The following table presents selected quarterly information for the fourth quarter of 2008 and the preceding four quarters:

Selected Quarterly Information:

(Dollars In Thousands, Except Per Share Amounts)


                                      Dec 2008   Sep 2008   Jun 2008   Mar 2008   Dec 2007
Net Income                              $5,012     $5,008     $5,436     $4,981     $4,481

Transactions Recorded in Net Income
(Net of Tax):
Visa Litigation (see page 21)         $   ---     $   ---      $ ---      $185      $(362)
Gain on Redemption of Visa Inc.            ---                              452        ---
Class B Shares                                        ---        ---
Other-Than-Temporary Impairment          (242)                   ---        ---        ---
(OTTI) (see page 20)                                (731)
Net Securities Gains (Losses)              249         4        (21)        ---        ---
Net Gain on the Sale of Premises                                                       ---
(see page 29)                              ---        ---        ---        69
Net Gains on Sales of Loans                 31          8         19          5          5
Net Gains (Losses) on the Sale of          18                                          (5)
Other Real Estate Owned                               ---        ---       ---

Period End Shares Outstanding           10,546     10,509     10,516     10,637     10,627
Basic Average Shares Outstanding        10,524     10,497     10,593     10,645     10,619
Diluted Average Shares Outstanding      10,588     10,559     10,650     10,694     10,682
Basic Earnings Per Share                  $.48       $.48       $.51       $.47       $.42
Diluted Earnings Per Share                 .47        .47        .51        .47        .42
Cash Dividends Per Share                   .25        .25        .24        .24        .24

Average Assets                      $1,687,366 $1,657,666 $1,625,093 $1,606,082 $1,601,053
Average Equity                         127,136    124,601    126,177    124,686    120,433
Return on Average Assets                 1.18%      1.20%      1.35%      1.25%      1.11%
Return on Average Equity                 15.68      15.99      17.33      16.07      14.76

Average Earning Assets              $1,615,240 $1,580,408 $1,548,365 $1,530,061 $1,526,148
Average Paying Liabilities           1,345,344  1,308,191  1,288,047  1,272,871  1,265,765
Interest Income, Tax-Equivalent 1       23,446     23,302     22,861     22,832     23,171
Interest Expense                         7,541      7,690      7,751      9,295     10,413
Net Interest Income, Tax-Equivalent     15,905     15,612     15,110     13,537     12,758
1
Tax-Equivalent Adjustment                  727        710        746        750        740
Net Interest Margin 1                    3.92%      3.93%      3.92%      3.56%      3.32%
Efficiency Ratio Calculation:1
Noninterest Expense                   $11,273    $10,532    $10,409    $10,179    $ 9,773
Less: Intangible Asset Amortization       (89)       (89)       (86)       (96)       (96)
  Net Noninterest Expense             $11,184    $10,443    $10,323    $10,083    $ 9,677
Net Interest Income, Tax-Equivalent
1                                     $15,905    $15,612    $15,110    $13,537    $12,758
Noninterest Income                      4,152      3,089      4,181      4,847      4,016
Less: Net Securities (Gains) Losses       (12)     1,204         35       (749)       ---
  Net Gross Income                    $20,045    $19,905    $19,326    $17,635    $16,774
Efficiency Ratio 1                      55.79%     52.46%     53.42%     57.18%     57.69%
Period-End Capital Information:
Tier 1 Leverage Ratio                    8.39%      8.32%      8.45%      8.54%      8.37%
Total Shareholders' Equity (i.e.      $125,802   $125,397   $124,080   $127,051   $122,256
Book Value)
Book Value per Share                     11.93      11.93      11.80      11.94      11.50
Intangible Assets                       16,378     16,457     16,495     16,593     16,590
Tangible Book Value per Share            10.38      10.36      10.23      10.38       9.94

Net Loans Charged-off as a
 Percentage of Average Loans,
Annualized                                .14%       .07%       .00%       .08%       .05%
Provision for Loan Losses as a
 Percentage of Average Loans,
Annualized                               .32        .09        .09        .11        .07
Allowance for Loan Losses as a
 Percentage of Loans, Period-end        1.20       1.16       1.20       1.20       1.19
Allowance for Loan Losses as a
 Percentage of Nonperforming Loans,
Period-end                            338.05     444.08     502.17     407.05     567.81
Nonperforming Loans as a
 Percentage of Loans, Period-end         .35        .26        .24        .29        .21
Nonperforming Assets as a
 Percentage of Total Assets,
Period-end                               .30        .24        .17        .20        .15

1 See "Use of Non-GAAP Financial Measures" on page 4.

Selected Twelve-Month Information:

(Dollars In Thousands, Except Per Share Amounts)

Share and per share amounts have been adjusted for subsequent stock dividends,
including the most recent September 2007 3% stock dividend.

                                                        Dec 2008   Dec 2007   Dec 2006
Net Income                                               $20,437    $17,332    $16,892

Transactions Recorded in Net Income (Net
of Tax):
Visa Litigation (see page 21)                              $185      $(362)     $ ---
Gain on Redemption of Visa Inc. Class B
Shares (see page 21)                                         452        ---        ---
Other-Than-Temporary Impairment (OTTI)
(see page 20)                                              (971)        ---        ---
Net Securities Gains (Losses)                                231        ---       (61)
Net Gain on the Sale of Premises (see page
29)                                                           69        ---        136
Net Gains on Sales of Loans                                   64         25         44
Net Gains (Losses) on the Sale of Other
Real Estate Owned                                            18         (2)        ---

Period End Shares Outstanding                             10,546     10,627     10,905
Basic Average Shares Outstanding                          10,565     10,714     10,922
Diluted Average Shares Outstanding                        10,622     10,786     11,067
Basic Earnings Per Share                                 $1.93      $1.62      $1.55
Diluted Earnings Per Share                                1.92       1.61       1.53
Cash Dividends Per Share                                   .98        .94        .91

Average Assets                                        $1,644,210 $1,558,251 $1,522,327
Average Equity                                           125,653    118,082    117,466
Return on Average Assets                                   1.24%      1.11%      1.11%
Return on Average Equity                                 16.26      14.68      14.38

Average Earning Assets                                $1,568,677 $1,486,707 $1,451,655
Average Paying Liabilities                             1,303,740  1,229,882  1,201,612
Interest Income, Tax-Equivalent 1                         92,441     89,498     82,999
Interest Expense                                          32,277     40,283     34,743
Net Interest Income, Tax-Equivalent 1                     60,164     49,215     48,256
Tax-Equivalent Adjustment                                  2,933      2,921      2,388
Net Interest Margin 1                                      3.84%      3.31%      3.32%
Efficiency Ratio Calculation 1
Noninterest Expense                                     $42,393    $37,930    $36,807
Less: Intangible Asset Amortization                        (360)      (394)      (436)
  Net Noninterest Expense                               $42,033    $37,536    $36,371
Net Interest Income, Tax-Equivalent 1                   $60,164    $49,215    $48,256
Noninterest Income                                       16,269     16,288     15,781
Less: Net Securities Losses (Gains)                         478        ---        102
  Net Gross Income                                      $76,911    $65,503    $64,139
Efficiency Ratio 1                                        54.65%     57.30%     56.71%
Period-End Capital Information:
Tier 1 Leverage Ratio (Period-end)                         8.39%      8.37%      8.63%
Total Shareholders' Equity (i.e. Book
Value)                                                  $125,802   $122,256   $118,130
Book Value per Share                                       11.93      11.50      10.83
Intangible Assets                                         16,378     16,590     16,925
Tangible Book Value per Share                              10.38       9.94       9.28

Net Loans Charged-off as a
 Percentage of Average Loans                                .07%       .04%       .08%
Provision for Loan Losses as a
 Percentage of Average Loans                               .16        .05        .08
Allowance for Loan Losses as a
 Percentage of Loans, Period-end                          1.20       1.19       1.22
Allowance for Loan Losses as a
 Percentage of Nonperforming Loans,
Period-end                                              338.05     567.81     442.12
Nonperforming Loans as a
 Percentage of Loans, Period-end                           .35        .21        .28
Nonperforming Assets as a
 Percentage of Total Assets, Period-end                    .30        .15        .21

1 See "Use of Non-GAAP Financial Measures" on page 4.

CRITICAL ACCOUNTING POLICIES

In order to prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, we were required to make estimates and assumptions that affected the amounts reported in these statements. There are uncertainties inherent in making these estimates and assumptions, which could materially affect our results of operations and financial position. We consider the following to be critical accounting policies:

The allowance for loan losses: The adequacy of the allowance for loan losses is sensitive to changes in current economic conditions that may make it difficult for borrowers to meet their contractual obligations. Any downward trend in the economy, regional or national, may require us to increase the allowance for loan losses resulting in a negative impact on our results of operations and financial condition at the same time that other areas of our operations, including new loan originations and assets under administration in our trust department may also be experiencing negative pressures from the same underlying negative economic conditions.

Liabilities for retirement plans: We have a variety of pension and retirement plans. Liabilities under these plans rely on estimates of future salary increases, numbers of employees and employee retention, discount rates and long-term rates of investment return. Changes in these assumptions due to changes in the financial markets, the economy, our own operations or applicable law and regulation may result in material changes to our liability for postretirement expense, with consequent impact on our results of operations and financial condition.

Valuation allowance for deferred tax assets: SFAS No. 109 "Accounting for Income Taxes," requires a reduction in the carrying amount of deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of the deferred tax assets will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. Our analysis of the need for a valuation allowance for deferred tax assets is, in part, based on an estimate of future taxable income.

Goodwill: SFAS No. 142 "Goodwill and Other Intangible Assets," requires that goodwill be tested for impairment at a level of reporting referred to as a reporting unit. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill.
The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill.

Other than temporary decline in the value of debt and equity securities: SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities," requires that, for individual securities classified as either available-for-sale or held-to-maturity, an enterprise shall determine whether a decline in fair value below the amortized cost basis is other than temporary. For example, if it is probable that the investor will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an other-than-temporary impairment shall be considered to have occurred. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security shall be written down to fair value as a new cost basis and the amount of the write-down shall be included in current period earnings. Any significant economic downturn might result, and historically have on occasion resulted, in an other-than-temporary impairment in securities held in our portfolio.

Valuation methods for securities available-for-sale measured at fair value on a recurring basis: We account for securities available-for-sale in accordance with SFAS No. 115, with changes to fair value recorded in other comprehensive income. Most of the portfolio, which includes U.S. Treasury and agency securities, mortgage-backed securities, collateralized mortgage obligations, municipal securities, corporate debt and equity securities are priced using industry-standard models that consider various assumptions that include time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are either observable in the marketplace, derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Municipal and corporate securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.

The following discussion and analysis focuses on and reviews our results of operations for each of the years in the three-year period ended December 31, 2008 and our financial condition as of December 31, 2008 and 2007. The discussion below should be read in conjunction with the selected quarterly and annual information set forth above and the consolidated financial statements and other financial data presented elsewhere in this Report. When necessary, prior-year financial information has been reclassified to conform to the current-year presentation.

A. OVERVIEW

Summary of 2008 Financial Results

We reported net income of $20.4 million for 2008, an increase of $3.1 million, or 17.9%, compared to 2007. Diluted earnings per share of $1.92 represented an increase of $.31, or 19.3%, from 2007. During 2008, both our net interest margin and net interest income increased due to a combination of falling short-term interest rates (which has a proportionately larger impact on the cost of our deposits than on our earnings from our assets) combined with a market-wide return of a positively-sloped yield curve (which has a proportionately larger impact on our earning assets than on our liabilities). A 5.5% increase in average earning assets also had a positive impact on the growth in our net interest income. Unlike many financial institutions, we did not experience significant deterioration in our loan and asset quality during 2008 despite the onset of a worldwide economic recession and severe disruption in the financial markets generally.

Earnings in all quarters of 2008 were higher than the respective 2007 quarters; in spite of the worsening economy late in 2008, annual earnings for 2008 represented a record high for the company.

Financial Market Turmoil: Over the past fifteen months, the Dow Jones Industrial Average (Dow Jones) slid from a high of over 14,000 to a low of under 8,000, with the most dramatic change occurring during the fourth quarter of 2008. The financial markets and particularly the banking sector have felt the impact of losses on subprime mortgages and other credit portfolios and loss of short-term liquidity, resulting in the September 2008 failure of Lehman Brothers Holdings (Lehman) and the distressed sales of Bear Stearns and Merrill Lynch.
In addition, the number of bank failures, while not at historic highs, has risen to levels not seen for several years. Many community banks that were not underwriting subprime residential real estate loans and were not investing significant amounts in private issue collateralized debt obligations, like our company, have not experienced the significant losses in their loan or investment portfolios or the liquidity concerns that many of our larger contemporaries have experienced. However, the magnitude of turmoil in the markets did have an impact on our operations during 2008 and may continue to influence our financial condition and results of operations in forthcoming periods.

Decision Not to Participate in U.S. Treasury TARP CCP: As previously disclosed in our Current Report in Form 8-K filed with the SEC on January 27, 2009, our Board of Directors determined in late January 2009, after we had applied to the U.S. Treasury Department and federal bank regulators for participation by the Company in the U.S. Government's Capital Purchase Plan ("CPP"), an element of the larger Troubled Assets Relief Program ("TARP"), and after we had been preliminarily approved by the Department of Treasury for participation, that we would not proceed ahead and sell shares of our preferred stock to the Treasury Department but would decline to participate. The basic reason for the Board's decision, as discussed in the Form 8-K, was that the Company's financial and liquidity positions remained sufficiently strong at year-end such that the potential loss of Board and management flexibility entailed in CPP participation was deemed too high a cost to warrant participation.

Economic recession and loan quality: As the economic recession got underway in late 2007, our market area of northeastern New York was relatively sheltered from falling real estate values and increasing unemployment. As the recession became stronger and deeper in late 2008, even northeastern New York began to feel the impact of the worsening national economy reflected in a slow-down in real estate sales and increasing unemployment rates. By year-end 2008, we had experienced a decline in the credit quality of our loan portfolio, although by standard measures our portfolio continued to appear stronger than the average for our peer group. Nonperforming loans amounted to $3.9 million at December 31, 2008, an increase of $1.7 million from the prior year-end. The ratio of nonperforming loans to period-end loans was .35% at December 31, 2008, an increase from .21% one year earlier. By way of comparison, this ratio for our peer group increased by 128 basis points from 1.08% at December 31, 2007 to 2.36% at December 31, 2008. Our loans charged-off (net of recoveries) against our allowance for loan losses were $800 thousand for 2008, as compared to $390 thousand for the prior year. At year-end 2008, the allowance for loan losses was $13.3 million, representing 1.20% of total loans, essentially the same as at the prior year-end. To date, we have not experienced significant deterioration in any of our three major loan portfolio segments:

o

Commercial Loans: We lend to small and medium size businesses, which typically do not encounter liquidity problems, since we may often also provide support for their supplementary liquidity needs. However, current unemployment rates in our region are higher than in the past few years and the number of total jobs has decreased, although these trends are largely attributable to a few changes in the local operations of a small number of larger corporations.

o

Residential Real Estate Loans: We have not experienced a notable increase in our foreclosure rates, primarily due to the fact that we did not originate or participate in underwriting subprime loans.

o

Indirect Automobile Loans: These loans comprise over 30% of our loan portfolio.
We have not experienced any significant change in our delinquency rate or level of charge-offs, although both delinquencies and charge-offs did increase moderately in the fourth quarter of 2008.

Investment securities and other-than-temporary impairment: We hold a $2.0 million par value senior unsecured bond issued by Lehman. On September 15, 2008, Lehman declared bankruptcy resulting in a significant decline in the market value of the bond. We deemed the decline to be other-than-temporary in the third quarter 2008, and, accordingly, recognized a non-cash other-than-temporary impairment charge to earnings of $731 thousand net of tax (a $.07 reduction in diluted earnings per share). After further deterioration, we recognized an additional charge to earnings of $241 thousand net of tax (a $.02 reduction in diluted earnings per share) in the fourth quarter of 2008. The remaining estimated value of our Lehman bond of $400 thousand has been included in non-performing assets as of December 31, 2008. The Lehman bankruptcy proceedings are ongoing and the ultimate value of our bond is subject to further change. Corporate bonds and other debt securities represented only $7.4 million, or 1.6%, of our $459.1 million investment securities portfolio at December 31, 2008. We did not hold any preferred or common stock of Fannie Mae or Freddie Mac. As of year-end, we had not experienced any impairment issues with our holdings of mortgage-backed securities or CMO's.

Liquidity and access to credit markets: We have not experienced any liquidity issues during 2008 and through the date of this report. The terms of our lines of credit with our correspondent banks, the FHLBNY and the Federal Reserve Bank, have not changed, except for some increases in the maximum borrowing capacity (see our general liquidity discussion on page 40). In general, we rely on asset-based liquidity (i.e. funds in overnight investments and cash flow from maturing investments and loans) with liability-based liquidity as a secondary source (overnight lending arrangements with our correspondent banks, FHLBNY overnight and term advances and the Federal Reserve Bank discount window, as primary sources). During the recent period of bank failures, some institutions experienced a run on deposits, even though there was no reasonable expectation that depositors would lose any of their insured deposits. We maintain, and periodically test, a contingent liquidity plan whose purpose is to ensure that we can generate an adequate amount of cash to meet a wide variety of potential liquidity crises.

Effect of VISA public offering, stock redemption and litigation reserves: In December 2007, we recorded a $600 thousand liability for our proportional share, as a member bank of the Visa credit card organization, of certain estimated litigation costs incurred by Visa U.S.A., Inc., as further described in our Form 10-K for December 31, 2007. On March 28, 2008, VISA Inc. distributed to member banks, in a mandatory redemption of 38.7% of its Class B shares held by the member banks, some of the proceeds realized by Visa from the IPO of its Class A shares on March 19, 2008. With another portion of the IPO proceeds, Visa established a $3 billion escrow to cover certain, but not all, of its continuing litigation liabilities. During the first quarter of 2008, we recorded the following transactions:

•

A gain of $749 thousand from the mandatory redemption by Visa of 38.7% of our Class B Visa Inc. shares, reflected in noninterest income, and

•

A reversal of $306 thousand of the $600 thousand accrual at December 31, 2007 representing our proportional share of Visa litigation costs, reflected as a reduction in 2008 other operating expense.

Accordingly, we have a remaining liability of $294 thousand included as a component of "Other Liabilities" in the consolidated balance sheet as of December 31, 2008, representing our estimate of the fair value of potential losses related to the remaining covered Visa litigation. Class B shares which were not redeemed will be converted to Class A shares, at a conversion ratio to be determined based on member banks' actual liability for litigation expenses, on the later of three years or the settlement of litigation indemnified by member banks. These remaining Class B shares are available to fund future Visa litigation liabilities indemnified by the member banks until that time. In accordance with Generally Accepted Accounting Principles (GAAP) and consistent with the Securities and Exchange Commission (SEC) guidance, the Company has not recognized any value for its remaining Visa Class B shares.

In October 2008, Visa announced that it had settled the lawsuit with Discover Financial Services, which was part of the covered litigation for which the Visa member banks are contingently liable. In December 2008, Visa deposited an additional $1.1 billion into the litigation escrow fund, thereby reducing the ratio for the conversion of Class B to Class A shares and effectively repurchasing approximately 12% of the remaining Class B shares held by member banks to fund its settlement of the Discover litigation. The Company had not previously recognized the value of the Class B shares in accordance with the SEC guidance discussed above, nor did the Company recognize any income or expense as a result of Visa's redemption of its Class B shares or settlement of the litigation in the fourth quarter. The estimation of the Company's proportionate share of any potential losses related to certain covered litigation is extremely difficult and involves a high degree of judgment. Management has determined the remaining $294 thousand liability included in "Other Liabilities" on our year-end consolidated balance sheet is the fair value of our proportionate share of the remaining covered Visa litigation as of December 31, 2008, but this value is subject to change depending upon future developments in the Visa litigation.

Change in Shareholder Equity: At December 31, 2008, our tangible book value per share (calculated based on shareholders' equity reduced by intangible assets including goodwill and other intangible assets) amounted to $10.38, an increase of $.44, or 4.4%, from year-end 2007. Our total shareholders' equity at year-end 2008 increased 2.9% over the year-end 2007 level. Major changes to shareholders' equity included: i) $20.4 million of net income for the year; ii) a $2.5 million net unrealized gain in securities available-for-sale, offset by;
iii) cash dividends of $10.3 million, iv) losses on our pension plan (reflected as other comprehensive income) of $6.9 million; and v) repurchases of our own common stock of $4.3 million. As of the last trading day of 2008, the average of our closing stock price was $21.43, resulting in a trading multiple of 2.42 to our tangible book value. We also continue to remain classified as "well-capitalized" under regulatory guidelines. As mentioned above, due to our strong capital, financial and liquidity positions at year-end, we did not participate in the U.S. Treasury's Capital Purchase Program (a component of TARP).

The Board of Directors declared a quarterly cash dividend of $.25 per share for the fourth quarter of 2008. For the year, total cash dividends (as adjusted for stock dividends) were $.98 compared to $.94 for 2007, an increase of $.04, or 4.3%.

Other Recent Transactions: In accordance with our Current Report in Form 8-K filed with the SEC on March 2, 2009, Arrow and its bank subsidiaries have . . .