Forward Looking Statements

Certain statements in this filing and future filings by the Company with the SEC, 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:
(1) 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; (2) changes in the level of non-performing assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company's borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) 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 including those under the Dodd-Frank Act; (16) 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;
(17) changes in the Company's organization, compensation and benefit plans; (18) 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; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; and (20) 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 advises 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 the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

General

The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of the Company and its wholly owned subsidiaries, the Bank, NBT Financial Services and NBT Holdings during 2012 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, 2012 and 2011 and for each of the years in the three-year period ended December 31, 2012 should be read in conjunction with this review. Amounts in prior period consolidated financial statements are reclassified whenever necessary to conform to the 2012 presentation.

Critical Accounting Policies

The Company has identified 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, pension accounting, other-than-temporary impairment, provision for income taxes and intangible assets.

Management of the Company considers the accounting policy relating to the allowance for loan 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 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 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 loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provision for loan 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 losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral values were significantly lower, the Company's allowance for loan policy would also require additional provision for loan 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 Pension Liability Index, market interest rates and discounted cash flows in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

Management of the Company considers the accounting policy relating to other-than-temporary impairment to be a critical accounting policy. Management systematically evaluates certain assets for other-than-temporary declines in fair value, primarily investment securities. Management considers historical values and current market conditions as a part of the assessment. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is generally recognized in other comprehensive income, net of applicable taxes.

The Company is subject to examinations from various taxing authorities. Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions. Management believes that the assumptions and judgments used to record tax-related assets or liabilities have been appropriate. Should tax laws change or the taxing authorities determine that management's assumptions were inappropriate, an adjustment may be required which could have a material effect on the Company's results of operations.

As a result of acquisitions, the Company has acquired goodwill and identifiable intangible assets. Goodwill represents the cost of acquired companies in excess of the fair value of net assets at the acquisition date. Goodwill is evaluated at least annually or when business conditions suggest that an impairment may have occurred. Goodwill will be reduced to its carrying value through a charge to earnings if impairment exists. Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives. The determination of whether or not impairment exists is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires them to select a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums and Company-specific risk indicators, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company's results of operations.

The Company's policies on the allowance for loan losses, pension accounting, provision for income taxes and intangible assets are disclosed in Note 1 to the consolidated financial statements. A more detailed description of the allowance for loan losses is included in the "Risk Management" section of this Form 10-K. All significant pension accounting assumptions, income tax assumptions, and intangible asset assumptions and detail are disclosed in Notes 18, 15 and 10, respectively, 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 of how the Company's financial performance is reported.

Overview

Significant factors management reviews to evaluate the Company's operating results and financial condition include, but are not limited to: net income and earnings per share, return on assets and equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons. The following information should be considered in connection with the Company's results for the fiscal year ended December 31, 2012:

· Significant strategic expansion during 2012:

† Announced the planned acquisition of Alliance Financial Corporation, a $1.4 billion financial holding company headquartered in Syracuse, N.Y., expected to close in early 2013;

† Acquired and successfully integrated Hampshire First Bank during the second quarter of 2012; now operating 5 branches in southern New Hampshire; and

† Acquired three branches in Greene County, New York in January 2012.

· Net interest margin for 2012 declined 23 basis points as a result of the continued low rate environment on loans and investments.

· 2012 organic loan growth of 6.8%, offsetting aforementioned margin compression, driven by:

† Consumer loan growth of 10.7%; and

† Commercial loan growth of 8.7%.

· Asset quality indicators showed improvement from last year:

† Nonperforming loans to total loans was 0.98%, down from 1.09% for last year;

† Past due accruing loans to total loans was 0.71%, down from 0.89% for last year; and

† Net charge-off ratio was 0.55%, down from 0.56% for last year.

· Service charges on deposit accounts continued to decrease due primarily to a decrease in overdraft activity.

The Company continued to experience pressure on net interest income in 2012 as low rates continued to have the effect of causing many assets to prepay or to be redeemed. As a result, reinvestment of cash flows in lower yielding assets has been the primary contributor to a decline in interest income in 2012. The yield on interest earning assets decreased from 4.88% in 2011 to 4.51% in 2012, with drops in the yields on loans and securities available for sale being the primary drivers. Rates paid on interest bearing liabilities also decreased in the low rate environment, which partially offset the decrease in earning asset yields. In particular, the decrease in rates paid on money market deposit accounts and time deposits contributed approximately $5.1 million to the decrease in interest expense in 2012 as compared with 2011. Average interest bearing liabilities increased approximately $237.9 million from 2011 to 2012, with the primary driver being the increase in interest bearing deposits from acquisition activity and organic deposit growth. The Company also took the following steps in 2012 in an effort to help offset the margin pressure created by the low interest rate environment:

· Continued the sale of conforming residential real estate mortgages in 2012, taking advantage of favorable interest rate conditions;

· Increased efforts to grow noninterest income with focus on organic growth of our trust, financial services and insurance businesses; and

· Continued strategic expansion into New Hampshire with the completed acquisition of Hampshire First Bank and into central New York with the planned acquisition of Alliance.

The Company reported net income of $54.6 million or $1.62 per diluted share for 2012, down 5.8% from net income of $57.9 million or $1.71 per diluted share for 2011. The provision for loan losses totaled $20.3 million for the year ended December 31, 2012, down $0.5 million, or 2.3%, from $20.7 million for the year ended December 31, 2011. The decrease in provision is attributable to the ongoing modeling of the required levels of reserves which considers historical charge-offs, loan growth and economic trends. Noninterest income increased $7.0 million, or 8.7%, from 2011 primarily due to an increase in other noninterest income of approximately $6.1 million. This increase was due in part to a $1.1 million payoff gain on a purchased commercial real estate loan. In addition, the Company recognized nonrecurring items totaling approximately $1.4 million during 2012 including a prepayment penalty fee related to a loss of a retirement plan client and flood related recoveries. Further, mortgage banking revenue increased approximately $2.6 million for the year ended December 31, 2012 as compared to the same period in 2011 as the Company sold certain residential mortgages as market conditions warranted. Noninterest expense for the year ended December 31, 2012 was $193.9 million, up from $180.7 million, or 7.3% for the year ended December 31, 2011.

2013 Outlook

The Company's 2012 earnings reflected the Company's continued ability to manage through the existing and near future economic conditions and challenges in the financial services industry, while investing in the Company's future. The Company believes effects of the economic crisis still exist and, as a result, there will be certain challenges faced in 2013. Significant items that may have an impact on 2013 results include:

· The Company expects that it will experience additional margin compression from the 2012 fourth quarter net interest margin of 3.83%. We expect that payments representing interest and principal on currently outstanding loans and investments will continue to be reinvested at rates that are lower than the rates currently outstanding on those loans and investments. In addition, deposit and borrowing rates are historically low and there are minimal opportunities for them to be lowered. Furthermore, the industry as a whole must focus on asset growth to increase interest income, thereby creating general pricing pressure in the entire industry.

· The Company experienced benefits from expiration of the statute of limitations of prior years' tax filings and state tax audit settlements in past years. The Company expects the tax rate to be more normalized in 2013 without those benefits.

· If asset quality trends continue to show improvement, the Company would eventually expect the level of provisioning to decrease. However, the economy may have an adverse affect on asset quality indicators, particularly indicators related to loans secured by real estate, which could adversely affect charge-offs, the allowance for loan losses, and the provision for loan losses.

· The cost of compliance as a result of the Dodd-Frank Act could continue to negatively impact certain fee generating products, which could negatively impact noninterest income and earnings.

· Competitive pressure on non-maturing deposits could result in an increase in interest expense if interest rates begin to rise.

· Our ability to integrate the operations and personnel and realize anticipated cost savings of the pending acquisition of Alliance may affect our results of operations in 2013.

The Company's 2013 outlook is subject to factors in addition to those identified above and those risks and uncertainties that could impact the Company's future results are explained in 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 resulting 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 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
                                          2012                                        2011                                        2010
                             Average                      Yield/         Average                      Yield/         Average                      Yield/
(Dollars in thousands)       Balance      Interest          Rate         Balance      Interest          Rate         Balance      Interest          Rate
ASSETS
Short-term interest
bearing accounts         $    66,207     $     179          0.27 %   $   101,224     $     269          0.27 %   $   137,818     $     354          0.26 %
Securities available
for sale (1)               1,177,969        28,904          2.45 %     1,123,215        33,319          2.97 %     1,088,376        38,759          3.56 %
Securities held to
maturity (1)                  65,582         3,583          5.46 %        81,558         4,350          5.33 %       128,727         6,104          4.74 %
Investment in FRB and
FHLB Banks                    28,358         1,378          4.86 %        27,089         1,389          5.13 %        31,850         1,821          5.72 %
Loans (2)                  4,053,420       209,370          5.17 %     3,677,931       205,318          5.58 %     3,629,047       214,258          5.90 %
Total interest earning
assets                   $ 5,391,536     $ 243,414          4.51 %   $ 5,011,017     $ 244,645          4.88 %   $ 5,015,818     $ 261,296          5.21 %
Other assets                 483,248                                     434,924                                     438,516
Total assets             $ 5,874,784                                 $ 5,445,941                                 $ 5,454,334

LIABILITIES AND STOCKHOLDERS' EQUITY
Money market deposit
accounts                 $ 1,116,583     $   2,054          0.18 %   $ 1,070,003     $   3,592          0.34 %   $ 1,092,789     $   6,273          0.57 %
NOW deposit accounts         709,889         1,854          0.26 %       685,542         2,313          0.34 %       709,920         2,938          0.41 %
Savings deposits             680,092           522          0.08 %       602,918           635          0.11 %       552,660           797          0.14 %
Time deposits                993,117        14,418          1.45 %       913,330        16,480          1.80 %       985,504        20,346          2.06 %
Total interest bearing
deposits                 $ 3,499,681     $  18,848          0.54 %   $ 3,271,793     $  23,020          0.70 %   $ 3,340,873     $  30,354          0.91 %
Short-term borrowings        165,742           188          0.11 %       153,965           205          0.13 %       158,280           402          0.25 %
Trust preferred
debentures                    75,422         1,730          2.29 %        75,422         2,092          2.77 %        75,422         4,140          5.49 %
Long-term debt               368,270        14,428          3.92 %       370,035        14,404          3.89 %       469,509        18,314          3.90 %
Total interest bearing
liabilities              $ 4,109,115     $  35,194          0.86 %   $ 3,871,215     $  39,721          1.03 %   $ 4,044,084     $  53,210          1.32 %
Demand deposits            1,139,896                                     966,282                                     805,594
Other liabilities             64,551                                      69,063                                      79,182
Stockholders' equity         561,222                                     539,381                                     525,474
Total liabilities and
stockholders' equity     $ 5,874,784                                 $ 5,445,941                                 $ 5,454,334
Net interest income
(FTE)                                      208,220                                     204,924                                     208,086
Interest rate spread                                        3.65 %                                      3.85 %                                      3.89 %
Net interest margin                                         3.86 %                                      4.09 %                                      4.15 %
Taxable equivalent
adjustment                                   4,017                                       4,648                                       5,558
Net interest income                      $ 204,203                                   $ 200,276                                   $ 202,528

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.

2012 OPERATING RESULTS AS COMPARED TO 2011 OPERATING RESULTS

Net Interest Income

While the rate paid on interest bearing liabilities decreased 17 basis points, the yield on interest earning assets declined 37 basis points compared to the same period for 2011, resulting in margin compression for the year ended December 31, 2012. The yield on securities available for sale was 2.45% for the year ended December 31, 2012, compared with 2.97% for the year ended December 31, 2011. This decrease was due primarily to the reinvestment of cash flows from maturing securities and cash received from branch acquisitions in 2011 and the first quarter of 2012 into lower yielding securities in the current rate environment. The average balance of securities available for sale for the year ended December 31, 2012 was $1.2 billion, up approximately $54.8 million, or 4.9%, from the year ended December 31, 2011. This increase was due primarily to reinvestment of cash flows from held to maturity securities into available for sale securities, and investment of liquidity from branch acquisition activity and deposit growth. The yield on loans was 5.17% for the year ended December 31, 2012, compared with 5.58% for the year ended December 31, 2011. The average balance of loans for the year ended December 31, 2012 was $4.1 billion, up approximately $375.5 million (including approximately $124.3 million from acquisitions), or 10.2%, from the year ended December 31, 2011. The reduction in yields on earning assets was partially offset by a reduction in rates paid on interest bearing liabilities. The rate on time deposits was 1.45% for the year ended December 31, 2012, compared with 1.80% for the year ended December 31, 2011. The rate on money market deposit accounts was 0.18% for the year ended December 31, 2012, compared with 0.34% for the year ended December 31, 2011. 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)
                                   2012 over 2011                            2011 over 2010
(In thousands)             Volume          Rate         Total        Volume          Rate         Total
Short-term
interest-bearing
accounts                $     (95 )   $       5     $     (90 )   $     (97 )   $      12     $     (85 )
Securities available
for sale                    1,562        (5,977 )      (4,415 )       1,207        (6,647 )      (5,440 )
Securities held to
maturity                     (871 )         104          (767 )      (2,445 )         691        (1,754 )
Investment in FRB and
FHLB Banks                     63           (74 )         (11 )        (256 )        (176 )        (432 )
Loans                      20,057       (16,005 )       4,052         2,855       (11,795 )      (8,940 )
Total interest income      20,716       (21,947 )      (1,231 )       1,264       (17,915 )     (16,651 )
Money market deposit
accounts                      150        (1,688 )      (1,538 )        (128 )      (2,553 )      (2,681 )
NOW deposit accounts           80          (539 )        (459 )         (98 )        (527 )        (625 )
Savings deposits               74          (187 )        (113 )          68          (230 )        (162 )
Time deposits               1,353        (3,415 )      (2,062 )      (1,421 )      (2,445 )      (3,866 )
Short-term borrowings          15           (32 )         (17 )         (11 )        (186 )        (197 )
Trust preferred
. . .