The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this document. Certain statements under this caption constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which First Niagara Financial Group, Inc. and its subsidiary operate, projections of future performance and perceived opportunities in the market. Our actual results may differ significantly from the results, performance, and achievements expressed or implied in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, economic conditions, competition in the geographic and business areas in which we conduct our operations, fluctuation in interest rates, credit quality and government regulation, and other factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2008 under Item 1A. "Risk Factors." First Niagara Financial Group, Inc. does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements.
OVERVIEW
First Niagara Financial Group, Inc. is a Delaware corporation and financial holding company serving both retail and commercial customers through our bank subsidiary, First Niagara Bank, which is a federally chartered savings bank subject to Office of Thrift Supervision regulation. We are a full-service, community focused bank in Upstate New York and Western Pennsylvania, with $14.1 billion in assets, $9.9 billion in deposits, and 170 full-service branch locations, including the 57 branch locations we acquired on September 4, 2009 from National City Corporation.
On July 26, 2009, First Niagara Financial Group, Inc. and Harleysville National Corporation ("Harleysville"), the holding company for Harleysville National Bank, jointly announced a definitive merger agreement under which Harleysville will merge into the Company in a transaction valued at approximately $237.0 million. At September 30, 2009, Harleysville had total assets of approximately $5.2 billion, including $3.3 billion in loans, and deposits of approximately $3.9 billion in 83 bank branches across nine Southeastern Pennsylvania counties. The merger is expected to be completed in the first quarter of 2010 and is subject to the approvals of Harleysville stockholders and the applicable regulatory agencies.
BUSINESS AND INDUSTRY
We operate as a community oriented bank that provides customers with a full range of products and services delivered through our customer focused business units. These products include commercial and residential real estate loans, commercial business loans and leases, home equity and other consumer loans, wealth management products, as well as various retail consumer and commercial deposit products. Additionally, we offer insurance and employee benefits consulting services through a wholly-owned subsidiary of the Bank. Our profitability is primarily dependent on the difference, or net spread, between the interest we receive on loans and investment securities, and the interest we pay on deposits and borrowings. The rate we earn on our assets and the rate we pay on our liabilities is a function of the general level of interest rates and competition within our markets. This net spread is also highly sensitive to conditions that are beyond our control, such as inflation, economic growth, and unemployment, as well as policies of the federal government and its regulatory agencies.
The Federal Reserve implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities, by adjusting depository institutions reserve requirements, and by varying the target federal funds and discount rates. The actions of the Federal Reserve in these areas influence the growth of our loans, investments, and deposits, and also affect interest rates that we earn on interest-earning assets and that we pay on interest-bearing liabilities.
MARKET AREAS AND COMPETITION
Our business operations are currently concentrated in Upstate New York and more recently, Western Pennsylvania; therefore, our financial results are affected by economic conditions in these geographic areas, which began to show signs of weakening during the latter half of 2008. If economic conditions in our markets do not improve, or continue to deteriorate, or if we are unable to sustain our competitive posture, both our ability to expand our business, as well as the quality of our loan portfolio, could materially impact our financial results. In addition, our pending merger with Harleysville will expand our market to the Southeastern Pennsylvania area. Our financial results could be materially impacted by deteriorating economic conditions in this area.
We face significant competition both in attracting deposits and providing loans in the Upstate New York and Western Pennsylvania markets, and upon completion of our pending acquisition, the Southeastern Pennsylvania market. We compete with numerous banking and financial services companies, many of whom (whether regional or national) have substantially greater resources and lending capacity, and may offer certain services that we do not or cannot provide. In this marketplace, opportunities to grow and expand are primarily a function of how we are able to differentiate our product offerings and customer experience from our competitors.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified accounting policies and estimates that we judge to be critical: those most important to the presentation of our financial condition and results of operations, and that require subjective and complex judgments. Accordingly, our accounting policies relating to our allowance for credit losses, the accounting treatment and valuation of our investment securities portfolio, the accounting treatment and valuation of acquired loans, the analysis of the carrying value of goodwill, and income taxes are considered critical, as our judgments could have a material effect on our financial results. Additional accounting policies are more fully described in Note 1 in the "Notes to Consolidated Financial Statements" presented in our 2008 Annual Report on Form 10-K. A brief description of our current accounting policies involving significant management judgment follows:
Allowance for Credit Losses
We establish our allowance for credit losses through charges to our provision for credit losses. We evaluate our allowance based on a continuing review of our loan portfolio. We generally review larger balance nonaccruing, impaired, and delinquent loans individually and we consider the value of any underlying collateral, if collateral dependent, or estimated future cash flows in determining estimates of losses and inherent risks associated with those loans. We estimate losses in smaller balance, homogeneous loans based on our historical experience, industry trends and current trends in the real estate market and the current economic environment in our market areas. The adequacy of our allowance for credit losses is based on our evaluation of various conditions including the following: changes in the composition of and growth in our loan portfolio; industry and regional conditions; the strength and duration of the current business cycle; existing general economic and business conditions in our lending areas; credit quality trends, including trends in our nonaccruing loans; our historical loan charge-off experience; and the results of bank regulatory examinations.
Investment Securities
Investment securities we classify as available for sale are recorded at estimated fair value in our Consolidated Statements of Condition. Unrealized gains or losses, net of deferred taxes, are reported in other comprehensive income as a separate component of stockholders' equity. Fair value is based upon quoted market prices of identical assets or liabilities, where available. Where sufficient data is not available to produce a fair valuation, fair value is based on broker quotes of similar assets or liabilities. Broker quotes may be adjusted to ensure that financial instruments are recorded at fair value. Adjustments may include amounts to reflect counterparty credit quality as well as unobservable parameters. If quoted prices are not available, fair value is based upon valuation models that use cash flow, security structure, and other observable information.
Investment securities we classify as held to maturity are recorded at amortized cost in our Consolidated Statements of Condition. We have the ability and intent to hold these securities until maturity.
We conduct a quarterly review and evaluation of our securities portfolio to determine if any declines in fair value below amortized cost are other than temporary. In making this determination we consider some or all of the following factors: the period of time the securities were in an unrealized loss position, the percentage decline in comparison to the securities' amortized cost, credit rating, the financial condition of the issuer and guarantor, where applicable, the delinquency or default rates of underlying collateral, credit enhancement, projected losses, level of credit loss, and projected cash flows. Any valuation decline below amortized cost that we determine to be other than temporary would require us to write down the credit component of such unrealized loss through a charge to current period operations. If we intend to sell a security with a fair value below amortized cost or if it is more likely than not that we will be required to sell such a security, we would record an other than temporary impairment charge through current period earnings for the full decline in fair value below amortized cost.
Acquired Loans
Loans that we acquire in connection with acquisitions subsequent to January 1, 2009 are recorded at fair value and the carryover of the related allowance for credit losses is prohibited by current accounting guidance. Fair value of the loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference. The nonaccretable difference includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require us to evaluate the need for an additional allowance for credit losses. Subsequent improvement in expected cash flows will result in the reversal of the nonaccretable difference which we will then reclassify as accretable yield that will have a positive impact on interest income.

Acquired loans that were previously classified as nonaccrual by the acquiree may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent. We generally expect to fully collect the new carrying value i.e., fair value, of the loans. As such, we may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans including the impact of any accretable purchase accounting fair value discount. In addition, net charge-offs on such loans would be applied to the nonaccretable purchase accounting fair value adjustment.
Due to the accounting requirements of acquired loans, certain trends and credit statistics may be impacted if such loans are included. We believe that excluding the acquired loans from the presentation of such statistics and trends is more meaningful and representative of our ongoing operations and credit quality. Goodwill
We assess goodwill for impairment in accordance with applicable accounting guidance. This assessment is performed on an annual basis or when certain triggering events are deemed to have occurred and utilizes the market comparable or income approach as the primary indicators of fair value of our business segments. If the estimated fair value of a business segment to which we have allocated goodwill is less than the financial statement carrying value, we would record a charge against earnings to reduce the carrying value of the goodwill. A more detailed description of our methodology for testing goodwill for impairment and the related assumptions made can be found within the "Critical Accounting Policies and Estimates" section in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2008 Annual Report on Form 10-K.
Income Taxes
We account for income taxes using the asset and liability approach. Under this approach, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such amounts are realized or settled. We must assess the likelihood that a portion or all of the deferred tax assets will not be realized. In doing so, judgments and estimates must be made regarding the projection of future taxable income. If necessary, a valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized.
In computing the income tax provision, estimates and assumptions must be made regarding the deductibility of certain expenses. It is possible that these estimates and assumptions may be disallowed as part of an examination by the various taxing authorities that we are subject to, resulting in additional income tax expense in future periods. In addition, we maintain a reserve related to uncertain tax positions. These uncertain tax positions are evaluated each reporting period to determine the level of reserve that is appropriate.
RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009
Overview
On September 4, 2009, we acquired 57 branch locations from National City Bank ("NatCity") in Western Pennsylvania, including cash of $3.1 billion, performing loans with a fair value of approximately $717.3 million, core deposits intangible of $29.8 million, and deposits with a fair value of $4.0 billion resulting in goodwill of $130.1 million.
Net income for the nine months ended September 30, 2009 was $50.5 million compared to $65.6 million for the nine months ended September 30, 2008. Our diluted earnings per common share for the first nine months of 2009 was $0.29 compared to $0.62 per share for the first nine months of 2008, reflecting $27.5 million of merger and acquisition integration expenses related to our acquisition of the NatCity branch locations and anticipated merger with Harleysville; the additional common shares issued in our April 2009 and September 2009 follow-on stock offerings; $3.7 million of preferred stock dividends; and $8.3 million in preferred stock discount accretion, including $7.7 million of accelerated accretion related to the full redemption in May 2009 of our preferred stock issued to the U.S. Department of the Treasury ("U.S. Treasury"). In addition, our results were impacted by an $11.5 million increase in federal deposit insurance premiums, which includes a $5.4 million special assessment, and modest credit quality deterioration due to the current economic environment.
Net income for the quarter ended September 30, 2009 was $10.9 million compared to $23.7 million for the quarter ended September 30, 2008. Our diluted earnings per share for the current quarter was $0.07 compared to $0.22 per share for the same period in 2008, reflecting $23.4 million of merger and acquisition integration expenses related to our merger and acquisition activity and the impact of the additional shares issued in our April 2009 and September 2009 follow-on stock offerings as well as increased federal deposit insurance premiums.
Results for the third quarter of 2009 as compared to the third quarter of 2008 reflect a number of positive trends highlighted by a $28.7 million, or 41%, increase in our net interest income resulting from an increase in our net earning assets, our strategy of pre-purchasing investments in anticipation of the NatCity branch acquisition and a more favorable funding mix as lower cost core deposits and wholesale borrowings replaced higher rate certificate of deposit balances.

Analysis of Financial Condition at September 30, 2009 Total assets increased $4.8 billion from $9.3 billion at December 31, 2008 to $14.1 billion at September 30, 2009, primarily due to our September 4, 2009 acquisition of 57 branch locations from NatCity and the proceeds from our follow-on stock offerings in April and September. In addition, we noted the following balance trends during 2009:
• Higher-yielding commercial loans increased $280.0 million, or 10% annualized, since December 31, 2008, excluding the loans acquired from NatCity.

• Core deposits increased $762.3 million, or 26% annualized, across retail, commercial, and municipal customers, excluding the deposits associated with the NatCity branch locations.

• Higher cost certificate of deposit account balances decreased $445.2 million, or 30% annualized, excluding the certificate of deposit accounts associated with the NatCity branch locations, as we executed our strategy of letting higher priced certificate of deposits run off and focused on building our lower cost relationship based deposit customers.

• Higher investment securities portfolio due to investment of proceeds from the NatCity branch acquisition.

Lending Activities
Our primary lending activity is the origination of commercial real estate and business loans, leases, and residential mortgages to customers located within our primary market areas. Our loan portfolio is concentrated in commercial real estate and business loans, which provide a higher yield than residential and consumer loans, in addition to providing opportunities to cross sell profitable merchant and cash management services. Consistent with our long-term customer relationship focus, we generally retain the servicing rights on residential mortgage loans that we sell which results in monthly service fee income to us. We also originate and retain in our lending portfolio various types of home equity and consumer loan products given their customer relationship building benefits.
We minimize our risk with regard to commercial real estate and multi-family loans by emphasizing geographic distribution within our market areas and diversification of these property types. In addition, our policy for commercial lending generally requires a maximum loan-to-value ("LTV") ratio of 75% on purchases of existing commercial real estate and 80% on purchases of existing multi-family real estate. For construction loans, the maximum LTV ratio varies depending on the project, however it generally does not exceed 90%. Our LTV requirements for residential real estate loans vary depending on the loan program as well as the secondary market investor, with a maximum of 100%. For loans we retain in our portfolio, we generally require a maximum LTV of 97% with acceptable mortgage insurance. We also offer both fixed-rate and floating-rate home equity products in amounts up to 89% of the appraised value of the property (including the first mortgage) with a maximum loan amount generally up to $250 thousand.
The following table presents the composition of our loan and lease portfolios as of the dates indicated (amounts in thousands):

                                           September 30, 2009                December 31, 2008
                                         Amount          Percent          Amount          Percent
Commercial:
Real estate                            $ 2,647,748            36.9 %    $ 2,211,402            34.4 %
Construction                               326,216             4.5          340,564             5.3
Business                                 1,425,956            19.8          940,304            14.6
Specialized lending                        208,574             3.0          178,916             2.8

Total commercial loans                   4,608,494            64.2        3,671,186            57.1
Residential real estate(1)               1,725,943            24.0        1,990,784            31.0
Home equity                                662,308             9.2          624,495             9.7
Other consumer                             189,271             2.6          143,989             2.2

Total loans and leases                   7,186,016           100.0 %      6,430,454           100.0 %

Net deferred costs and unearned
discounts                                   29,746                           33,321
Allowance for credit losses                (83,077 )                        (77,793 )

Total loans and leases, net            $ 7,132,685                      $ 6,385,982

(1) Includes $22.8 million and $1.7 million of loans held for sale at September 30, 2009 and December 31, 2008, respectively.

Excluding the $657.3 million in commercial loans we acquired from NatCity, we experienced a $280.0 million, or 10% annualized, increase in our higher yielding commercial loan portfolio during the first nine months of 2009 as a result of our continued strategic focus on the portfolio and decreased competition as larger banks and nonbank entities continue to face liquidity and capital issues. While we originated $441.0 million in new residential loans, our residential real estate loan portfolio decreased by 18% annualized as ongoing consumer preference is for long-term fixed rate products which we generally do not maintain in our portfolio. Despite the continued recessionary economy, we experienced 8% annualized growth in our relationship based home equity lending portfolio. In addition, we experienced a 14% decrease in our other consumer loans portfolio, excluding the $60.1 million in consumer loans we acquired from NatCity, as we continue to deemphasize certain types of consumer loans, including indirect auto loans.
Allowance for Credit Losses and Nonperforming Assets Credit quality describes how our loans perform relative to their repayment terms. In general, when loan payments are timely and defaults are low, credit quality is high. As part of the lending process, subjective judgments about a borrower's ability to repay and the value of any underlying collateral are made prior to approving a loan.
Credit risk is the risk associated with the potential inability of some of our borrowers to repay their loans according to their contractual terms. This inability to repay could result in higher levels of nonperforming assets and credit losses, which could potentially reduce our earnings.
The following table presents the analysis of our allowance for credit losses for the periods indicated (amounts in thousands):

                                                                 Nine months ended September 30,
                                                                   2009                   2008
Balance at beginning of period                               $         77,793       $         70,247
Net charge-offs:
Charge-offs                                                           (28,761 )              (11,671 )
Recoveries                                                              1,395                  1,698

Net charge-offs                                                       (27,366 )               (9,973 )

Provision for credit losses                                            32,650                 14,500
Acquired at acquisition date                                                -                  2,890

Balance at end of period                                     $         83,077       $         77,664


Ratio of annualized net charge-offs to average loans
outstanding during the period                                            0.56 %                 0.21 %
Ratio of annualized provision for credit losses to
average loans outstanding during the period                              0.67 %                 0.31 %

The primary indicators of credit quality are the level of our nonperforming and classified loans as well as the net charge-off ratio which measures loan losses as a percentage of total loans outstanding. We place loans on nonaccrual status when they become more than 90 days past due, or earlier if we don't expect the full collection of interest or principal. When a loan is placed on nonaccrual status, any interest previously accrued and not collected is reversed from interest income.

The following table presents our nonaccruing loans and nonperforming assets at the dates indicated (amounts in thousands):

                                                               September 30,        December 31,
                                                                   2009                 2008
Nonaccruing loans:
Commercial real estate                                        $        32,477      $       26,546
Commercial business                                                     4,629               7,411
Specialized lending                                                     3,105               4,354
Shared national credits                                                14,103                   -
Residential real estate                                                 9,140               5,516
Home equity                                                             2,979               2,076
Other consumer                                                            373                 514

Total nonaccruing loans                                                66,806              46,417
Real estate owned                                                       8,872               2,001

Total nonperforming assets                                    $        75,678      $       48,418


Total nonaccruing loans as a percentage of total loans                   0.93 %              0.72 %
Total nonperforming assets as a percentage of total assets               0.54 %              0.52 %
Allowance for credit losses to total loans                               1.15 %              1.20 %
Allowance for credit losses to nonaccruing loans                          124 %               168 %

Despite the continued recessionary environment and some deterioration in our portfolio, our credit quality continued to compare favorably to the industry and our peers. We believe the level of allowance is sufficient to cover the inherent risk of loss in our loan portfolios. Total nonaccruing loans as a percentage of total loans increased 12 basis points from the prior quarter to 0.93% of total loans and increased 21 basis points from December 31, 2008 as we have experienced some deterioration in the credit quality of our shared national . . .