GENERAL

The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of NBT Bancorp Inc. (the "Registrant") and its wholly owned subsidiaries, the Bank, NBT Financial and NBT Holdings during 2008 and, in summary form, the preceding two years. Collectively, the Registrant and its subsidiaries are referred to herein as "the Company." Net interest margin is presented in this discussion on a fully taxable equivalent (FTE) basis. Average balances discussed are daily averages unless otherwise described. The audited consolidated financial statements and related notes as of December 31, 2008 and 2007 and for each of the years in the three-year period ended December 31, 2008 should be read in conjunction with this review. Amounts in prior period consolidated financial statements are reclassified whenever necessary to conform to the 2008 presentation.

The preparation of the consolidated financial statements requires management to make estimates and assumptions, in the application of certain accounting policies, about the effect of matters that are inherently uncertain. Those estimates and assumptions affect the reported amounts of certain assets, liabilities, revenues and expenses. Different amounts could be reported under different conditions, or if different assumptions were used in the application of these accounting policies.

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 within its market area, 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, insurance commissions, 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 expenses.

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

CRITICAL ACCOUNTING POLICIES

The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses and pension accounting.

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 uncertainty 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 may need to be increased. For example, if historical loan and lease loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provision 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 have 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 values were significantly lowered, the Company's allowance for loan and lease policy would also require additional provision for loan and lease losses.

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 Liability Index and 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. In 2006, the Pension Protection Act of 2006 was enacted, which established certain criteria to ensure that pension plan assets are sufficient to satisfy future obligations. The law identifies at risk plans and applies stricter funding requirements to help stabilize at risk plans. The Company has determined that the law does not materially affect the Company's funding obligations with respect to its benefit plans.

The Company's policy on the allowance for loan and lease losses and pension accounting is disclosed in Note 1 to the consolidated financial statements. A more detailed description of the allowance for loan and lease losses is included in the "Risk Management" section of this Form 10-K. All significant pension accounting assumptions and detail is disclosed in Note 17 to the consolidated financial statements. All accounting policies are important, and as such, the Company encourages the reader to review each of the policies included in Note 1 to obtain a better understanding on how the Company's financial performance is reported.

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, or in oral statements made with the approval of an authorized executive officer, 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," "will," "can," "would," "should," "could," "may," 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 possibilities:

• Local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company's assessment of that impact.
• Changes in the level of non-performing assets and charge-offs.
• Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
• The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
• Inflation, interest rate, securities market and monetary fluctuations.
• Political instability.

• Acts of war or terrorism.
• The timely development and acceptance of new products and services and perceived overall value of these products and services by users.
• Changes in consumer spending, borrowings and savings habits.
• Changes in the financial performance and/or condition of the Company's borrowers.
• Technological changes.
• Acquisitions and integration of acquired businesses.
• The ability to increase market share and control expenses.
• Changes in the competitive environment among financial holding companies.
• The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply.
• The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
• Changes in the Company's organization, compensation and benefit plans.
• The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.
• Greater than expected costs or difficulties related to the integration of new products and lines of business.
• The Company's success at managing the risks involved in the foregoing items.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including but not limited to those described above, 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.

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

OVERVIEW

The Company had net income of $58.4 million or $1.80 per diluted share for 2008, up 15.9% from net income of $50.3 million or $1.51 per diluted share for 2007. Net interest income increased $21.0 million or 12.7% in 2008 compared to 2007. The increase in net interest income resulted from decreases in rates paid on interest bearing deposits and liabilities in 2008 as compared with 2007. In addition, average earning assets increased $132.7 million, or 2.8%, in 2008 over 2007. The provision for loan and lease losses totaled $27.2 million for the year ended December 31, 2008, down $2.9 million, or 9.7%, from $30.1 million for the year ended December 31, 2007. Noninterest income increased $12.0 million or 20.1% compared to 2007. The increase in noninterest income was driven primarily by an increase in service charges on deposit accounts and ATM and debit card fees, which collectively increased $6.0 million due to various initiatives in 2008. Also included in noninterest income for 2008 were net securities gains totaling $1.5 million compared to net securities gains of $2.1 million in 2007. Excluding net security gains and losses, total noninterest income increased 21.9% in 2008 compared with 2007. Noninterest expense increased $24.3 million, or 19.8%, in 2008 compared with 2007. The increase in noninterest expense was due to several factors including increases in salaries and employee benefits, occupancy, equipment and data processing and communications expenses, professional fees and outside services, loan collection and other real estate owned expenses, and other operating expenses. Please refer to "NONINTEREST EXPENSE" on page 42 for additional information.

The Company had net income of $50.3 million or $1.51 per diluted share for 2007, down 10.0% from net income of $55.9 million or $1.64 per diluted share for 2006. The provision for loan and lease losses totaled $30.1 million for the year ended December 31, 2007, up $20.7, or 220.3%, from $9.4 million for the year ended December 31, 2006. This increase was due in large part to increases in nonperforming loans and charge-offs in 2007. The increase in the provision for loan and lease losses was offset by several factors. Net interest income increased $1.2 million or 0.7% in 2007 compared to 2006. The increase in net interest income resulted mainly from an increase in average earning assets of $171.4 million, or 3.7% to $4.7 billion in 2007, driven by a 3.7% increase in average loans and leases for the period. Noninterest income increased $11.1 million or 22.8% compared to 2006. The increase in noninterest income was driven primarily by an increase in service charges on deposit accounts from fee initiatives during the year. Also included in noninterest income for 2007 were net securities gains totaling $2.1 million compared to net securities losses of $0.9 million in 2006. Excluding net security gains and losses, total noninterest income increased 16.3% in 2007 compared with 2006. Noninterest expense remained relatively stable from $123.0 million in 2006 to $122.5 million in 2007.

2009 OUTLOOK

While the Company reported record earnings for 2008, it anticipates that current global economic conditions and challenges in the financial services industry may negatively impact earnings in 2009. In particular, the Company currently expects that in 2009:

• premiums paid to the Federal Deposit Insurance Corporation will increase significantly;

• pension and postretirement expenses will increase significantly;

• revenue from Federal Home Loan Bank dividends may decrease significantly;

• payments representing interest and principal on currently outstanding loans and investments will most likely be reinvested at rates that are lower than the rates on currently outstanding loans and investments; and

• the economy may have an adverse affect on asset quality indicators and the provision for loan and lease losses, and therefore credit costs, which have trended higher in recent years, are not expected to decline until economic indicators improve.

Due to current uncertainty in economic conditions and the financial services industry in general, it is particularly difficult to estimate certain revenues, expenses and other related matters. There may be factors in addition to those identified above that impact 2009 results. For a discussion of risks and uncertainties that could impact the Company's future results, see ITEM 1A. RISK FACTORS.

ASSET/LIABILITY MANAGEMENT

The Company attempts to maximize net interest income, and net income, while actively managing its liquidity and interest rate sensitivity through the mix of various core deposit products and other sources of funds, which in turn fund an appropriate mix of earning assets. The changes in the Company's asset mix and sources of funds, and the resultant impact on net interest income, on a fully tax equivalent basis, are discussed below. The following table includes 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 and leases has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.

Table 1. Average Balances and Net Interest Income
                                        2008                                        2007                                        2006
                           Average                      Yield/         Average                      Yield/         Average                      Yield/
(Dollars in
thousands)                 Balance      Interest          Rate         Balance      Interest          Rate         Balance      Interest          Rate
Assets
Short-term interest
bearing accounts       $     9,190     $     186          2.03 %   $     8,395     $     419          4.99 %   $     8,116     $     395          4.87 %
Securities available
for sale 1               1,113,810        56,841          5.10       1,134,837        57,290          5.05       1,110,405        53,992          4.86
Securities held to
maturity 1                 149,775         8,430          5.63         144,518         8,901          6.16         115,636         7,071          6.11
Investment in FRB
and FHLB Banks              39,735         2,437          6.13          34,022         2,457          7.22          39,437         2,076          5.26
Loans and leases 2       3,567,299       233,016          6.53       3,425,318       243,317          7.10       3,302,080       230,800          6.99
Total earning assets     4,879,809       300,910          6.17       4,747,090       312,384          6.58       4,575,674       294,334          6.43
Other non-interest
earning assets             384,846                                     362,497                                     349,396
Total assets           $ 5,264,655                                 $ 5,109,587                                 $ 4,925,070

Liabilities and
stockholders' equity
Money market deposit
accounts               $   778,477        14,373          1.85 %   $   663,532        22,402          3.38 %   $   543,323        18,050          3.32 %
NOW deposit accounts       485,014         4,133          0.85         449,122         3,785          0.84         443,339         3,297          0.74
Savings deposits           467,572         2,161          0.46         485,562         4,299          0.89         532,788         4,597          0.86
Time deposits            1,507,966        55,465          3.68       1,675,116        76,088          4.54       1,534,556        61,854          4.03
Total
interest-bearing
deposits                 3,239,029        76,132          2.35       3,273,332       106,574          3.26       3,054,006        87,798          2.87
Short-term
borrowings                 223,830         4,847          2.17         280,162        12,943          4.62         331,255        15,448          4.66
Trust preferred
debentures                  75,422         4,747          6.29          75,422         5,087          6.74          70,055         4,700          6.71
Long-term debt             563,460        22,642          4.02         384,017        16,486          4.29         414,976        17,063          4.11
Total
interest-bearing
liabilities              4,101,741       108,368          2.64       4,012,933       141,090          3.52       3,870,292       125,009          3.23
Demand deposits            682,656                                     639,423                                     614,055
Other
non-interest-bearing
liabilities                 68,156                                      57,932                                      54,170
Stockholders' equity       412,102                                     399,299                                     386,553
Total liabilities
and
stockholders' equity   $ 5,264,655                                 $ 5,109,587                                 $ 4,925,070
Interest rate spread                                      3.53 %                                      3.06 %                                      3.20 %
Net interest
income-FTE                               192,542                                     171,294                                     169,325
Net interest margin                                       3.95 %                                      3.61 %                                      3.70 %
Taxable equivalent
adjustment                                 6,496                                       6,267                                       5,492
Net interest income                    $ 186,046                                   $ 165,027                                   $ 163,833

1. Securities are shown at average amortized cost.

2. For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding. The interest collected thereon is included in interest income based upon the characteristics of the related loans.

NET INTEREST INCOME

On a tax equivalent basis, the Company's net interest income for 2008 was $192.5 million, up from $171.3 million for 2007. The Company's net interest margin increased to 3.95% for 2008 from 3.61% for 2007. The increase in the net interest margin resulted primarily from interest-bearing liabilities repricing down faster than earning assets. Earning assets, particularly those tied to a fixed rate, reprice at a slower rate than interest-bearing liabilities, and have not fully realized the effect of the lower interest rate environment. The yield on earning assets decreased 41 basis points (bp), from 6.58% for 2007 to 6.17% for 2008. Meanwhile, the rate paid on interest bearing liabilities decreased 88 bp, from 3.52% for 2007 to 2.64% for 2008. Average earning assets increased $132.7 million, or 2.8%, from 2007 to 2008. This increase was driven primarily by a $142.0 million increase in average loans and leases, which was driven primarily by a 23.4% increase in consumer indirect installment loans. The following table presents changes in interest income, on a FTE basis, and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume), and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.

Table 2. Analysis of Changes in Taxable Equivalent Net Interest Income

                            Increase (Decrease)                       Increase (Decrease)
                              2008 over 2007                            2007 over 2006
(In thousands)        Volume          Rate         Total        Volume          Rate         Total
Short-term
interest-bearing
accounts           $      44     $    (276 )   $    (232 )   $      14     $      10     $      24
Securities
available for
sale                  (1,021 )         222          (799 )       1,205         2,093         3,298
Securities held
to maturity              228          (538 )        (310 )       1,779            51         1,830
Investment in
FRB and FHLB
Banks                    380          (400 )         (20 )        (314 )         695           381
Loans and leases      10,908       (21,250 )     (10,342 )       8,711         3,806        12,517
Total interest
income                10,539       (22,242 )     (11,703 )      11,184         6,866        18,050
Money market
deposit accounts       4,969       (12,998 )      (8,029 )       4,054           298         4,352
NOW deposit
accounts                 305            43           348            44           444           488
Savings deposits        (154 )      (1,984 )      (2,138 )        (416 )         118          (298 )
Time deposits         (7,095 )     (13,528 )     (20,623 )       5,967         8,267        14,234
Short-term
borrowings            (2,223 )      (5,873 )      (8,096 )      (2,362 )        (143 )      (2,505 )
Trust preferred
debentures                 -          (340 )        (340 )         362            25           387
Long-term debt         7,133          (977 )       6,156        (1,308 )         731          (577 )
Total interest
expense                2,935       (35,657 )     (32,722 )       4,727        11,354        16,081
Change in FTE
net interest
income             $   7,604     $  13,415     $  21,019     $   6,457     $  (4,488 )   $   1,969

LOANS AND LEASES AND CORRESPONDING INTEREST AND FEES ON LOANS

The average balance of loans and leases increased 4.1%, totaling $3.6 billion in 2008 compared to $3.4 billion in 2007. The yield on average loans and leases decreased from 7.10% in 2007 to 6.53% in 2008, as loan rates, particularly for loans indexed to the Prime Rate and other short-term variable rate indices, declined due to the declining rate environment in 2008. Interest income from loans and leases on a FTE basis decreased 4.2%, from $243.3 million in 2007 to $233.0 million in 2008. The decrease in interest income from loans and leases was due to the decrease in yield on loans and leases in 2008 compared to 2007 noted above.

Total loans and leases increased 5.7% at December 31, 2008, totaling $3.7 billion from $3.5 billion at December 31, 2007. The increase in loans and leases was driven by strong growth in consumer loans and home equity loans. Consumer loans increased $139.7 million or 21.3%, from $655.4 million at December 31, 2007 to $795.1 million at December 31, 2008. The increase in consumer loans was driven primarily by an increase in indirect installment loans of $155.0 million, from $520.7 million in 2007 to $675.7 million in 2008. Home equity loans increased $44.9 million or 7.7% from $582.7 million at December 31, 2007 to $627.6 million at December 31, 2008. The increase in home equity loans was due to strong product demand and successful marketing of home equity products. Commercial and commercial real estate increased $26.9 million at December 31, 2008 when compared to December 31, 2007. These increases were partially offset by a decrease in real estate construction and development loans, which decreased $13.5 million, or 16.6% at December 31, 2008 as compared to December 31, 2007.

The following table reflects the loan and lease portfolio by major categories as of December 31 for the years indicated:

Table 3. Composition of Loan and Lease Portfolio

                                                                 December 31,
(In thousands)                           2008            2007            2006            2005            2004
Residential real estate
mortgages                         $   722,723     $   719,182     $   739,607     $   701,734     $   721,615
Commercial and commercial real
estate                              1,241,779       1,214,897       1,240,383       1,127,705       1,069,451
Real estate construction and
development                            67,859          81,350          94,494          69,135          86,031
Agricultural and agricultural
real estate                           113,566         116,190         118,278         114,043         108,181
. . .