FORWARD LOOKING INFORMATION
Statements in this Quarterly Report on Form 10-Q that are based on other than historical data are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:
• statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Financial Institutions, Inc. ("the parent" or "FII") and its subsidiaries (collectively "the Company," "we," "our," "us");

• statements preceded by, followed by or that include the words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "projects," or similar expressions.

These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management's views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this Quarterly Report on Form 10-Q, including, but not limited to, those presented in the Management's Discussion and Analysis. Factors that might cause such differences include, but are not limited to:
• changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including without limitation, reduced rates of business formation and growth, commercial and residential real estate development and real estate prices;

• fluctuations in markets for equity, fixed-income, commercial paper and other securities, including availability, market liquidity levels, and pricing;

• changes in interest rates, the quality and composition of the loan and securities portfolios, demand for loan products, deposit flows and competition;

• changes in fiscal, monetary, regulatory, trade and tax policies and laws, including policies of the U.S. Department of Treasury and the Federal Reserve Board;

• the Company's participation or lack of participation in governmental programs implemented under the Emergency Economic Stabilization Act ("EESA") and the American Recovery and Reinvestment Act ("ARRA"), including without limitation the Troubled Asset Relief Program ("TARP"), the Capital Purchase Program ("CPP"), and the Temporary Liquidity Guarantee Program ("TLGP") and the impact of such programs and related regulations on the Company and on international, national, and local economic and financial markets and conditions;

• changes in consumer spending and savings habits;

• increased competitive challenges and expanding product and pricing pressures among financial institutions;

• demand for financial services in the Company's market areas;

• legislation or regulatory changes which adversely affect the Company's operations or business, including the Obama Administration's regulatory reform proposals concerning the financial services sector released on June 17, 2009;

• the Company's ability to comply with applicable laws and regulations, including restrictions on dividend payments;

• changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or regulatory agencies;

• increased costs of deposit insurance and changes with respect to Federal Deposit Insurance Corporation ("FDIC") insurance coverage levels; and

• declines in the market value of the Company's publicly traded stock price or declines in the Company's ability to generate future cash flows may increase the potential that goodwill recorded on the Company's consolidated statement of financial condition be designated as impaired and that the Company may incur a goodwill write-down in the future.

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, 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 obligation 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.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ACCOUNTING ESTIMATES The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and are consistent with predominant practices in the banking industry. Application of critical accounting policies, which are those policies that management believes are the most important to the Company's financial condition and results, requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date of the financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the financial statements.
The Company has numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements included in the Company's 2008 Annual Report on Form 10-K. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets, liabilities, revenues and expenses are reported in the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for loan losses, valuation of goodwill and deferred tax assets, the valuation of securities and determination of other-than-temporary impairment ("OTTI"), and accounting for defined benefit plans require particularly subjective or complex judgments important to the Company's financial condition and results of operations, and, as such, are considered to be critical accounting policies. These estimates and assumptions are based on management's best estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current economic environment. The Company adjusts these estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and volatile equity have combined with declines in consumer spending to increase the uncertainty inherent in these estimates and assumptions. As future events cannot be determined with precision, actual results could differ significantly from the Company's estimates.
For additional information regarding critical accounting policies, refer to Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements and the section captioned "Critical Accounting Estimates" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2008 Annual Report on Form 10-K. There have been no material changes in the Company's application of critical accounting policies related to the allowance for loan losses, valuation of goodwill and deferred tax assets, the valuation of securities and determination of OTTI, and accounting for defined benefit plans since December 31, 2008.
OVERVIEW
The principal objective of this discussion is to provide an overview of the financial condition and results of operations of the Company for the periods covered in this quarterly report. Certain reclassifications have been made to make prior periods comparable. This discussion and tabular presentations should be read in conjunction with the accompanying consolidated financial statements and accompanying notes.
During third quarter of 2009, we announced the appointment of Karl F. Krebs to the position of Executive Vice President and Chief Financial Officer ("CFO"). Mr. Krebs succeeded Mr. Ronald Miller, who retired as CFO effective October 1, 2009 as part of the Company's management succession plan. As previously announced, Mr. Miller will continue to serve as Executive Vice President and Secretary and will be assisting with the transition and special projects until his formal retirement in early 2010.
RESULTS OF OPERATIONS
Summary of Performance
Net income was $3.4 million for the third quarter of 2009 compared to a net loss of $28.4 million for the third quarter of 2008. Net income applicable to common shareholders for the third quarter of 2009 was $2.5 million, or $0.23 per diluted share, compared with a net loss of $28.8 million, or $2.66 per diluted share, for the third quarter of last year. Net income for the nine months ended September 30, 2009 totaled $9.0 million compared to a net loss of $23.0 million for the same period in 2008. For the first nine months of 2009 net income applicable to common shareholders was $6.2 million, or $0.57 per diluted share, compared with a net loss of $24.1 million, or $2.21 per diluted share, for the first nine months of 2008.
Included in the results for the three and nine month periods ended September 30, 2008, is a pre-tax OTTI charge of $31.0 million related to auction rate preferred equity securities collateralized by preferred stock of Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"). The tax benefit recognized on this OTTI charge was based on its treatment being classified as a capital loss for tax purposes, which significantly limited the tax benefit. A provision of EESA, enacted during the fourth quarter of 2008, permitting banks to recognize losses relating to FNMA and FHLMC preferred stock as an ordinary loss, increased the tax benefit to the Company in the fourth quarter. Had the tax benefit been recognized during the third quarter of 2008, it would have reduced the net losses for the three and nine month periods ended September 30, 2008 by $12.0 million.
Details of the changes in the various components of net income are further discussed in the sections that follow.

Net Interest Income
The principal source of the Company's revenue is net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities and the interest expense on liabilities used to fund those assets, such as interest-bearing deposits and borrowings. Net interest income is impacted by both changes in the amount and composition of interest-earning assets and interest-bearing liabilities, as well as market interest rates.
Net interest income was $18.1 million and $16.7 million for the three months ended September 30, 2009 and 2008, respectively. For the nine months ended September 30, 2009 and 2008, net interest income was $53.1 million and $48.0 million, respectively. The increases for both periods resulted primarily from favorable changes in the mix of our interest-earning assets and repricing of interest-bearing liabilities at lower interest rates.
Net interest income was $18.1 million for the third quarter, up $1.3 million or 8%, from the third quarter of 2008. For the third quarter of 2009, average loans and securities represented 66% and 31%, respectively, of average earning assets compared to 59% and 41% in the third quarter of 2008. The tax equivalent net interest margin was relatively unchanged at 3.99% and 3.98% for the third quarters of 2009 and 2008, respectively. A decrease of $861 thousand, or 4%, in total interest income was surpassed by a decrease of $2.2 million, or 28%, in total interest expense.
Interest on investment securities and interest-earning deposits was $5.0 million for the third quarter of 2009, compared to $7.5 million for the third quarter of 2008. The average balance of investment securities was $585.8 million with an average tax equivalent yield of 3.79% for the third quarter of 2009, compared to an average balance of $721.4 million with an average yield of 4.66% for the third quarter of 2008. The decrease in yield is primarily due to lower market interest rates, coupled with less risk and shorter average maturities in the investment securities. In addition, selected higher yielding securities were sold for gains during the three months ended September 30, 2009. The sale of these securities, coupled with principal payments, maturities and calls on investment securities has contributed to lower interest income as the proceeds from these transactions were reinvested at lower yields.
Interest on loans was $18.7 million for third quarter of 2009, compared to $17.0 million for the third quarter of 2008. The average balance of loans was $1.236 billion with an average yield of 6.01% for the third quarter of 2009 compared to an average balance of $1.039 billion with an average yield of 6.52% for the third quarter of 2008. Average commercial loans in the third quarter of 2009 increased $83.6 million, as compared to the third quarter of 2008 primarily due to continued strong growth in our commercial loan portfolio. The average balance of consumer indirect loans, comprised almost entirely of automobile loans, increased $133.5 million for the third quarter of 2009 over the corresponding quarter last year. This 67% increase in volume was primarily responsible for the $2.3 million increase in interest income on consumer indirect loans when comparing the third quarter of 2009 to that of 2008. Interest on deposits was $4.8 million for the third quarter of 2009, compared to $6.5 million for the third quarter of 2008. The average balance of interest-bearing deposits was $1.430 billion with an average cost of 1.34% for the third quarter of 2009 compared to an average balance of $1.300 billion with an average cost of 2.00% for the third quarter of 2008. The average balance of noninterest-bearing deposits increased by 2% to $298.7 million during the third quarter of this year compared to the same quarter last year. The increase in the balance of total average deposits is due to a 7% increase in public and 9% increase in nonpublic deposits, while the decrease in average cost is due primarily to the beneficial repricing of certificates of deposits, and to a lesser extent savings and money market accounts, at lower interest rates. The declines in interest and average cost on total borrowed funds from last year's third quarter to this year's third quarter are due to a combination of lower market interest rates and average borrowings outstanding. For the nine months ended September 30, 2009, net interest income was $53.1 million, an increase of $5.0 million or 10% over the same period in 2008. For the nine months ended September 30, 2009, average loans and securities represented 65% and 32%, respectively, of average earning assets compared to 56% and 42% for the same period in 2008. The nine month period ended September 30, 2009 reflected an increase of 15 basis points in net interest margin to 4.03% compared to the same period last year. The improved net interest margin resulted principally from lower funding costs and the benefits associated with a higher percentage of earning assets being deployed in higher yielding loan assets. A decrease of $4.3 million, or 6%, in total interest income was surpassed by a decrease of $9.3 million, or 35%, in total interest expense. Interest on investment securities and interest-earning deposits was $16.5 million for the nine months ended September 30, 2009, compared to $24.2 million for the same period in 2008. The average balance of investment securities was $593.5 million with an average tax equivalent yield of 4.17% for the nine months ended September 30, 2009 compared to an average balance of was $739.9 million with an average yield of 4.87% for the same period in 2008. The decrease in yield is primarily due to lower market interest rates as proceeds from securities transactions, including the sale of selected higher yielding securities during the nine months ended September 30, 2009, were reinvested at lower rates. A change in the mix of the investment portfolio that included a decline in the level of tax-exempt securities and resulting interest income also contributed to the decrease in yield.

Interest on loans was $53.5 million for first nine months of 2009, compared to $50.1 million for the first nine months of 2008. The average balance of loans was $1.190 billion with an average yield of 6.01% for the nine month period ended September 30, 2009 compared to an average balance of $998.0 million with an average yield of 6.70% for the same period in 2008. Average commercial loans increased by $64.0 million during the first nine months of 2009, as compared to same period in 2008 primarily due to strong growth in our commercial loan portfolio. The average balance of consumer indirect loans, comprised almost entirely of automobile loans, increased $136.0 million for the first nine months of 2009 over the corresponding period last year. This 82% increase in volume was primarily responsible for the $6.9 million increase in interest income on consumer indirect loans when comparing the nine months ended September 30, 2009 to the same period in 2008.
Interest on deposits was $14.7 million for the nine month period ended September 30, 2009, compared to $23.2 million for the same period in 2008. The average balance of interest-bearing deposits was $1.422 billion with an average cost of 1.38% for the nine month period ended September 30, 2009 compared to an average balance of $1.326 billion with an average cost of 2.34% for the same period in 2008. The average balance of noninterest-bearing deposits increased by 4% to $288.9 million during the first nine months of this year compared to the same period last year. The increase in the balance of total average deposits is due to a 4% increase in public and a 10% increase in nonpublic deposits, while the decrease in average cost is due primarily to the beneficial repricing of certificates of deposits, and to a lesser extent savings and money market accounts, at lower interest rates.
The following table provides a reconciliation between tax equivalent net interest income as presented in the average balance sheets above and net interest income in the consolidated financial statements filed herewith in

                                          Three months ended              Nine months ended
                                             September 30,                  September 30,
                                          2009           2008            2009           2008
Net interest income (tax
equivalent)                            $   18,669      $  17,686      $   55,202      $  51,448
Less: tax-exempt tax equivalent
adjustment                                    591            940           2,152          3,430

Net interest income                    $   18,078      $  16,746      $   53,050      $  48,018

The following tables sets forth certain information relating to the consolidated balance sheets and reflects the average yields earned on interest-earning assets, as well as the average rates paid on interest-bearing liabilities for the periods indicated (in thousands).

                                                     Three months ended September 30,
                                            2009                                          2008
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
Interest-earning
assets:
Federal funds sold and
interest-earning
deposits                  $    39,945      $      20          0.20 %    $    12,897      $      68          2.10 %
Investment securities
(1):
Taxable                       450,266          3,819          3.39          493,438          5,577          4.52
Tax-exempt (2)                135,564          1,737          5.13          227,981          2,835          4.96

Total investment
securities                    585,830          5,556          3.79          721,419          8,412          4.66
Loans held for sale             1,490             21          5.76              799             14          6.81
Loans:
Commercial                    194,803          2,299          4.68          147,350          2,244          6.06
Commercial real estate        288,658          4,515          6.20          249,769          4,234          6.74
Agricultural                   43,250            597          5.48           45,965            732          6.34
Residential real
estate                        148,325          2,266          6.11          173,175          2,669          6.17
Consumer indirect             334,123          5,938          7.05          200,586          3,626          7.19
Consumer direct and
home equity                   226,355          3,076          5.39          222,241          3,499          6.26

Total loans                 1,235,514         18,691          6.01        1,039,086         17,004          6.52

Total interest-earning
assets                      1,862,779         24,288          5.19        1,774,201         25,498          5.73

Allowance for loan
losses                        (20,893 )                                     (16,385 )
Other
noninterest-earning
assets                        198,144                                       150,761

Total assets              $ 2,040,030                                   $ 1,908,577


Interest-bearing
liabilities:
Deposits:
Interest-bearing
demand                    $   361,147      $     174          0.19 %    $   342,188      $     738          0.86 %
Savings and money
market                        369,562            271          0.29          366,449            853          0.93
Certificates of
deposit                       699,011          4,381          2.49          591,025          4,947          3.33

Total interest-bearing
deposits                    1,429,720          4,826          1.34        1,299,662          6,538          2.00
Short-term borrowings          47,794             77          0.64           52,608            287          2.17
Long-term borrowings           46,848            716          6.09           65,415            987          6.02

Total interest-bearing
liabilities                 1,524,362          5,619          1.46        1,417,685          7,812          2.19

Noninterest-bearing
demand deposits               298,723                                       294,136
Other
noninterest-bearing
liabilities                    21,925                                        15,652
Shareholders' equity          195,020                                       181,104

Total liabilities and
shareholders' equity      $ 2,040,030                                   $ 1,908,577

Net interest income
(tax-equivalent)                           $  18,669                                     $  17,686

Interest rate spread                                          3.73 %                                        3.54 %

Net earning assets        $   338,417                                   $   356,516

Net interest margin
(tax-equivalent)                                              3.99 %                                        3.98 %

Ratio of average
interest-earning
assets to average
interest-bearing
liabilities                                                 122.20 %                                      125.15 %

(1) Investment securities are shown at amortized cost and include non-performing securities.

(2) The interest on tax-exempt securities is calculated on a tax equivalent basis assuming a Federal tax rate of 34%.

                                                     Nine months ended September 30,
                                            2009                                          2008
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
Interest-earning
assets:
Federal funds sold and
interest-earning
deposits                  $    44,209      $      73          0.22 %    $    29,751      $     572          2.57 %
Investment securities
(1):
Taxable                       428,387         12,222          3.80          492,434         16,570          4.49
Tax-exempt (2)                165,146          6,331          5.11          247,462         10,508          5.66

Total investment
securities                    593,533         18,553          4.17          739,896         27,078          4.87
Loans held for sale             2,176             82          5.02              891             41          6.11
Loans:
Commercial                    181,515          6,326          4.66          144,060          6,981          6.47
Commercial real estate        277,633         13,114          6.32          248,544         12,831          6.90
Agricultural                   42,771          1,780          5.57           45,283          2,391          7.05
Residential real
estate                        163,665          7,443          6.06          169,939          8,021          6.29
Consumer indirect             301,110         15,737          6.99          165,153          8,815          7.13
Consumer direct and
home equity                   223,187          9,136          5.47          225,050         11,066          6.57

Total loans                 1,189,881         53,536          6.01          998,029         50,105          6.70

Total interest-earning
assets                      1,829,799         72,244          5.27        1,768,567         77,796          5.87

Allowance for loan
losses                        (20,128 )                                     (15,857 )
Other
noninterest-earning
assets                        195,985                                       146,313

Total assets              $ 2,005,656                                   $ 1,899,023


Interest-bearing
liabilities:
Deposits:
Interest-bearing
demand                    $   362,870      $     584          0.22 %    $   343,247      $   2,616          1.02 %
Savings and money
market                        377,877            785          0.28          368,882          3,134          1.13
Certificates of
deposit                       681,204         13,360          2.62          613,443         17,443          3.80

Total interest-bearing
deposits                    1,421,951         14,729          1.38        1,325,572         23,193          2.34
. . .