General

The purpose of this discussion and analysis is to provide the reader with a concise description of the financial condition and results of operations of NBT Bancorp Inc. ("the Registrant") and its wholly owned subsidiaries, NBT Bank, N.A. (the "Bank"), NBT Financial Services, Inc. ("NBT Financial"), NBT Holdings, Inc., Hathaway Agency, Inc., CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II (collectively referred to herein as the "Company"). This discussion will focus on Results of Operations, Financial Position, Capital Resources and Asset/Liability Management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10-Q as well as to the Company's 2007 Form 10-K for an understanding of the following discussion and analysis.

The business of the Company is providing commercial banking and financial services through its subsidiaries. The Company's primary market area is central and upstate New York and northeastern Pennsylvania. The Company has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services. The Company's principal business is attracting deposits from customers within its market area and investing those funds primarily in loans and leases, and, to a lesser extent, in marketable securities. The financial condition and operating results of the Company are dependent on its net interest income which is the difference between the interest and dividend income earned on its earning assets and the interest expense paid on its interest bearing liabilities, primarily consisting of deposits and borrowings. Net income is also affected by provisions for loan and lease losses and noninterest income, such as service charges on deposit accounts, broker/dealer fees, trust fees, and gains/losses on securities sales; it is also impacted by noninterest expense, such as salaries and employee benefits, data processing, communications, occupancy, and equipment.

Forward-looking Statements

Certain statements in this filing and future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or shareholder communications, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as "anticipate," "believe," "expect," "forecasts," "projects," or other similar terms. There are a number of factors, many of which are beyond the Company's control that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) revenues may be lower than expected; (3) changes in the interest rate environment may affect interest margins; (4) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduced demand for credit; (5) legislative or regulatory changes, including changes in accounting standards or tax laws, may adversely affect the businesses in which the Company is engaged;
(6) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than the Company; (7) adverse changes may occur in the securities markets or with respect to inflation; (8) acts of war or terrorism; (9) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (10) internal control failures; and (11) the Company's success in managing the risks involved in the foregoing.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above and other factors discussed in the Company's annual and quarterly reports previously filed with the Securities and Exchange Commission, could affect the Company's financial performance and could cause the Company's actual results or circumstances for future periods to differ materially from those anticipated or projected.

Unless required by law, the Company does not undertake, and specifically disclaims any obligations to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Critical Accounting Policies

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

Management of the Company considers the accounting policy relating to pension accounting to be a critical accounting policy. Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Citigroup Pension Discount Curve, Moody's AA and AAA corporate bond yields, and other market interest rates in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

Management of the Company considers the accounting policy relating to other-than-temporary impairment to be a critical accounting policy. Management systematically evaluates certain assets for other-than-temporary declines in market value, primarily investment securities and lease residual assets. Management considers historical values and current market conditions as a part of the assessment. Assets for which declines in market value are deemed to be other-than-temporary are written down to current market value and the resultant changes are included in earnings as realized losses.

Recent Economic Developments

In the past year, declining housing values have resulted in deteriorating economic conditions across the U.S., resulting in significant writedowns in the values of mortgage-backed securities and derivative securities by financial institutions, government sponsored entities, and major commercial and investment banks. This has led to decreased confidence in financial markets among borrowers, lenders, and depositors as well as extreme volatility in the capital and credit markets and the failure of some entities in the financial sector. The Company is fortunate that the markets it serves have been impacted to a lesser extent than many areas around the country.

In response to the financial crises affecting the banking system and financial markets, there have been several recent announcements of Federal programs designed to purchase assets from, provide equity capital to, and guarantee the liquidity of, the industry.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the "EESA") was signed into law. The EESA authorizes the U.S. Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities, and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The Company did not originate or invest in sub-prime assets and, therefore, does not expect to participate in the sale of any of our assets into these programs. EESA also immediately increases the FDIC deposit insurance limit from $100,000 to $250,000 through December 31, 2009.

On October 14, 2008, the U.S. Treasury announced that it will purchase equity stakes in a wide variety of banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the "TARP Capital Purchase Program"), the U.S. Treasury will make $250 billion of capital available (from the $700 billion authorized by the EESA) to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the U.S. Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the U.S. Treasury's standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.

Overview

The Company earned net income of $15.1 million ($0.46 diluted earnings per share) for the three months ended September 30, 2008, which was the same as net income of $15.1 million ($0.46 diluted earnings per share) for the three months ended September 30, 2007. Net interest income increased approximately $5.9 million, or 14.2%, for the three months ended September 30, 2008 as compared to the same period in 2007. The increase in net interest income was due primarily to a decrease in interest expense of approximately $9.4 million, or 26.2%. In addition, noninterest income increased $2.4 million, or 14.7%, for the three months ended September 30, 2008 as compared to the third quarter of 2007. The increases in net interest income and noninterest income were partially offset by a $5.8 million, or 18.7%, increase in noninterest expense for the three months ended September 30, 2008 as compared with the same period in 2007. In addition, the provision for loan and lease losses was up $2.4 million for the three months ended September 30, 2008 as compared to the same period in 2007.

The Company earned net income of $43.5 million ($1.34 diluted earnings per share) for the nine months ended September 30, 2008 compared to net income of $41.3 million ($1.22 diluted earnings per share) for the nine months ended September 30, 2007. The increase in net income from 2007 to 2008 was primarily the result of an increase in net interest income of approximately $13.9 million, or 11.3%. The increase in net interest income was due primarily to a decrease in interest expense of approximately $21.9 million, or 20.7%. Also contributing to the increase in net income was an increase in noninterest income of approximately $8.3 million, or 19.1%. The increases in net interest income and noninterest income were partially offset by a $16.4 million, or 18.2%, increase in noninterest expense for the nine months ended September 30, 2008 as compared with the same period in 2007. In addition, the provision for loan and lease losses was up $2.8 million for the nine months ended September 30, 2008 as compared to the same period in 2007.

Table 1 depicts several annualized measurements of performance using GAAP net income. Returns on average assets and equity measure how effectively an entity utilizes its total resources and capital, respectively. Net interest margin, which is the net federal taxable equivalent (FTE) interest income divided by average earning assets, is a measure of an entity's ability to utilize its earning assets in relation to the cost of funding. Interest income for tax-exempt securities and loans is adjusted to a taxable equivalent basis using the statutory Federal income tax rate of 35%.

Table 1 - Performance Measures
                                                                                                         Nine Months
                                                                                                        Ended Sept 30,
2008                                        First Quarter       Second Quarter       Third Quarter           2008
Return on average assets (ROAA)                       1.07 %               1.12 %              1.13 %             1.11 %
Return on average equity (ROAE)                      13.68 %              14.49 %             14.58 %            14.26 %
Net Interest Margin                                   3.84 %               3.94 %              3.94 %             3.91 %

2007
Return on average assets (ROAA)                       1.13 %               0.95 %              1.17 %             1.08 %
Return on average equity (ROAE)                      14.06 %              11.90 %             15.41 %            13.77 %
Net Interest Margin                                   3.63 %               3.63 %              3.56 %             3.61 %

Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and borrowings. Net interest income is affected by the interest rate spread, the difference between the yield on earning assets and cost of interest bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the major determining factors in a financial institution's performance as it is the principal source of earnings. Table 2 represents an analysis of net interest income on a federal taxable equivalent (FTE) basis.

FTE net interest income increased $5.9 million, or 13.8%, during the three months ended September 30, 2008, compared to the same period of 2007. The increase in FTE net interest income resulted primarily from a decrease in the rate paid on interest bearing liabilities of 98 bp, to 2.57% for the three months ended September 30, 2008 from 3.55% for the same period in 2007. The interest rate spread increased 51 bp during the three months ended September 30, 2008 compared to the same period in 2007. For the three months ended September 30, 2008, total FTE interest income decreased $3.5 million, or 4.5%. The yield on earning assets for the period decreased 47 bp to 6.09% for the three months ended September 30, 2008 from 6.56% for the same period in 2007. This decrease was partially offset by an increase in average interest earning assets of $148.8 million, or 3.1%, for the three months ended September 30, 2008 when compared to the same period in 2007, principally from growth in average loans and leases.

For the quarter ended September 30, 2008, total interest expense decreased $9.4 million, or 26.2%, primarily the result of the 275 bp decrease in the Federal Funds target rate since September 30, 2007, which impacts the Company's short-term borrowing, money market account and time deposit rates. Additionally, average interest bearing liabilities increased $94.9 million, or 2.4%, for the three months ended September 30, 2008 when compared to the same period in 2007, principally from growth in long-term debt and money market deposit accounts. Total average interest bearing deposits decreased $9.1 million, or 0.3%, for the three months ended September 30, 2008 when compared to the same period in 2007. The rate paid on average interest bearing deposits decreased 105 bp from 3.29% for the three months ended September 30, 2007 to 2.24% for the same period in 2008. For the three months ended September 30, 2008, the Company experienced a shift in its deposit mix from savings and time deposits to money market deposit accounts and NOW accounts. Average savings and time deposit accounts collectively decreased approximately $180.8 million, or 8.3%, when compared to the same period in 2007, while money market accounts and NOW accounts collectively increased approximately $171.6 million, or 15.6%.

Total average borrowings, including trust preferred debentures, increased $104.0 million, or 13.8%, for the three months ended September 30, 2008 compared with the same period in 2007. Average short-term borrowings decreased by $167.6 million, or 52.0%, from $322.2 million for the three months ended September 30, 2007 to $154.6 million for the three months ended September 30, 2008. Interest expense from short-term borrowings decreased $3.1 million, or 80.4%. The rate paid on short-term borrowings decreased 282 bp from 4.78% for the three months ended September 30, 2007 to 1.96% for the same period in 2008. Average long-term debt increased $271.7 million, or 76.7%, for the three months ended September 30, 2008, compared with the same period in 2007. The rate paid on long-term debt decreased to 4.01% for the three months ended September 30, 2008, compared with 4.23% for the same period in 2007. As a result of the increase in the average balance of long-term debt, interest paid on long-term debt increased $2.5 million, or 67.4%, for the three months ended September 30, 2008 as compared to the same period in 2007.

The interest rate spread increased 51 bp for the three months ended September 30, 2008 as compared with the three months ended September 30, 2007. The net interest margin increased by 38 bp to 3.94% for the three months ended September 30, 2008, compared with 3.56% for the same period in 2007.

FTE net interest income increased $14.2 million, or 11.1%, during the nine months ended September 30, 2008, compared to the same period of 2007. The increase in FTE net interest income resulted primarily from a decrease in the yield on interest bearing liabilities of 79 bp to 2.75% for the nine months ended September 30, 2008 from 3.54% for the same period in 2007. The interest rate spread increased 41 bp during the nine months ended September 30, 2008 compared to the same period in 2007. For the nine months ended September 30, 2008, total FTE interest income decreased $7.8 million, or 3.3%. The yield on earning assets for the period decreased 38 bp to 6.22% for the nine months ended September 30, 2008 from 6.60% for the same period in 2007. This decrease was partially offset by an increase in average interest earning assets of $118.2 million, or 2.5% for the nine months ended September 30, 2008 when compared to the same period in 2007, principally from growth in average loans and leases.

For the nine months ended September 30, 2008, total interest expense decreased $21.9 million, or 20.7%, primarily the result of the 275 bp decrease in the Federal Funds target rate since September 30, 2007, which impacts the Company's short-term borrowing, money market account and time deposit rates. Additionally, average interest bearing liabilities increased $76.7 million, or 1.9%, for the nine months ended September 30, 2008 when compared to the same period in 2007, principally from growth in long-term debt and money market deposit accounts. Total average interest bearing deposits decreased $44.0 million, or 1.3%, for the nine months ended September 30, 2008 when compared to the same period in 2007. The rate paid on average interest bearing deposits decreased 80 bp from 3.27% for the nine months ended September 30, 2007 to 2.47% for the same period in 2008. For the nine months ended September 30, 2008, the Company experienced a shift in its deposit mix from savings and time deposits to money market deposit accounts and NOW accounts. Average savings and time deposit accounts collectively decreased approximately $145.7 million, or 6.7%, when compared to the same period in 2007, while money market accounts and NOW accounts collectively increased approximately $101.7 million, or 9.2%.

Total average borrowings, including trust preferred debentures, increased $120.7 million, or 16.5%, for the nine months ended September 30, 2008 compared with the same period in 2007. Average short-term borrowings decreased by $41.2 million, or 14.8%, from $279.4 million for the nine months ended September 30, 2007 to $238.2 million for the nine months ended September 30, 2008. Interest expense from short-term borrowings decreased $5.4 million, or 54.9%. The rate paid on short-term borrowings decreased from 4.73% for the nine months ended September 30, 2007 to 2.50% for the same period in 2008. Average long-term debt increased $161.9 million, or 42.8%, for the nine months ended September 30, 2008, compared with the same period in 2007. The rate paid on long-term debt decreased to 4.02% for the nine months ended September 30, 2008, compared with 4.33% for the same period in 2007. As a result of the increase in the average balance of long-term debt, interest paid on long-term debt increased $4.0 million, or 32.5%, for the nine months ended September 30, 2008 as compared to the same period in 2007.

The interest rate spread increased 41 bp for the nine months ended September 30, 2008 as compared with the nine months ended September 30, 2007. The net interest margin increased by 30 bp to 3.91% for the nine months ended September 30, 2008, compared with 3.61% for the same period in 2007.

Table 2
Average Balances and Net Interest Income
The following tables include the condensed consolidated average balance sheet,
an analysis of interest income/expense and average yield/rate for each major
category of earning assets and interest bearing liabilities on a taxable
equivalent basis. Interest income for tax-exempt securities and loans has been
adjusted to a taxable-equivalent basis using the statutory Federal income tax
rate of 35%.

Three months ended September 30,
                                           2008                                          2007
                          Average                        Yield/         Average                        Yield/
(dollars in
thousands)                Balance        Interest        Rates          Balance        Interest        Rates
ASSETS
Short-term interest
bearing accounts        $     4,077     $       20           1.95 %   $     7,714     $      102           5.25 %
Securities available
for sale
(1)(excluding
unrealized gains or
losses)                   1,116,089         14,159           5.05 %     1,142,009         14,458           5.02 %
Securities held to
maturity (1)                148,397          2,026           5.43 %       144,713          2,216           6.08 %
Investment in FRB and
FHLB Banks                   40,401            653           6.43 %        33,637            579           6.83 %
Loans and leases (2)      3,605,700         58,371           6.44 %     3,437,798         61,405           7.09 %
Total interest
earning assets            4,914,664         75,229           6.09 %     4,765,871         78,760           6.56 %
Other assets                386,976                                       356,225
Total assets              5,301,640                                     5,122,096

LIABILITIES AND
STOCKHOLDERS' EQUITY
Money market deposit
accounts                    779,954          3,593           1.83 %       658,741          5,620           3.38 %
NOW deposit accounts        491,673          1,060           0.86 %       441,243            892           0.80 %
Savings deposits            474,602            514           0.43 %       488,010          1,077           0.88 %
Time deposits             1,512,072         13,184           3.47 %     1,679,446         19,473           4.60 %
Total interest
bearing deposits          3,258,301         18,351           2.24 %     3,267,440         27,062           3.29 %
Short-term borrowings       154,567            763           1.96 %       322,245          3,885           4.78 %
Trust preferred
debentures                   75,422          1,154           6.09 %        75,422          1,277           6.72 %
Long-term debt              625,733          6,310           4.01 %       354,037          3,770           4.23 %
Total interest
bearing liabilities       4,114,023         26,578           2.57 %     4,019,144         35,994           3.55 %
Demand deposits             706,803                                       656,176
Other liabilities            69,355                                        56,913
Stockholders' equity        411,459                                       389,863
Total liabilities and
stockholders' equity    $ 5,301,640                                   $ 5,122,096
Net interest income
(FTE)                                       48,651                                        42,766
Interest rate spread                                         3.52 %                                        3.01 %
Net interest margin                                          3.94 %                                        3.56 %
Taxable equivalent
adjustment                                   1,608                                         1,579
Net interest income                     $   47,043                                    $   41,187

(1) Securities are shown at average amortized cost.

(2) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding.

Nine months ended September 30,

                                          2008                                         2007
                          Average                       Yield/         Average                       Yield/
(dollars in
thousands)                Balance       Interest        Rates          Balance       Interest        Rates
ASSETS
Short-term interest
bearing accounts        $     6,517     $     145           2.98 %   $     8,523     $     320           5.03 %
Securities available
for sale
(1)(excluding
unrealized gains or
losses)                   1,112,582        42,689           5.13 %     1,131,533        42,682           5.04 %
Securities held to
maturity (1)                153,010         6,544           5.71 %       144,693         6,704           6.19 %
Investment in FRB and
FHLB Banks                   39,730         2,042           6.87 %        33,668         1,820           7.23 %
Loans and leases (2)      3,544,787       174,635           6.58 %     3,419,983       182,283           7.13 %
Total interest
earning assets            4,856,626       226,055           6.22 %     4,738,400       233,809           6.60 %
Other assets                379,504                                      358,208
Total assets              5,236,130                                    5,096,608