurring Basis

The fair values of debt securities available-for-sale are determined by obtaining matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value of mutual fund securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges.

Assets measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at December 31, 2008 Using
	Fair Value at December 31, 2008			Quoted market prices in active     markets for identical assets (Level 1)		Significant other observable inputs (Level 2)
				(in thousands)
Available for sale securities		$	299,149		$        988		$            298,161

Assets Measured on a Non-Recurring Basis

Loans held-for-sale – The fair value of loans held-for-sale is determined, when possible, using quoted secondary-market prices. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan.

Leases held-for-sale – The fair value of leases held-for-sale is primarily determined using an unadjusted quoted price for those leases, when available. If no such quoted price exists, the fair value of a lease is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that lease.

Mortgage servicing rights – The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would used in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness.

Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace and the related non-recurring fair value measurement adjustments have generally been classified as Level 2. Estimates of fair value used for other collateral supporting commercial loans generally are not observable in the marketplace and therefore, such valuations have been classified as Level 3.

The following represents impairment charges recognized during 2008:

During the first quarter of 2008, loans and leases held-for-sale were carried at a fair value of $15.1 million (of which $10.6 million, $3.8 million and $800,000 were measured using Level 1, Level 2 and Level 3 inputs, respectively within the fair value hierarchy), resulting in a valuation allowance of $187,000. There are no leases held for sale at December 31, 2008. During the first quarter of 2008, losses of $187,000 were recorded in other income.

Loans subject to non-recurring fair value measurement using Level 3 inputs had a gross carrying amount of $1.4 million with an associated valuation allowance of $193,000 for a fair value of $1.3 million. Impairment write-downs during 2008 resulted in $2.0 million in charges to the allowance for credit losses.

70

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

17. Fair Value of Financial Instruments (cont’d)

The carrying amounts and estimated fair values of financial instruments, not previously presented, at December 31 are as follows (in thousands):

	2008				2007
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	$	21,172	$	21,172	$	30,704	$	30,704
Fed funds sold		26,918		26,918		—		—
FHLB and FRB stock		11,844		N/A		9,507		N/A
Loans held for sale		875		875		3,163		3,163
Loans and leases, net of unearned income		910,755		930,920		895,533		890,990
Allowance for credit losses		(9,161)		—		(8,426)		—
Net loans and leases		901,594		930,920		887,107		890,990
Accrued interest receivable		4,218		4,218		4,501		4,501
Financial Liabilities:
Deposits	$	937,882	$	943,182	$	945,230	$	945,563
Borrowings		238,972		241,421		200,757		199,176
Junior subordinated obligations		25,774		20,792		25,774		25,774
Accrued interest payable		3,037		3,037		3,903		3,903

The fair value of commitments to extend credit and standby letters of credit is not significant.

The Company’s fair value estimates are based on our existing on and off balance sheet financial instruments without attempting to estimate the value of any anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on our fair value estimates and have not been considered in these estimates.

The fair value estimates are made as of a specific point in time, based on relevant market information and information about the financial instruments, including our judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in our assumptions could significantly affect the estimates.

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and Cash Equivalents

The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets’ fair value.

Fed Funds Sold

The carrying amount reported in the consolidated balance sheet for Fed Funds Sold approximate the assets’ fair value.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its transferability.

Loans and Leases

Variable-rate loans reprice as the associated rate index changes. Therefore, the carrying value of these loans approximates fair value. The fair value of our fixed-rate loans and leases were calculated by discounting scheduled cash flows through the estimated maturity using current origination rates, credit adjusted for delinquent loans and leases. Our estimate of maturity is based on the contractual cash flows adjusted for prepayment estimates based on current economic and lending conditions. The fair value of accrued interest approximates carrying value.

Deposits

The fair values disclosed for non-interest-bearing accounts and accounts with no stated maturity are, by definition, equal to the amount payable on demand at the reporting date. The fair value of time deposits was estimated by discounting expected monthly maturities at interest rates approximating those currently being offered at the FHLB on similar terms. The fair value of accrued interest approximates carrying value.

Borrowings

The fair value of borrowings are estimated using discounted cash flow analysis, based on interest rates approximating those currently being offered for borrowings with similar terms.

71

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

17. Fair Value of Financial Instruments (cont’d)

Junior Subordinated Obligations

The fair value of trust preferred debentures has been estimated using a discounted cash flow analysis.

Off-balance-sheet Instruments

Off-balance-sheet financial instruments consist of commitments to extend credit and standby letters of credit, with fair value based on fees currently charged to enter into agreements with similar terms and credit quality. Amounts are not significant.

18. Capital and Regulatory Matters

Capital Requirements

The Company and its banking subsidiary are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and its subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined). The leverage ratio (as defined in the regulations) reflects Tier 1 capital divided by the average total assets for the period. Average assets used in the calculation exclude the Company’s intangible assets.

The capital levels at the Company’s subsidiary bank are maintained at or above the well-capitalized minimums of 10%, 6% and 5% for the total risk-based, Tier 1 capital, and leverage ratio, respectively. As of December 31, 2008, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.

The Company’s regulatory capital measures are presented in the following table (dollars in thousands):

	Actual		For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of December 31, 2008
Total risk-based capital
Company	$133,962	15.08%	$71,047	³8.00%	N/A	N/A
Bank	124,941	14.19%	70,415	³8.00%	88,019	³10.00%
Tier 1 capital
Company	124,801	14.05%	35,523	³4.00%	N/A	N/A
Bank	115,780	13.15%	35,207	³4.00%	52,811	³6.00%
Leverage
Company	124,801	9.59%	52,064	³4.00%	N/A	N/A
Bank	115,780	8.97%	51,657	³4.00%	64,571	³5.00%
As of December 31, 2007
Total risk-based capital
Company	$102,311	11.59%	$70,610	³8.00%	N/A	N/A
Bank	99,024	11.30%	70,098	³8.00%	87,622	³10.00%
Tier 1 capital
Company	93,885	10.64%	35,305	³4.00%	N/A	N/A
Bank	90,598	10.34%	35,049	³4.00%	52,573	³6.00%
Leverage
Company	93,885	7.53%	49,899	³4.00%	N/A	N/A
Bank	90,598	7.26%	49,905	³4.00%	62,382	³5.00%

Preferred Stock and Warrants under the U.S. Treasury’s Capital Purchase Plan

In December 2008, the Treasury Department purchased 26,918 shares of the Company’s newly issued, non-voting senior cumulative preferred stock valued at $26.9 million, with an initial annual dividend of 5% for five years and 9% thereafter. Dividends are accrued as earned by the Treasury Department. The preferred stock may not be redeemed for a period of three years from the date of the investment, except with the proceeds from a “qualified equity offering”. After the third anniversary of the date of this investment, the preferred stock may be redeemed, in whole or in part, at any time, at the option of the Company. The preferred stock qualifies as Tier 1 capital for regulatory reporting purposes.

72

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

18. Capital and Regulatory Matters (cont’d.)

The American Recovery and Reinvestment Act of 2009 (“ARRA”) provides an opportunity for TARP recipients to immediately repay a TARP financing assistance without first needing to raise any funds, subject to the consultation by the Treasury Department with the appropriate federal banking agency. The nature of the consultation process is not defined under the ARRA, and banking regulators might seek to require a withdrawing TARP recipient to raise additional funds from third parties if the regulators determine that there are not otherwise sufficient capital reserves. Under repayment, the Treasury Department is required to liquidate any warrants it received from the Company.

The Treasury Department’s consent is required for any increase in common dividends per share and any repurchases of common stock until the earlier of a redemption or third anniversary of the date of the preferred stock issuance.

The Treasury Department also received warrants to purchase 173,069 shares of the Company’s common stock with an exercise price of $23.33 per share representing an aggregate market price of $4.0 million or 15% of the preferred stock investment. The warrants are immediately exercisable and expire in ten years. The Company allocated $1.1 million of the proceeds from the issuance of the preferred stock to the value of the warrants representing an unamortized discount on preferred stock. The discount is being amortized to preferred stock using an effective yield method over a five year period. $6,000 of the discount was accreted to preferred stock during 2008.

19. Parent Company Financial Information

Condensed financial statement information of Alliance Financial Corporation for the years ended December 31 is as follows (in thousands):

Condensed Balance Sheets

Assets:	2008		2007
Investment in subsidiaries	$	160,770	$	135,308
Cash		4,927		1,504
Securities		1,512		1,538
Investment in limited partnerships		2,350		2,110
Other Assets		2,081		2,215
Total Assets	$	171,640	$	142,675
Liabilities:
Junior subordinated obligations	$	25,774	$	25,774
Dividends payable		1,232		1,135
Other liabilities		153		206
Total Liabilities		27,159		27,115
Shareholders’ Equity:
Preferred stock		25,785		—
Common stock		4,901		4,889
Surplus		42,468		38,847
Undivided profits		81,110		75,844
Accumulated other comprehensive income		971		1,205
Directors’ stock-based deferred compensation plan		(2,098)		—
Treasury stock		(8,656)		(5,225)
Total Shareholders’ Equity		144,481		115,560
Total Liabilities and Shareholders’ Equity	$	171,640	$	142,675

Condensed Statements of Income

	2008		2007		2006
Dividend income from subsidiary Bank	$	9,500	$	7,600	$	—
Interest and dividends on securities		43		58		58
Income from limited partnerships		202		230		100
Interest expense on junior subordinated debentures		(1,399)		(1,960)		(1,139)
Non-interest expenses		(129)		(101)		(87)
		8,217		5,827		(1,068)
Equity in undistributed income of subsidiaries		2,140		3,650		8,379
Net Income	$	10,357	$	9,477	$	7,311

73

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

19. Parent Company Financial Information (cont’d.)

Condensed Statements of Cash Flows

	2008		2007		2006
Operating Activities:
Net Income	$	10,357	$	9,477	$	7,311
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiary		(2,140)		(3,650)		(8,379)
Depreciation expense		116		89		24
Net change in other assets and liabilities		114		270		3,590
Net cash provided by operating activities		8,447		6,186		2,546
Investing Activities:
Purchase of securities available-for-sale		(23)		—		(464)
Acquisition		—		—		(13,171)
Net cash used in investing activities		(23)		—		(13,635)
Financing Activities:
Proceeds from issuing subordinated debentures		—		—		15,464
Treasury stock purchased		(3.431)		(2,314)		(3,407)
Proceeds from the exercise of stock options		—		178		1,127
Issuance of preferred stock		26,918		—		—
Capital contribution to subsidiary		(23,918)		(660)		—
Cash dividends paid		(4,570)		(4,213)		(3,111)
Net cash (used in) provided by financing activities		(5,001)		(7,009)		10,073
Increase (decrease) in cash and cash equivalents		3,423		(823)		(1,016)
Cash and cash equivalents at beginning of year		1,504		2,327		3,343
Cash and cash equivalents at end of year	$	4,927	$	1,504	$	2,327
Supplemental Disclosures of Cash Flow Information:
Non-cash financing activities:
Dividend declared and unpaid	$	1,191	$	1,135	$	1,057

On October 26, 2001 the Company’s Board of Directors adopted a shareholders’ rights plan. Under the plan, Series A Junior Participating Preferred Stock Purchase Rights were distributed at the close of business on October 29, 2001 to shareholders of record as of that date. The Rights trade with the Common Stock, and are exercisable and trade separately from the Common Stock only if a person or group acquires or announces a tender or exchange offer that would result in such person or group owning 20% or more of the Common Stock of the Company. In the event the person or group acquires a 20% Common Stock position, the Rights allow other holders to purchase stock of the Company at a discount to market value. The Company is generally entitled to redeem the Rights at $.001 per Right at any time prior to the 10th day after a person or group has acquired a 20% Common Stock position. The Rights will expire on October 29, 2011 unless the plan is extended or the Rights are earlier redeemed or exchanged.

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Item 9 — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable

Item 9A — Controls and Procedures

REPORT OF MANAGEMENT’S RESPONSIBILITY

Management is responsible for preparation of the consolidated financial statements and related financial information contained in all sections of this Annual Report on Form 10-K, including the determination of amounts that must necessarily be based on judgments and estimates. It is the belief of management that effective internal controls over financial reporting have been designed to produce reliable financial statements that have been prepared in conformity, in all material respects, with generally accepted accounting principles appropriate in the circumstances, and that the financial information appearing throughout this annual report is consistent, in all material respects, with the consolidated financial statements.

The Audit Committee of the Board of Directors, composed solely of independent directors, meets periodically with the Company’s management, internal auditors and independent registered public accounting firm, Crowe Horwath LLP to review matters relating to the quality of financial reporting, internal accounting control, and the nature, extent, and results of audit efforts. The internal auditors and independent public accounting firm have unlimited access to the Audit Committee to discuss all such matters.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management’s responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance with accounting principles generally accepted in the United States. As disclosed in the Report on Management’s Assessment of Internal Control Over Financial Reporting which is set forth in Item 8—“Financial Statements and Supplementary Data” on page 35 and is incorporated herein by reference, management assessed the Corporation’s system of internal control over financial reporting as of December 31, 2008, in relation to criteria for effective internal control over financial reporting as described in “Internal Control – Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2008, its system of internal control over financial reporting met those criteria and is effective.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There has been no change in the Company’s internal control over financial reporting during the quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

The Company’s principal executive officer and principal financial officer evaluated, as of December 31, 2008, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures as of December 31, 2008 were effective.

AUDIT REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2008 has been audited by Crowe Horwath LLP, an independent registered public accounting firm, as stated in its report, which is set forth in Item 8 – “Financial Statements and Supplementary Data” on page 36 and is incorporated herein by reference.

Item 9B — Other Information

Not applicable

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PART III

Item 10 — Directors and Executive Officers of the Registrant and Corporate Governance

The information required by this Item 10 is incorporated herein by reference to the sections entitled “Information Concerning Nominees for Directors, Directors Continuing in Office and Executive Officers,” “Audit Committee Report,” and “Section 16 (a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement issued in connection with its 2008 Annual Meeting of Shareholders (“Proxy Statement”). The Company has adopted a Code of Ethics applicable to its Chief Executive Officer, Chief Financial Officer, Controller and senior financial management. The Company’s Code of Ethics for Senior Officers is available at the Company’s website at www.alliancebankna.com.

Item 11 — Executive Compensation

The information required by this Item 11 is incorporated herein by reference to the section entitled “Executive Compensation” in the Company’s Proxy Statement.

Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item 12 is incorporated herein by reference to the section entitled “Information Concerning Nominees For Directors, Directors Continuing In Office And Executive Officers” and “Security Ownership of Certain Beneficial Owners” in the Company’s Proxy Statement.

Item 13 — Certain Relationships, Related Transactions and Director Independence

The information required by this Item 13 is incorporated herein by reference to the section entitled “Certain Transactions” in the Company’s Proxy Statement.

Item 14 — Principal Accountant Fees and Services

The information required by this Item 14 is incorporated herein by reference to the section entitled “Independent Public Accountants” in the Company’s Proxy Statement.

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PART IV

Item 15 — Exhibits and Financial Statement Schedules

The financial statement schedules and exhibits filed as part of this form 10-K are as follows:

(a) (1)	The following consolidated financial statements are included in Part II, Item 8 hereof:
	Consolidated Balance Sheets at December 31, 2008 and 2007.
	Consolidated Statements of Income for the years ended December 31, 2008, 2007 and 2006.
	Consolidated Statements of Comprehensive Income for the years ended December 31, 2008, 2007 and 2006.
	Consolidated Statements of Shareholders’ Equity for each of the years ended December 31, 2008, 2007 and 2006.
	Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006.
	Notes to Consolidated Financial Statements.
(a) (2)	Financial statement schedules are omitted from this Form 10-K since the required information is not applicable to the Company.
(a) (3)	Exhibits:

The following documents are filed as Exhibits to this Form 10-K or are incorporated by reference to the prior filings of the Company with the Securities and Exchange Commission (the “Commission”).

Exhibit Number	Exhibit
3.1	Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 3.1 to the Company’s Registration Statement on Form S-4 (Registration No. 333-62623) filed with the Commission on August 31, 1998
3.2	Certificate of Amendment to Certificate of Incorporation of the Company
3.3	Certificate of Amendment to Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the Commission on December 23, 2008).
3.4	Amended and Restated Bylaws of the Company (incorporated herein by reference to exhibit 3.2 to the Company’s Current Report on Form 8-K filed with the Commission on September 3, 2004)
3.5	Amended and Restated Bylaws of the Company (incorporated herein by reference to exhibit 3.3 to the Company’s Current Report on Form 8-K filed with the Commission on November 27, 2007)
4.1	Rights Agreement dated October 19, 2001 between Alliance Financial Corporation and American Stock Transfer & Trust Company, including the Certificate of Amendment to the company’s Certificate of Incorporation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively (incorporated herein by reference to exhibit 4.1 to the Company’s Form 8-A12G filed with the Commission on October 25, 2001)
4.2	Warrant to Purchase Common Stock, dated December 19, 2008 (incorporated herein by reference to exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the Commission on December 23, 2008).
4.3	Letter Agreement, dated December 19, 2008, including the Securities Purchase Agreement-Standard Terms attached thereto, by and between the Company and the United States Department of the Treasury (incorporated herein by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on December 23, 2008).
10.1	Alliance Financial Corporation 1998 Long Term Incentive Compensation Plan (incorporated herein by reference to exhibit 10.1 to the Company’s Registration Statement on Form S-4, Registration No. 333-62623, filed with the Commission on August 31, 1998, as amended)
10.2	Employment Agreement dated July 6, 2006 by and between the Company and Jack H. Webb (incorporated herein by reference to exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on July 7, 2006)
10.3	Directors Compensation Deferral Plan of the Company (incorporated herein by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed with the Commission on August 13, 1999)
10.4	Supplemental Retirement Agreement, dated as of May 1, 2000, by and among the Company, Alliance Bank, N.A. and Jack H. Webb (incorporated herein by reference to exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed with the Commission on August 14, 2000)

77

10.5	First National Bank of Cortland Excess Benefit Plan for David R. Alvord, dated December 31, 1991, and all amendments thereto (incorporated herein by reference to exhibit 10.13 to the Company’s Annual Report on Form 10-K filed with the Commission on March 30, 2001)
10.6	Oneida Valley National Bank Supplemental Retirement Income Plan for John C. Mott, dated September 1, 1997, and all amendments thereto (incorporated herein by reference to exhibit 10.14 to the Company’s Annual Report on Form 10-K filed with the Commission on March 29, 2002)
10.7	Change of Control Agreement, dated May 3, 2006 by and between the Company and J. Daniel Mohr (incorporated by reference to exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on May 4, 2006)
10.8	Employment Agreement dated October 6, 2005 by and among the Company and John H. Watt Jr. (incorporated herein by reference to exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed with the Commission on November 3, 2005)
10.9	Director Supplemental Retirement Benefit Plan of Oswego County Savings Bank, dated as of March 15, 2000 (incorporated by reference to exhibit 10.10 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2007)
10.10	Oswego County National Bank Voluntary Deferred Compensation Plan for Directors, Amended and Restated effective January 1, 2005 (incorporated by reference to exhibit 10.11 to the Company’s Annual Report on Form 10-K filed with the Commission on March 13, 2007)
10.11	Form of Change of Control Agreement, dated January 27, 2009, by and between the Company, Alliance Financial Corporation, and James W. Getman and Steven G. Cacchio
10.12	Alliance Financial Corporation Director Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 14, 2008)
10.13	Alliance Bank Executive Incentive Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on March 14, 2008)
10.14	Alliance Financial Corporation Stock-Based Deferral Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on March 14, 2008)
12	Computation of Ratios of Earnings to Fixed Charges and Preferred Dividends
21	List of the Company’s Subsidiaries
23.1	Consent of Crowe Horwath LLP
23.2	Consent of PricewaterhouseCoopers LLP
31.1	Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of J. Daniel Mohr, Treasurer and Chief Financial Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of J. Daniel Mohr, Treasurer and Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) See Item 15(a)(3) above.

(c) See Item 15(a)(2) above.

78

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	ALLIANCE FINANCIAL CORPORATION
	(Registrant)
Date    March 13, 2009	By	/s/ Jack H. Webb
		Jack H. Webb, Chairman, President & CEO
		(Principal Executive Officer)
Date    March 13, 2009	By	/s/ J. Daniel Mohr
		J. Daniel Mohr, Treasurer & CFO
		(Principal Financial and Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, and in the capacities and on the dates indicated.

/s/ Mary Pat Adams	Date    March 11, 2009
Mary Pat Adams, Director
/s/ Donald S. Ames	Date    March 11, 2009
Donald S. Ames, Director
/s/ Donald H. Dew	Date    March 11, 2009
Donald H. Dew, Director
/s/ John M. Endries	Date    March 11, 2009
John M. Endries, Director
/s/ Samuel J. Lanzafame	Date    March 11, 2009
Samuel J. Lanzafame, Director
/s/ Margaret G. Ogden	Date    March 11, 2009
Margaret G. Ogden, Director
/s/ Lowell A. Seifter	Date    March 11, 2009
Lowell A. Seifter, Director
/s/ Charles E. Shafer	Date    March 11, 2009
Charles E. Shafer, Director
/s/ Charles H. Spaulding	Date    March 11, 2009
Charles H. Spaulding, Director
/s/ Paul M. Solomon	Date    March 11, 2009
Paul M. Solomon, Director
/s/ Deborah F. Stanley	Date    March 11, 2009
Deborah F. Stanley, Director
/s/ John H. Watt, Jr.	Date    March 11, 2009
John H. Watt, Jr., Executive Vice President & Director
/s/ Jack H. Webb	Date    March 11, 2009
Jack H. Webb, Chairman, President
& CEO and Director
(Principal Executive Officer)

79

EX-3.2

Exhibit 3.2

CERTIFICATE OF AMENDMENT

To the Certificate of Incorporation of

ALLIANCE FINANCIAL CORPORATION

Under Section 805 of the Business Corporation Law

The undersigned, being the President of ALLIANCE FINANCIAL CORPORATION, does hereby certify:

A. The name of the Corporation is ALLIANCE FINANCIAL CORPORATION

B. The Certificate of Incorporation of the Corporation was filed by the Department of State on May 30, 1986 under the name CORTLAND FIRST FINANCIAL CORPORATION. The Amended and Restated Certificate of Incorporation of the Corporation was filed by the Department of State on November 25, 1998.

C. The Certificate of Incorporation as now in full force and effect is hereby amended by the addition of a provision setting forth the number, designation, relative rights, preferences and limitations of a series of Preferred Shares, having a par value of $1.00 per share, as fixed by the Board of Directors before the issuance of such series pursuant to the authority contained in Article 4 of the Corporation’s Amended and Restated Certificate of Incorporation (the “Certificate of Incorporation”), and in accordance with the provisions of Section 502 of the Business Corporation Law of the State of New York (the “NYBCL”).

1. Designation and Amount.  The shares of this series shall be designated as “Series A Junior Participating Preferred Stock” (the “Series A Preferred Stock”) and the number of shares constituting the Series A Preferred Stock shall be One Hundred Thousand (100,000). Such number of shares may be increased or decreased by resolution of the Board of Directors, provided that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock.

2. Proportional Adjustment.  In the event that the Corporation shall at any time after the issuance of any share or shares of Series A Preferred Stock (i) declare any dividend on the Common Stock of the Corporation, par value $1.00 per share (“Common Stock”), payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Corporation shall simultaneously effect a proportional adjustment to the number of outstanding shares of Series A Preferred Stock.

3. Dividends and Distributions.

(a) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any other stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the last day of March, June, September and December in each year (each such date being referred to herein as a “Quarterly Dividend Payment Date”), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount (if any) per share (rounded to the nearest cent), equal to 1,000 times the aggregate per share amount of all cash dividends, and 1,000 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock.

(b) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (a) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock).

(c) Dividends due pursuant to paragraph (a) of this Section shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof.

4. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights:

(a) Each share of Series A Preferred Stock shall entitle the holder thereof to 1,000 votes on all matters submitted to a vote of the shareholders of the Corporation.

(b) Except as otherwise provided in the Certificate of Incorporation, including any other Amendment thereto creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of shareholders of the Corporation.

(c) Except as set forth herein, or as otherwise required by law, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for the taking of any corporate action.

5. Certain Restrictions.

(a) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 3 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not:

(i) Declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock,

(ii) Declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution, or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; or

(iii) Redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (as to dividends and upon dissolution, liquidation or winding up) to the Series A Preferred Stock.

(iv) Redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes.

(b) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (a) of this Section 5, purchase or otherwise acquire such shares at such time and in such manner.

6. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein or in the Certificate of Incorporation, as amended, including any Certificate of Amendment creating a series of Preferred Stock or any similar stock, or as otherwise required by law.

7. Liquidation, Dissolution or Winding Up.  Upon any liquidation, dissolution or winding up of the Corporation, the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share equal to 1,000 times the aggregate amount to be distributed per share to holders of shares of Common Stock plus an amount equal to any accrued and unpaid dividends.

8. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share equal to 1,000 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged.

9. Redemption. The shares of Series A Preferred Stock shall not be redeemable.

10. Amendment. The Certificate of Incorporation, as amended, shall not be amended in any manner, including in a merger or consolidation, which would alter, change, or repeal the powers, preferences or special rights of the Series A Preferred Stock so as to

affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class.

11. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and upon liquidation, dissolution and winding up, junior to all other series of Preferred Stock of the Corporation.

12. Fractional Shares. Series A Preferred Stock may be issued in fractions of a share which shall entitle the holder, in proportion to such holder’s fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series A Preferred Stock.

The foregoing amendment of the Certificate of Incorporation was authorized by vote of the Board of Directors of the Corporation.

IN WITNESS WHEREOF, I have signed and verified this Certificate on October 23, 2001 and affirm under the penalties of perjury that the statements contained herein are true.

ALLIANCE FINANCIAL CORPORATION
By:	/s/ David R. Alvord
	David R. Alvord
	Chairman and CEO

EX-10.11

Exhibit 10.11

ALLIANCE FINANCIAL CORPORATION

FORM OF CHANGE OF CONTROL AGREEMENT

This Change of Control Agreement (the “Agreement”) is made and entered into as of January 27, 2009, by and between Alliance Financial Corporation (the “Company”) and                  (“Employee”). Certain capitalized terms used in this Agreement are defined in Section 1 below.

RECITALS

A.        Employee is employed by Alliance Bank, N.A., the Company’s subsidiary.

B.        The Company may at some time in the future consider the possibility of a Change of Control. The Board of Directors of the Company (the “Board”) recognizes that this could be a distraction to Employee and can cause Employee to consider alternative employment opportunities.

C.        The Board believes that it is in the best interests of the Company to provide Employee with an incentive to continue his employment upon a Change of Control.

D.        In order to provide Employee with enhanced financial security and encourage Employee to remain with the Company notwithstanding the possibility of a Change of Control, the Board wishes to provide Employee with certain benefits in the event of Employee’s termination following a Change of Control.

AGREEMENT

In consideration of the mutual covenants contained herein and the continued employment of Employee by the Company, the parties agree as follows:

1.        Definition of Terms. The following terms referred to in this Agreement shall have the following meanings for purposes of this Agreement:

(a)        Cause. “Cause” is defined as (i) an act of dishonesty made by Employee in connection with Employee’s responsibilities as an employee that results in material harm to the Company, (ii) Employee’s conviction of, or plea of guilty or nolo contendere to, a felony, (iii) an act by Employee which constitutes gross misconduct or fraud and which is materially injurious to the Company, or (iv) Employee’s continued, substantial violations of Employee’s employment responsibilities after Employee has received a written notice from the Company which sets forth the specific factual basis for the Company’s belief that Employee has not substantially performed his duties.

(b)        Change of Control. “Change of Control” of the Company is defined as: (i) a merger or consolidation of the Company in which the stockholders of the Company immediately prior to such transaction would own, in the aggregate, less than 50% of the total combined voting power of all classes of capital stock of the surviving entity normally entitled to vote for the election of directors of the surviving entity, or (ii) the sale by the Company of all or substantially all the Company’s assets in one transaction or in a series of related transactions, or (iii) “incumbent directors” constitute less than a majority of the Board of Directors, with “incumbent directors” defined to mean members of the Board of Directors as of this date and subsequently elected members who are nominated or approved by at least 75% of the incumbent directors prior to their election.

(c)        Constructive Termination. “Constructive Termination” is defined as a resignation of Employee’s employment within ninety (90) days following the occurrence of any of the following events: (i) without Employee’s written consent, either a reduction by the Company of the Employee’s base salary as in effect from time to time or a significant reduction of Employee’s duties or responsibilities relative to Employee’s duties or responsibilities in effect immediately prior to such reduction, or (ii) a relocation of Employee’s principal workplace outside of the Syracuse, New York area.

2.        Term of Agreement. This Agreement shall terminate upon the earlier to occur of (i) the date that all obligations of the parties hereto under this Agreement have been satisfied or (ii) the date that Employee is no longer employed by the Company, provided such termination occurs prior to a Change of Control.

3.        At-Will Employment. The Company and Employee acknowledge that Employee’s employment is and shall continue to be at-will, as defined under applicable law. If Employee’s employment terminates for any reason, Employee shall not be entitled to any payments, benefits, damages, awards or compensation other than as provided by this Agreement, or as may otherwise be established under the Company’s then existing employee benefit plans, agreements and policies at the time of termination.

4.        Benefits.

(a)        Termination Following a Change of Control. If, within twenty-four (24) months following a Change of Control, the Company terminates Employee other than for Cause or Employee voluntarily terminates as a result of a Constructive Termination, then, provided Employee also executes and does not revoke a release of all claims in a form determined by the Company at the time of termination:

(i)        Employee will be entitled to receive a lump sum severance payment equal to two-hundred percent (200%) of Employee’s annual base salary as in effect as of the date of such termination;

(ii)        All unvested stock options and restricted stock granted to Employee prior to the Change of Control shall accelerate and become vested and exercisable as of the date of termination; and

(iii)        if (1) Employee constitutes a qualified beneficiary, as defined in Section 4980B(g)(1) of the Internal Revenue Code of 1986, as amended, and (2) Employee elects continuation coverage pursuant to Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”), within the time period prescribed pursuant to COBRA, Employee and his or her qualified family members shall be entitled to health care coverage under COBRA paid for by the Company, until the earlier of (x) the date Employee is no longer eligible to receive continuation coverage pursuant to COBRA, (y) twenty-four (24) months following such termination, or (z) for such shorter period until Employee obtains new employment offering health insurance coverage.

    (b)        Accrued Wages and Vacation; Expenses. Without regard to the reason for, or the timing of, Employee’s termination of employment: (i) the Company shall pay Employee any unpaid base salary due for periods prior to the date of termination; (ii) the Company shall pay Employee all of Employee’s accrued and unused vacation time through the date of termination; and (iii) following submission of proper expense reports by Employee, the Company shall reimburse Employee for all expenses reasonably and necessarily incurred by Employee in connection with the business of the Company prior to the date of termination. These payments shall be made promptly upon termination and within the period of time mandated by law.

5.        Limitation on Payments. In the event that the benefits provided for in this Agreement or otherwise payable to Employee (i) constitute “parachute payments” within the meaning of Section 280G of the Code, and (ii) would be subject to the excise tax imposed by Section 4999 of the Code (the “Excise Tax”), then Employee’s benefits under this Agreement shall be either

          (a)        delivered in full, or

          (b)        delivered as to such lesser extent as will result in no portion of such benefits being subject to the Excise Tax,

whichever of the foregoing amounts, taking into account the applicable federal, state and local income taxes and the Excise Tax, results in the receipt by Employee on an after-tax basis, of the greatest amount of benefits, notwithstanding that all or some portion of such benefits may be taxable under Section 4999 of the Code.

Unless the Company and Employee otherwise agree in writing, any determination required under this Section shall be made in writing by the Company’s regular independent public accountants (the “Accountants”), whose determination shall be conclusive and binding upon Employee and the Company for all purposes. For purposes of making the calculations required by this Section, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of Section 280G and 4999 of the Code. The Company and Employee shall furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make a determination under this Section. The Company shall bear all costs the Accountants may reasonably incur in connection with any calculations contemplated by this Section.

6.        No Duty to Mitigate. Employee shall not be required to mitigate the amount of any payment contemplated by this Agreement, nor shall any such payment be reduced by any earnings that Employee may receive from any other source.

7.        Waiver. No provision of this Agreement may be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by Employee and by an authorized officer of the Company (other than Employee). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party shall be considered a waiver of any other condition or provision or of the same condition or provision at another time.

8.        Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision hereof, which shall remain in full force and effect.

9.        Arbitration. Employee agrees that any and all disputes arising out of the terms of this Agreement, their interpretation, and any of the matters herein released, shall be subject to binding arbitration in Syracuse, New York under the rules of the American Arbitration Association. Employee agrees that the prevailing party in any arbitration shall be entitled to injunctive relief in any court of competent jurisdiction to enforce the arbitration award. Employee agrees that the prevailing party in any arbitration shall be awarded its reasonable attorney’s fees and costs.

10.      Integration; Amendment. This Agreement represents the entire agreement and understanding between the parties regarding its subject matter, and supersedes all prior or contemporaneous agreements, whether written or oral, with respect to such subject matter. No modification of this Agreement may be made except by written agreement of the parties hereto.

11.      Tax Withholding. All payments made pursuant to this Agreement shall be subject to withholding of applicable income and employment taxes.

12.      Governing Law. This Agreement will be governed by the laws of the State of New York (with the exception of its conflict of laws principles).

13.      Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument.

IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by its duly authorized officer, as of the day and year first above written.

ALLIANCE FINANCIAL CORPORATION
	[Signature]
By:
Title:

EX-12

Exhibit 12

RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS

The ratio of earnings to fixed charges and preferred dividends are presented in the following table. No shares of our Series A Preferred Stock, or any other class of preferred stock, were outstanding during the years ended December 31, 2007, 2006, 2005 and 2004 and we did not pay preferred stock dividends during these periods. Consequently, the ratios of earnings to fixed charges and preferred dividends are the same as the ratios of earnings to fixed charges for the same periods listed above. The ratios of earnings to fixed charges and preferred dividends for the year ended December 31, 2008 and the ratio of earnings to fixed charges for the years ended December 31, 2007, 2006, 2005 and 2004 are as follows:

	Years ended December 31,
	2008	2007	2006	2005	2004
Excluding interest on deposits	2.41	2.16	2.13	2.60	3.20
Including interest on deposits	1.43	1.32	1.30	1.49	1.71

For purposes of calculating the ratio of earnings to fixed charges, earnings are the sum of income before taxes and fixed charges, less the amount of preference security dividends (calculated as the amount of the dividend divided by one minus the Company’s effective tax rate).

For purposes of calculating the ratio of earnings to fixed charges, fixed charges are the sum of

¡ interest and debt expenses, excluding interest on deposits, and, in the second alternative shown above, including interest on deposits; and

¡ that portion of net rental expense deemed to be the equivalent to interest on long-term debt.

EX-21

Exhibit 21

SUBSIDIARIES OF THE REGISTRANT

Alliance Bank, N.A. is a wholly-owned subsidiary of Alliance Financial Corporation and is a national banking association organized under the laws of the United States.

Alliance Financial Capital Trust I is a wholly-owned subsidiary of Alliance Financial Corporation and is organized under the laws of the State of Delaware.

Alliance Financial Capital Trust II is a wholly-owned subsidiary of Alliance Financial Corporation and is organized under the laws of the State of Delaware.

Ladd’s Agency, Inc. is a wholly-owned subsidiary of Alliance Financial Corporation and is organized under the laws of the State of New York.

Alliance Preferred Funding Corp. is a substantially wholly-owned subsidiary of Alliance Bank, N.A. and is organized under the laws of the State of Delaware.

Alliance Leasing, Inc. is a wholly-owned subsidiary of Alliance Bank, N.A. and is organized under the laws of the State of New York.

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statement on Form S-3D (No. 033-65417), and Form S-3 (No. 333-156785) and Form S-8 (No. 333-95343) of Alliance Financial Corporation of our reports dated March 12, 2009 relating to the consolidated financial statements and the effectiveness of internal control over financial reporting, which appears in this Form 10-K for December 31, 2008.

/s/ Crowe Horwath LLP

Crowe Horwath LLP

Livingston, New Jersey

March 12, 2009

EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statement on Form S-3D (No. 033-65417), Form S-8 (No. 333-95343) and Form S-3 (No. 333-156785) of Alliance Financial Corporation of our report dated March 13, 2007 relating to the financial statements which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts

March 13, 2009

EX-31.1

Exhibit 31.1

CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Jack H. Webb, hereby certify that:

1. I have reviewed this annual report on Form 10-K of Alliance Financial Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

Dated: March 13, 2009

/s/ Jack H. Webb
Name:	Jack H. Webb
Title:	Chairman of the Board, President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF THE CHIEF FINANCIAL OFFICER

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, J. Daniel Mohr, hereby certify that:

1. I have reviewed this annual report on Form 10-K of Alliance Financial Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

Dated: March 13, 2009

/s/ J. Daniel Mohr
Name:	J. Daniel Mohr
Title:	Treasurer and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report on Form 10-K of Alliance Financial Corporation (the “Company”) for the year ended December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jack H. Webb, Chairman of the Board of Directors, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: March 13, 2009

/s/ Jack H. Webb
Name:	Jack H. Webb
Title:	Chairman of the Board, President and Chief Executive Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report on Form 10-K of Alliance Financial Corporation (the “Company”) for the year ended December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, J. Daniel Mohr, Treasurer and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: March 13, 2009

/s/ J. Daniel Mohr
Name:	J. Daniel Mohr
Title:	Treasurer and Chief Financial Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.