Alliance Financial Announces Second Quarter Earnings

Net income for the six months ended June 30, 2012 was $5.6 million or $1.16 per diluted share, compared with $6.8 million or $1.43 per diluted share in the first half of 2011.

Net interest income decreased $1.3 million and $2.4 million in the three and six month periods ended June 30, 2012, respectively, compared with the year-ago periods due to the continuing pressure on our net interest margin caused by the exceptionally low interest rate environment, which was partially mitigated by strong loan growth.

Jack H. Webb, President and CEO of Alliance said, "Our loan portfolio grew at an annualized rate of 13% in the second quarter with broad-based loan growth in each of our commercial, residential, and indirect portfolios as we continue to capture market share. Loan originations across all our business lines totaled more than $106 million in the second quarter, which was an increase of 98% from the second quarter of 2011, and was up 47% from the first quarter of this year."

Webb added, "While we grew our loan portfolio, we also continued to improve on our already low levels of non-performing and delinquent loans. Our non-performing loans dropped 25% in the second quarter as a direct result of successful workouts and payoffs of non-performing loans. Total loan delinquencies were also down 12% in the second quarter."

Balance Sheet Highlights

Total assets were $1.4 billion at June 30, 2012, which was an increase of $7.2 million from March 31, 2012. Total loans and leases (net of unearned income) increased $28.6 million from the previous quarter to $898.5 million at June 30, 2012.

Loan origination volumes in the second quarter increased $52.5 million, or 97.5%, to $106.4 million, compared with $53.8 million in the year-ago quarter and $72.5 million in the first quarter of 2012 on strong origination growth in each of our commercial, residential mortgage and indirect lending businesses.

Commercial loans and mortgages increased $9.3 million in the second quarter and totaled $283.1 million at June 30, 2012. Originations of commercial loans and mortgages in the second quarter (excluding lines of credit) totaled $21.6 million, compared with $8.3 million in the first quarter of 2012 and $17.7 million in the year-ago quarter. The $13.3 million increase in commercial originations during the second quarter resulted from the capture of additional market share through a sustained sales effort.

Residential mortgages outstanding increased $7.1 million in the second quarter to $320.9 million. Originations of residential mortgages totaled $44.2 million in the second quarter of 2012, compared with $30.0 million in the first quarter of 2012 and $18.0 million in the year-ago quarter. Alliance retained in portfolio approximately $22.0 million of the second quarter originations that were bi-weekly payment mortgages or monthly payment mortgages with maturities of 15 years or less.

Indirect auto loan balances were $188.8 million at the end of the second quarter, which was an increase of $16.9 million from the end of the first quarter of 2012. Alliance originated $39.8 million of indirect auto loans in the second quarter, compared with $33.2 million in the first quarter of 2012 and $17.3 million in the year-ago quarter. The increase in originations this year is attributable to a change in the Company's rate structure designed to increase its market share without lowering its underwriting standards, along with the implementation of an electronic application system. 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 employed in its direct lending programs.

The Company's investment securities portfolio totaled $341.8 million at June 30, 2012, compared with $346.4 million at March 31, 2012. 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 the securities portfolio at June 30, 2012 was 77.0% government-sponsored entity-guaranteed mortgage-backed securities, 21.6% municipal securities and 0.5% obligations of U.S. government-sponsored corporations. Mortgage-backed securities, which totaled $263.4 million at June 30, 2012, 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 U.S. government. The Company's municipal securities portfolio, which totaled $73.7 million at the end of the second quarter, is primarily comprised of highly rated general obligation bonds issued by local municipalities in New York State. Net unrealized gains on our securities portfolio totaled $11.3 million at the end of the second quarter.

Deposits increased $5.6 million in the second quarter, and were $1.1 billion at June 30, 2012. Low-cost transaction accounts comprised 75.6% of total deposits at the end of the second quarter, compared with 75.7% at March 31, 2012 and 69.7% at June 30, 2011. Alliance's liability mix remained favorably weighted towards transaction accounts in the second quarter as retail and municipal depositors continue to refrain from locking up funds in time accounts in the low interest rate environment, and also because of the buildup of cash on commercial customers' balance sheets.

Shareholders' equity was $146.8 million at June 30, 2012, compared with $145.0 million at the end of the first quarter. Net income for the quarter increased shareholders' equity by $2.9 million and was partially offset by common stock dividends declared of $1.5 million or $0.31 per common share.

The Company's Tier 1 leverage ratio was 9.38% and its total risk-based capital ratio was 15.75% at the end of the second quarter. The Company's tangible common equity capital ratio (a non-GAAP financial measure) was 7.85% at June 30, 2012.

Asset Quality and the Provision for Credit Losses

Delinquent loans and leases (including non-performing) totaled $12.6 million at June 30, 2012, compared with $14.4 million at March 31, 2012 and $17.0 million at December 31, 2011. The largest decline in delinquent loans in the second quarter occurred in loans delinquent 90 days or more or on non-accrual status, which declined $2.3 million or 25.3%.

Non-performing assets were $6.7 million or 0.47% of total assets at June 30, 2012, compared with $9.2 million or 0.65% of total assets at March 31, 2012 and $11.7 million or 0.83% of total assets at December 31, 2011. The decline in non-performing assets in the second quarter resulted primarily from non-accrual loans returning to accrual status as a result of satisfactory payment performance and to pay-offs of non-performing loans. Included in non-performing assets at the end of the second quarter are non-performing loans and leases totaling $6.7 million, compared with $8.9 million at March 31, 2012 and $11.3 million at December 31, 2011.

Conventional residential mortgages comprised $2.5 million (39 loans) or 38.3% of non-performing loans and leases, and commercial loans and mortgages totaled $3.3 million (25 loans) or 50.2% of non-performing loans and leases at the end of the second quarter.

Net charge-offs were $166,000 and $1.6 million in the three and six months ended June 30, 2012, respectively, compared with $155,000 and $360,000 in the year-ago periods. Net charge-offs annualized equaled 0.08% and 0.36%, respectively, of average loans and leases during the three months and six months ended June 30, 2012, compared with 0.07% and 0.08% in the year-ago periods, respectively. Gross charge-offs were $460,000 and recoveries were $294,000 in the second quarter of 2012.

A negative provision expense resulted in $300,000 of income being recorded in the second quarter, compared with provision expense of $160,000 in the year-ago quarter and no provision expense in the first quarter of 2012. Alliance assesses a number of quantitative and qualitative factors at the individual portfolio level in determining the adequacy of the allowance for credit losses and the required provision expense each quarter. In addition, Alliance analyzes certain broader, non-portfolio specific factors in assessing the adequacy of the allowance for credit losses, such as the allowance as a percentage of total loans and leases, the allowance as a percentage of non-performing loans and leases and the provision expense as a percentage of net charge-offs. As the Company's asset quality metrics and net charge-off levels have improved in recent quarters (excluding the charge-offs related to a $3.6 million commercial relationship previously discussed in the Company's Form 10-Q for the first quarter of 2012), an increasing portion of the allowance for credit losses has been considered "unallocated," which means it is not based on either quantitative or qualitative factors, but on the broader, non-portfolio specific factors. At June 30, 2012, $1.3 million or 14% of the allowance for credit losses was considered to be "unallocated," compared to $991,000 or 9% at December 31, 2011. Absent any material deterioration in credit quality or material growth in the loan and lease portfolio, some portion of this "unallocated" allowance may be reduced by future credit losses and/or negative credit loss provisions, which would have the effect of lowering the amount of provision expense relative to net charge-offs compared with past quarters (i.e. provision expense being less than net charge-offs), or a negative provision expense, which was the case in the second quarter of 2012.

The provision for credit losses as a percentage of net charge-offs was not meaningful in the second quarter due to the negative provision that was recorded. The provision for credit losses as a percentage of net charge-offs was 103% in the year-ago quarter and 0% in the first quarter of 2012.

The allowance for credit losses was $8.9 million at June 30, 2012, compared with $9.4 million at March 31, 2012 and $10.8 million at December 31, 2011. The ratio of the allowance for credit losses to total loans and leases was 0.99% at June 30, 2012, compared with 1.08% at March 31, 2012 and 1.24% at December 31, 2011. The ratio of the allowance for credit losses to non-performing loans and leases was 134% at June 30, 2012, compared with 105% at March 31, 2012 and 96% at December 31, 2011.

Net Interest Income

Net interest income totaled $10.0 million in the three months ended June 30, 2012, compared with $11.3 million in the year-ago quarter, and $9.8 million in the first quarter of 2012. The tax-equivalent net interest margin decreased 27 basis points in the second quarter compared with the year-ago quarter due to the effect of persistently low interest rates on the Company's interest-earning assets. The rate of margin decline slowed considerably in the first quarter of 2012 in large part due to a slowing in prepayments on our mortgage-backed securities portfolio. The net interest margin increased 4 basis points from the first to the second quarter of 2012 with most of the increase attributable to the accrual of $133,000 of interest on non-accrual loans which were returned to performing status in the second quarter.

The net interest margin on a tax-equivalent basis was 3.26% in the second quarter of 2012, compared with 3.53% in the year-ago quarter of 2011 and 3.22% in the first quarter of 2012. The net interest margin in the second quarter adjusted for the accrual of non-accrual interest was 3.22%. The decrease in the net interest margin compared with the second quarter of 2011 was the result of a decrease in the tax-equivalent earning asset yield of 54 basis points in the second quarter compared with the year-ago quarter, which was partially offset by a decrease in the cost of interest-bearing liabilities of 29 basis points over the same period. On a linked-quarter basis, the decline in our earning-assets yield was 9 basis points in the second quarter, which was offset by a 15 basis-point drop in the cost of our interest-bearing liabilities. Adjusted for the recovery of non-accrual interest in the second quarter, our tax-equivalent earning asset yield declined 58 basis points and 13 basis points, compared with the year-ago quarter and the first quarter of 2012, respectively.

Average interest-earning assets were $1.3 billion in the second quarter, which was a decrease of 4.0% from the year-ago quarter but was unchanged from the first quarter of 2012. Most of the decline from the year-ago quarter occurred in our securities portfolio, with the average balance down 25% due to our decision to temporarily shrink the portfolio in the second half of 2011 due to the very low yields available on the types of securities in which we invest. Average loans and leases was roughly equal in the second quarter compared with the year-ago quarter as growth in our average commercial loan and consumer loan portfolios offset lower average lease balances. Total average loans and leases were 68.4% of total interest-earning assets in the second quarter of 2012, compared with 65.6% in the year-ago quarter and 67.1% in the first quarter of 2012.

Net interest income for the six months ended June 30, 2012 totaled $19.8 million, which was down $2.4 million or 11.0% compared with the year-ago period. The tax equivalent net interest margin was 3.24% for the six months ended June 30, 2012, compared to 3.49% for the first half of 2011. The tax-equivalent earning asset yield decreased 46 basis points in the first half of 2012 compared with the year-ago period, which was partially offset by a decrease of 22 basis points in the cost of interest-bearing liabilities of basis points over the same period.

Average interest-earning assets were $1.3 billion in the first half of 2012, which was a decrease of 3.9% from the first half of 2011. The changes in the average balances of securities and loans for the first half of 2012 compared with the year-ago period were similar to that as discussed above for the second quarter. Total average loans and leases were 67.7% of total interest-earning assets in the first half of 2012, compared with 65.7% in the year-ago period.

Net interest margin is expected to remain under pressure in coming quarters as the persistently low interest rate environment continues to negatively affect the return on loan and investment portfolios, while the ability to further reduce funding costs is limited.

Non-Interest Income and Non-Interest Expenses

Non-interest income was $4.5 million in the second quarter of 2012, compared with $4.4 million in the second quarter of 2011 and $4.5 million in the first quarter of 2012. Gains on the sale of loans increased $259,000 compared with the second quarter of 2011 due to higher volumes of mortgages originated and sold in 2012.

Non-interest income totaled $9.0 million in the first six months of 2012 and 2011. Gains on the sale of loans increased $330,000, compared with the first half of 2011 and were partially offset by a $243,000 decrease in other non-interest income.

Non-interest income accounted for 31.1% of total revenue in the second quarter of 2012, compared with 28.2% in the year-ago quarter. Non-interest income accounted for 31.2% of total revenue in the first half of 2012, compared with 28.8% in the year-ago period.

Non-interest expenses were $11.0 million in the quarter ended June 30, 2012, compared with $10.8 million in the year-ago quarter and $10.9 million in the first quarter of 2012. Non-interest expenses were $21.9 million in the six months ended June 30, 2012, compared with $21.8 million in the first half of 2011.

The Company's efficiency ratio was 75.8% in the second quarter of 2012, compared with 68.8% in the year-ago quarter. The Company's efficiency ratio was 75.9% in the six months ended June 30, 2012, compared with 69.6% in the year-ago period.

The Company's effective tax rate was 23.5% and 23.3% for the three and six months ended June 30, 2012, respectively, compared with 26.9% and 25.8% in the year-ago periods, respectively. The decrease in our effective tax rate from 2011 was due to a higher level of tax-exempt income as a percentage to total taxable income.

About Alliance Financial Corporation

Alliance Financial Corporation is a financial holding company with Alliance Bank, N.A. as its principal subsidiary that provides retail, commercial and municipal banking, and trust and investment services through 29 offices in Cortland, Madison, Oneida, Onondaga and Oswego counties. Alliance also operates an investment management administration center in Buffalo, N.Y. and an equipment lease financing company, Alliance Leasing, Inc.

Forward-Looking Statements

This press release contains certain forward-looking statements with respect to the financial condition, results of operations and business of Alliance Financial Corporation. These forward-looking statements 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 affect the net interest margin; changes in the regulatory environment; general economic conditions, either nationally or 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; our ability to maintain and increase market share and control expenses; increases in FDIC insurance premiums may cause earnings to decrease; and other risks set forth under the caption "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011, and in subsequent filings with the Securities and Exchange Commission.