UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 204920549

FORM 10-K

Annual Report pursuant to Section 15(d) of the Securities and Exchange Act of 1934

For for the fiscal year ended December 31, 2002.2003. Commission File No. 0-13666

BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)

Maine01-0393663
(State or other jurisdiction of                                                                                                          (I.R.S. Employer
incorporation or organization)                                                                                                          Identification No.)

PO Box 400
82 Main Street, Bar Harbor, ME04609-0400
(Address of principal executive offices)                                                                                          (Zip Code)

(207) 288-3314
(Registrant’s telephone number, including area code)

Title of Class: Common Stock --- Par Value: $2.00 per share
(Securities registered pursuant to Section 12(g) of the Act)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(D) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES: (X) NO: ( )

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. ( )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act: Yes ( ) No (X)

Based on the closing price of the common stock of the registrant, the aggregate market value of the voting stock held by non-affiliates of the registrant, as of March 25,June 30, 2003 is:was:

Common Stock, $2.00 par value -- $59,734,451$66,662,653

The number of voting shares outstanding of each of the registrant’s classes of common stock, as of March 25, 200319, 2004 is:

Common Stock -- 3,163,901– 3,105,905

Documents incorporated by Reference:

1. Certain information required in response to Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K are incorporated by reference from the Bar Harbor Bankshares Proxy Statement for 2003the 2004 annual meeting of stockholders, prepared pursuant to Regulation 14A of the General Rules and Regulations of the Commission and filed with the Commission on March 27, 2003, is29, 2004.

FORWARD LOOKING STATEMENTS

Certain statements contained in this Form 10-K, or incorporated herein by reference, into Part IIIcontain statements which may be considered to be forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 (the "PSLRA"). You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. For these statements, the Company claims the protection of the safe harbor for forward-looking statements provided by the PSLRA.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

(i) The Company’s success is dependant to a significant extent upon general economic conditions in Maine, and Maine’s ability to attract new business;

(ii) The Company’s earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Bank and thus the Bank’s results of operations may be adversely affected by increases or decreases in interest rates;

(iii) The banking business is highly competitive and the profitability of the Company depends on the Bank’s ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and nontraditional institutions such as credit unions and finance companies;

(iv) A significant portion of the Bank’s loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other more intangible factors which are considered in making commercial loans and, accordingly, the Company’s profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;

(v) A significant delay in or inability to execute strategic initiatives designed to grow revenues and or control expenses;

(vi) The potential need to adapt to industry changes in information technology systems, on which the Company is highly dependent, could present operational issues or require significant capital spending;

(vii) Significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company’s business environment or affect its operations; and

(viii) Acts or threats of terrorism and actions taken by the United States or other governments as a result of such acts or threats, including military action, could further adversely affect business and economic conditions in the United States generally and in the Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s common stock.

The forward looking statements contained herein represent the Company’s judgment as of the date of this report.Form 10-K, and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the foregoing discussion, or elsewhere in this Form 10-K, except to the extent required by federal securities laws.

INDEXTABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

ORGANIZATION

Bar Harbor Bankshares ("the Company"(the "Company") was incorporated January 19, 1984. As of March 25, 2003,19, 2004, the Company’s securities consisted of one class of common stock, ("the Common Stock"), par value of $2.00 per share, of which there were 3,163,901 3,105,905 shares outstanding held of record by approximately 1,0561,057 shareholders. The Company has two, primary, wholly-ownedwholly owned operating subsidiaries: Bar Harbor Banking and Trust Company ("the Bank"(the "Bank"), a community bank which offers a wide range of deposit, loan, and related banking products; and BTI Financial Group ("BTI"), a financial services holding company offering brokerage, trust, private banking, financial planning, brokerage and investment management services to individuals, businesses, not-for-profit organizations and municipalities.

The Company is a bank holding company ("BHC") registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent (the "Superintendent") of the Maine Bureau of Financial Institutions ("BFI").

BANK

The Bank, originally founded in 1887 and now a direct, wholly owned subsidiary of the Company, is a Maine financial institution, and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum extent permitted by law. The Bank is subject to the supervision, regulation, and examination of the FDIC and the BFI. It is not a member of the Federal Reserve Bank.

The Bank has teneleven branch offices in coastallocated throughout Down East and Mid Coast Maine, including its principal office located at 82 Main Street, Bar Harbor, as well asHarbor. The Bank’s offices are located in Hancock, CountyWashington, and adjacent Washington County, which representKnox Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Northeast Harbor, Southwest Harbor, Blue Hill, Deer Isle, Ellsworth, Northeast Harbor, Southwest Harbor, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Knox County office, acquired in February 2004, is located in Rockland. The Bank delivers its operations and technology services from its operations center located on Avery Lane in Ellsworth, Maine.

The Bank is a retail bank serving individual and corporatebusiness customers, retail establishments and restaurants, seasonal lodging and campgrounds, and restaurants.a large contingent of retirees. As a coastal bank, it serves the tourism, hospitality, lobstering, fishing, boat building and fishingmarine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. ItThe Bank operates in a competitive market that includes other community banks, savings institutions, and credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area. The Bank continues to be one of the larger independent commercial banks in the state of Maine.

The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materially adverse effect on its business. TheHistorically, the banking business in the Bank’s market area historically has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Approximately 86% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on certificatesall of the deposit Individual Retirement Accounts (IRAS), NOW and money market accountsaccount products it offers and does not anticipate any material loss of these deposits.

The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses for whomto which the Bank offers a wide variety of products and services.

Retail Products and Services: The Bank provides alloffers a variety of consumer financial products and services designed to satisfy the traditional bankingdeposit and loan needs of its retail customers. The Bank’s retail products and services offered by a commercial bank, includinginclude interest bearing checking accounts, NOW accounts, savings accounts, money market accounts, timesavings accounts, club accounts, short-term and long-term certificates of deposit, accounts, individual retirement accounts,and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, student loans, credit cards, installment loans, and overdraft protection. Overdraft protection is offered via a standby credit product. Secured and unsecured installment loans are provided for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit boxes, bank by mailbox rental, wire transfers, bank-by-mail services, night depositorycheck collection services, foreign currency exchange, money orders, Travelers Checks, and a variety of cash management services.US Savings Bonds. The Bank also staffs a customer service center, providing customers with immediate responses to their questions and needs.

Electronic Banking Services: The Bank continues to offer free, on-line real-time Internet banking services, including free check image and electronic bill payment, through its dedicated website at www.bhbt.com. Additionally, the Bank offers TeleDirect, an interactive voice response system through which customers can get product information, check account balances and activity, on their accounts as well as performinitiate money transfers between their accounts. The Bank continues to offer free, on-line real-time Internet banking services through its dedicated website at www.bhbt.com. Automated Teller Machines (ATMs) are located at each of the teneleven branch locations, in addition to threeas well as two machines in non-Bank locations. These ATMsATM’s access major networks for use of the Bank’s cards throughout the United States, including the Plus, and NYCE, systems as well as theand major credit card networks. Drive-up facilitiescompanies. Additionally, the Bank is a member of Maine Cash Access, providing customers with surcharge-free access to over 150 ATM’s throughout the state of Maine. Visa debit cards are availablealso offered, providing customers with free access to their deposit account balances at all banking offices.point of sale locations throughout most of the world.

Commercial Products and Services: The Bank offers a comprehensive array of lending services, including consumer credit inserves the form of installment loans, overdraft protection (stand-by-credit), VISA credit card accounts, student loans, residential mortgage loans,small business market throughout Down East and home equity loans.Mid Coast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate purchases, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and individuals in the tourist, hospitality, health care, blueberry, shipbuilding, and fishing industries, as well as to other small and mid-size businesses associated with small coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with correspondent banks, whereby the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances.

The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s policycash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. During 2003 the Bank started offering Premier E-corp, an on-line real-time Internet banking service for lending limits is upbusinesses. This service allow business clients to 20% of its equity to any borrower provided that the loans are secured,view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and approved by the Directors’ Loan Committee. This committee is chaired by a member of the Bank’s Board of Directors,order both domestic and includes non-voting members of the Bank’s managementforeign wire transfers. Other commercial banking services include merchant credit card processing, night depository, and Board of Directors.coin and currency handling.

BTI

BTI Financial Group is a wholly owned subsidiary of the Company. It was incorporated on August 16, 1999, as the holding company for three operating subsidiaries: Bar Harbor Trust Services ("Trust"Trust Services"), a Maine chartered trust company; Block Capital Management ("Block"), an SEC registered investment advisor; and Dirigo Investments, Inc. ("Dirigo"), a National Association of Securities Dealers (NASD) registered broker-dealer. BTI is ableThese companies were organized to provide a comprehensive array of, private banking, financial planning, investment management, and trust services to individuals, businesses, not-for-profit organizations, and municipalities of varying assets size,size.

BTI Restructuring Plan: In the fourth quarter of 2003 the Board of Directors approved a restructuring plan for BTI. Pursuant to this plan, the portfolio management professionals at Block were unified as one team with Trust Services. Block subsequently discontinued operations as an independent subsidiary of BTI. All services provided by Block to clients of Trust Services remained unchanged.

Also pursuant to the restructuring plan, during the first quarter of 2004 Trust Services will become a wholly owned subsidiary of the Bank, and discontinued operations as an independent subsidiary of BTI. All products and services provided by Trust Services will remain unchanged. In addition to provide the highest level of customized personal service. The staff includes credentialed investment management and trust professionals with extensive experience.

financial planning, Trust Services offers revocable, irrevocable, charitable remainder and testamentary trust management, andas well as estate planning and management services such as probate, estate settlement, and tax return preparation. The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2002, Trust Services had 837737 accounts, with assets totaling $202 million.

Block provides discretionary and non-discretionary investment advisory services for corporate and individual investment portfolios, personal trusts, individual and corporate retirement funds, and endowments for not-for-profit organizations. At December 31, 2002, Block had $181 million in assets under management primarily for clients of Trust.and held in custody amounting to $176 million and $33 million, respectively.

Dirigo principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. APursuant to the BTI restructuring plan, Dirigo will discontinue its operations as a stand - -alone broker-dealer subsidiary of BTI. The Bank has retained Infinex Investments, Inc. ("Infinex") as a full service third party processor provides Dirigo’s supportbroker-dealer, which will be conducting business as Bar Harbor Financial Services ("BHFS"), starting in the second quarter of 2004. It is planned that Infinex will assume responsibility for all of the customer accounts of Dirigo. Infinex was formed by a group of member banks, and clearing services.

BTI’s central offices are locatedis currently the largest provider of third party investment and insurance services to banks and their customers in New England. Management believes that through Infinex / BHFS, the Company will be able to take advantage of the expertise, capabilities, and experience of a much larger broker-dealer in a 22,000-square-foot office facility sharedmore cost-effective manner. It is anticipated that this transaction will be completed in the second quarter of 2004.

One of the principal goals underlying the restructuring plan was to simplify and more closely align the Company’s brand names and operating model without diminishing functionality. The Company anticipates the changes will enable it to improve customer service, broaden its product offerings, and achieve increased operating efficiencies. The Company believes that by reducing the number of brand names under which it operates, a clearer message will be presented to its customers and the marketplace.

The Company expects the overall restructuring plan will be completed by the end of the second quarter of 2004. Once the restructuring plan is complete, the BTI corporate entity will be formally retired and dissolved.

ECONOMY

Maine is a state of approximately 1.2 million people inhabiting a space that is roughly the size of the other five New England states combined. Maine’s economy has long been based on the bounty of its natural resources, namely: fishing, farming, forestry, and tourism. The very nature of these industries has meant that a significant portion of Maine’s employment opportunity is seasonal, and overall earnings lag behind national averages. Maine’s population growth can be described in three ways: its population is growing slowly, it’s growing older and it’s growing unevenly. Poverty rates are relatively high at 13.7%, but vary dramatically by region, ranging from 10% in York County to 22% in Washington County. The marketplace served by the Company is driven, in part, by the tourism and hospitality industries, which represent one in ten jobs in the state of Maine.

Despite Maine’s strong natural resource heritage and the independent nature of its people, Maine’s economic vitality has become dependant on regional and national activity. As Maine’s economy has transitioned from an agricultural and industrial foundation towards a service and information-based economy, it has become increasingly dependant on the global market place. As in other states, Maine’s economy is being shaped and propelled by several factors including its population dynamics, the changing composition of the job base, globalization, fiscal devolution, technology, and the increases of women in the workforce.

Housing appreciated in Maine during 2003 as it did elsewhere in New England. House prices increased 7.9% on a year-over-year basis, representing a modest deceleration from the 10.7% rate posted over the two previous full years. Housing construction accelerated more in Maine than in other New England states.

The Northern New England economy continued to improve and strengthen throughout the year. Demand for residential real estate within the region is still strong primarily due to historical lows in long-term interest rates and limited inventory. Retailers in New England reported increases in sales in the fourth quarter compared with prior periods. The lumber and homebuilding sector continue to report strength in residential construction and home improvements. Along with the Bank, located at 135 High Street, Ellsworth, Maine. Dirigo, Trust, and Block maintain their principal offices at the Ellsworth facility and maintain additional offices at One Cumberland Place, Bangor, Maine. BTI also maintains officesincrease in overall economic activity, there were modest improvements in the headquarters buildinglabor markets. These improvements generally took the form of reduced layoffs or modestly increased hiring, although new hiring was still quite minimal.

Changes in the Bankeconomy are difficult to predict, and the foregoing discussion may or may not be indicative of whether the Northern New England economy, including the State of Maine, and particularly Down East and Mid Coast Maine, is improving or will continue to strengthen. A downturn in Bar Harbor, Maine.the local economies that the Company serves, or adverse changes in the real estate markets could negatively impact the Company’s business, financial condition, and results of operations.

COMPETITION

The Company competes principally in Down East coastaland Mid Coast Maine, which can generally be characterized as a rural area.areas. The Company considers its primary market areas to be in Hancock, Knox, and Washington counties, each in the state of Maine. TheAccording to the most recent Census Bureau Report, the population of these three counties is 52,336, 40,147 and 33,573 respectively, representing a combined population of these two counties is approximately 86,000 people, and their135,000. Their economies are based primarily on tourism, health care, fishing, aquaculture, agriculture, and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions, savings and loan institutions, and credit unions. Other competitors in the Company’s primary market area include insurance companies and financing affiliates of consumer durable goods manufacturers.manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.

As a bank holding company and state-chartered commercial bank, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulation that limits the type and scope of their activities. The non-bank financial service providers that compete with the Company and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, continues to be aggressive.

The Bank has generally been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers. However,customers; however, no assurance can be given that the Bank will continue to be able to compete effectively with other financial institutions in the future.

The financial services landscape has changed considerably over the past five years in the Company’s primary market area. The subsidiaries of BTI each separately face significant competition for their services from local banks, which now or in the future may offer a similar range of services, as well as from a number of brokerage firms and investment advisors with offices in the Company’s market area. In addition, many of these services are widely available to customers by telephone and over the Internet through firms located outsideNo material part of the Company’s market area.business is dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.

MANAGEMENT AND EMPLOYEES

The Company has fourthree principal officers: Joseph M. Murphy, President and Chief Executive Officer; Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer; Dennis K. Miller, Senior Vice President, Audit and Risk Management; and Judith W. Fuller, Corporate Secretary. Marsha C. Sawyer serves as the Clerk of the Company.

Joseph M. Murphy also serves as President and Chief Executive Officer of BTI.the Bank. Dean S. Read serves as President and Chief Executive Officer of the Bank. Gerald Shencavitz also serves as Chief Financial Officer of each of the Company’s subsidiaries, as well as Chief Operating Officer and Treasurer of the Bank. Other senior operating positions in the Company include Presidentsa President of the BTI, subsidiaries, and Senior Vice Presidents in charge of retail banking, lending, credit administration / risk management, and human resources.

As of December 31, 2002,2003, the Bank employed 152 full time and 26 part time137 full-time equivalent employees, BTI employed 19 full-time equivalent employees, and BTIthe holding company employed 205 full-time and 2 part time employees, representing a full-time equivalent complement of 186161 employees of the Company and its subsidiaries.

The Company maintains comprehensive employee benefit programs, which provide health, dental, long-term and short-term disability, and life insurance. All Company employees are eligible for participation in the Bar Harbor Bankshares 401(k) plan and Profit Sharing Plan. Certain officers and employees of the Company may also participate in the Company’s 2000 stock option planStock Option Plan and/or have Supplemental Executive Retirement Agreements with the Company or the Bank.

The Company’s management believes that employee relations are good, and there are no known disputes between management and employees.

SUPERVISION AND REGULATION

The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation, and examination by various federal and state bank regulatory agencies, including the FRB, the FDIC, and the Superintendent, as well as other governmental agencies in the states in which the Company and its subsidiaries operate. The supervision, regulation, and examination to which the Company and its subsidiaries are subject are intended primarily to protect depositors and other customers, or are aimed at carrying out broad public policy goals, and are not necessarily for the protection of the shareholders.

Some of the more significant statutory and regulatory provisions applicable to banks and BHCs, to which the Company and its subsidiaries are subject, are described more fully below, together with certain statutory and regulatory matters concerning the Company and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on the Company’s business and operations, as well as those of its subsidiaries. The Company’s shareholders generally are not subject to these statutory and regulatory provisions.

Bank Holding Company Act - As a registered BHC and a Maine financial institution holding company, the Company is subject to regulation under the BHC Act and Maine law and to examination and supervision by the FRB and the Superintendent, and is required to file reports with, and provide additional information requested by, the FRB and the Superintendent. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals that violate the BHC Act or orders or regulations thereunder,there under, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary of a BHC.

The BHC Act prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior FRB approval. Unless a BHC becomes a "financial holding company" (an "FHC") under the Gramm-Leach-Bliley Act ("GLBA"), as discussed below, the BHC Act also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or BHC, and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. In addition, Maine law requires approval by the Superintendent prior to acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company that controls a Maine financial institution. The Superintendent also must approve acquisition by a Maine financial institution holding company of more than 5% of a financial institution or financial institution holding company domiciled outside of the State of Maine.

Federal Reserve Act - Various other laws and regulations, including Sections 23A and 23B of the Federal Reserve Act, as amended (the "FRA"), generally limit borrowings, extensions of credit, and certain other transactions between the Company and its non-bank subsidiaries and its affiliate insured depository institutions. Section 23A of the FRA also generally requires that an insured depository institution’s loans to non-bank affiliates be secured in appropriate amounts, and Section 23B of the FRA generally requires that transactions between an insured depository institution and its non-bank affiliates be on market terms. These laws and regulations also limit BHCs and their subsidiaries from engaging in certain tying arrangements in connection with any extension of credit, sale or lease of property, or furnishing of services.

Financial Services Modernization - The Gramm-Leach-Bliley Act ("GLBA"), which significantly altered banking laws in the United States, was signed into law in 1999. GLBA enabled combinations among banks, securities firms and insurance companies beginning in 2000. As a result of GLBA, many of the depression-era laws that restricted these affiliations and other activities that may be engaged in by banks and bank holding companies, were repealed. Under GLBA, bank holding companies are permitted to offer their customers virtually any type of service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking.

The Gramm-Leach-Bliley Act established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit BHCs that qualify and elect to be treated as financial holding companies to engage in a range of financial activities broader than would be permissible for traditional BHCs that have not elected to be treated as FHCs, such as the Company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

In order to elect to become an FHC, a BHC must meet certain tests and file an election form with the FRB. To qualify, all of a BHC’s subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the BHC’s banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act evaluation.

A BHC that elects to be treated as an FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. The Company has not elected to become an FHC.

Further, the GLBA permits state banks, to the extent permitted under state law, to engage in certain new activities that are permissible for subsidiaries of an FHC. The GLBA expressly preserves the ability of state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a state bank must be well-capitalized,well capitalized, and such banks would be subject to certain capital deduction, risk management, and affiliate transaction rules. Also, the FDIC’s final rules governing the establishment of financial subsidiaries adopt the position that a state nonmember bank may only conduct through a financial subsidiary activities that a national bank could only engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC’s standard activities rules. Moreover, to mirror the FRB’s actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 - - The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally authorizes BHCs to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers, and to a lesser extent, interstate banking.

Declaration of Dividends - According to its Policy Statement on Cash Dividends Not Fully Covered by Earnings (the "FRB Dividend Policy"), the FRB considers adequate capital to be critical to the health of individual banking organizations and to the safety and stability of the banking system. Of course, one of the major components of the capital adequacy of a bank or a BHC is the strength of its earnings and the extent to which its earnings are retained and added to capital, or paid to shareholders in the form of cash dividends. Accordingly, the FRB Dividend Policy suggests that banks and BHCs generally should not maintain their existing rate of cash dividends on common stock, unless the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The FRB Dividend Policy reiterates the FRB’s belief that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC’s ability to serve as a source of strength.

Under currentUntil June 30, 2003, Maine corporation law previously provided that a corporation’s board of directors maycould declare, and the corporation may pay, dividends on its outstanding shares in cash or other property, generally out of the corporation’s unreserved and unrestricted earned surplus, or out of the unreserved and unrestricted net earnings of the current fiscal year and the next proceeding fiscal year taken as a single period, except under certain circumstances, including when the corporation is insolvent, or when the payment of the dividend would render the corporation insolvent, or when the declaration would be contrary to the corporation’s charter. These same limitations generally apply to investor-owned, Maine financial institutions. Currentwere repealed effective as of July 1, 2003. Under current Maine corporation law, will be repealed and replaced effective July 1, 2003, with the new Maine Business Corporation Act (the "New Maine Act"). The New Maine Act adopts a simplified test for when the directors of a corporation may make distributions to its shareholders if (subject to restriction by the articles of incorporation), namely, (1) the corporation’s assets must exceed its liabilities (plus any amounts payable to preferred classes of stock), and (2) the corporation must beis able to pay its debts as they become due in the usual course of business (i.e., it must not be insolvent). These new limitations generally apply to investor owned Maine financial institutions and financial institution holding companies.

Federal bank regulatory agencies also have authority to prohibit banking institutions from paying dividends if those agencies determine that, based on the financial condition of the bank, such payment would constitute an unsafe or unsound practice.

Capital Adequacy Guidelines -Guidelines: The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a BHC and in analyzing applications to it under the BHC Act. The FRB’s capital adequacy guidelines apply on a consolidated basis to BHCs with consolidated assets of $150 million or more; thus, these guidelines apply to the Company.

The FRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items, with at least one-half of that amount consisting of Tier 1 or core capital and the remaining amount consisting of Tier 2 or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital), less goodwill and other non-qualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments; perpetual preferred stock, which is not eligible to be included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital (defined by reference to the risk-based capital guidelines) to total assets of 3.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0% leverage ratio requirement is the minimum for the strong BHCs without any supervisory, financial or operational weaknesses or deficiencies, or those that are not experiencing or anticipating significant growth. All other BHCs are required to maintain a minimum leverage ratio of at least 4.0%. BHCs with supervisory, financial, operational, or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels.

At December 31, 2002,2003, and at the time of this report, the Company’s risk-based capital ratio and leverage ratio were well in excess of regulatory requirements, and its management expects these ratios to remain in excess of regulatory requirements. Separate, but substantially similar, capital requirements under FDIC regulations apply to the Company’s bank subsidiary, and these also exceed regulatory requirements at December 31, 2002.2003.

Failure to meet capital guidelines could subject the Company or the Bank to a variety of FDIC corrective actions, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution’s assets, and (v) requiring prior approval of certain expansion proposals.

Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from Part II, Item 7, section entitled "Capital Resources" and from Part II, Item 8, Notes to Consolidated Financial Statements, Note 13, "Shareholders’ Equity," each in this annual report on Form 10-K for the year ended December 31, 2002.2003.

Activities and Investments of Insured State-Chartered Banks -Banks: FDIC insured, state-chartered banks, such as the Bank, are also subject to similar restrictions on their business and activities. Section 24 of the Federal Deposit Insurance Act ("FDIA"), generally limits the activities as principal and equity investments of FDIC insured, state-chartered banks to those activities that are permissible to national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.

Safety and Soundness Standards –Standards: The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), as amended, directs each federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk, asset growth, compensation, asset quality, earnings, and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing federal banking agencies to publish guidelines rather than regulations covering safety and soundness.

FDICIA also contains a variety of other provisions that may affect the Company’s and the Bank’s operations, including reporting requirements, regulatory guidelines for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch.

Community Reinvestment –Reinvestment: Pursuant to the Community Reinvestment Act ("CRA") and similar provisions of Maine law, regulatory authorities review the performance of the Company and the Bank in meeting the credit needs of the communities served by the Bank. The applicable regulatory authorities consider compliance with this law in connection with the applications for, among other things, approval for branches, branch relocations, and acquisitions of banks and bank holding companies. The Bank received a "satisfactory" rating at its most recent CRA examination, May 28, 2002.

Customer Information Security -Security: The FDIC and other bank regulatory agencies have published final guidelines establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to, or use of such information that could result in substantial harm or inconvenience to any customer.

Privacy.Privacy: The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.

USA Patriot Act.Act: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the United StatesU.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, requirestogether with the implementing regulations of various federal regulatory agencies, have caused financial institutions, including the Bank and BTI, to adopt and implement additional or amend existing policies and procedures with respect to, moneyamong other things, anti-money laundering compliance, suspicious activities,activity and currency transaction reporting, customer identity verification and due diligence on customers. Implementationcustomer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions. It also requires the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHC Act, or under the Bank Merger Act. Management believes the Company is in compliance with all of the requirements prescribed by the Patriot Act’s requirements will occur in stages, as rules regarding its provisions are finalized by government agencies.Act and all applicable final implementing regulations.

Deposit Insurance.Insurance - The FDIA does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. A resumption of assessments of deposit insurance premiums charged to well-capitalized institutions, such as the Company’s subsidiary bank, could have an effect on the Company’s net earnings. The Company cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.

Securities Regulation.Regulation - The common stock of the Company is registered with the U. S. Securities and Exchange Commission ("SEC") under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Act"). Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Act.

Sarbanes-Oxley Act of 2002 – On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Actact of 2002 (the "S-O("S-O Act"), which generally establishes a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies, and strengthen the independence of auditors. The following are some, but not all,S-O Act implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America and better protect investors from the type of corporate wrongdoings that occurred at Enron and WorldCom, among other companies. The S-O Act’s significant reforms:principal provisions, many of which have been interpreted through regulations released in 2003, provide for and include, among other things:

1. The creation of a strong andon an independent, public company accounting oversight board which is empowered to overseeset auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review. The new board is funded with mandatory fees paid by all public companies. The new legislation also improves the conduct of auditors of public companies and aFinancial Accounting Standards Board, giving it full financial independence from the accounting industry.
2. The strengthening of auditor independence requirements from corporate management by, among other things, limiting the scope of non-auditconsulting services that auditors can provide to their clients;offer public company audit clients.
3. Requires steps to enhance the directA heightened responsibility of public company directors and senior corporate management for financial reporting andmanagers for the quality of the financial reporting and disclosures made by public companies, including certification bytheir companies. Among other things, the Chief Executive Officer and Chief Financial Officer of the reporting company of certain periodic reports filed with the SEC;
4. Publicnew legislation provides for a strong public company audit committees arecommittee that will be directly responsible for the appointment, compensation, and oversight of the work performed by the public company auditors.
5. Provisions which will deter wrongdoing. CEO’s and CFO’s now have to certify that company financial statements fairly represent the company’s financial condition. If a misleading financial statement later results in a restatement, the CEO and CFO must forfeit and return to the company any bonus, stock or stock option compensation received in the twelve months following the misleading financial report. The new legislation also prohibits any company officer or director from attempting to mislead or coerce an auditor. Among other reforms, the new legislation empowers the SEC to bar certain persons from serving as officers or directors of their auditors. The independence ofa public company; prohibits insider trades during pension fund "blackout periods"; directs the SEC to adopt rules requiring attorneys to report securities law violations; and requires that civil penalties imposed by the SEC go into a disgorgement fund to benefit harmed investors.
6. Requirements that audit committee is enhanced by barring committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees or being affiliated personsfrom the Company;
7. A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on non-preferential terms and in compliance with other bank regulatory requirements;
8. The imposition of a broad range of new corporate disclosure requirements. Among other things, the company other thannew legislation requires public companies to report all off balance sheet transactions and conflicts, as well as to present any pro forma disclosures in their capacities as board members;
9. Requires prompt disclosuresa way that is not misleading and in accordance with requirements established by the SEC. The new legislation also accelerated the required reporting of insider transactions, in company stock, which now generally now must be reported by the end of the second business day following a covered transaction; requires that annual reports filed with the transaction;SEC include a statement by management asserting that they are responsible for creating and
10. Imposes maintaining adequate internal controls and assessing the effectiveness of those controls; and requires companies to disclose whether or not they have adopted an ethics code for senior financial officers, and, if not, why not, and whether the audit committee includes at least one "financial expert", a range of new criminal penalties for fraud and other wrongful acts, as well as extending the period duringterm which certain types of lawsuits can be brought against the Company or its insiders.

In addition, Dirigo and Block are subject to certain Broker Dealer and Investment Adviser Regulations promulgatedhas been defined by the NASDSEC in accordance with specified requirements. The new legislation also requires the SEC, based on certain enumerated factors, to regularly and SEC.systematically review corporate filings.

The Company has taken steps to comply with and anticipates that it will incur additional expenses in continuing to comply with the provisions of the S-O Act and its underlying regulations. Management believes that such compliance efforts have strengthened the Company’s overall financial reporting and corporate governance structure and does not expect that such compliance has to date, or will in the future have a material impact on the Company’s results of operations or financial condition.

Other Proposals.Proposals - Other legislative and regulatory proposals regarding changes in banking, and the regulation of banks and other financial institutions, are regularly considered by the executive branch of the federal government, Congress and various state governments, including Maine and state and federal regulatory authorities. It cannot be predicted what additional legislative and/or regulatory proposals, if any, will be considered in the future, whether any such proposals will be adopted or, if adopted, how any such proposals would affect the Company or the Bank.

STOCK DIVIDEND

On December 8, 1998, the Board of Directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data information included in the Form 10-K has been restated to reflect the 100% stock dividend.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The information set forth under this item is incorporated by cross-reference to the Company financial statements set forth below in Part II, Item 8 of this report.report on Form 10-K.

AVAILABILITY OF INFORMATION - COMPANY WEBSITE

The Company maintains a website on the World Wide Web at http://www.bhbt.com. The Company makes available, free of charge, on its web site, which is located at http://www.bhbt.com, ourwebsite its annual report on Form 10-K, quarterly reports on the dateForm 10-Q, current reports on which we electronically file the report withForm 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Commission. InvestorsAct of 1934, as amended, as soon as reasonably practicable after such reports are encouragedelectronically filed with, or furnished to, accessthe SEC. The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at http://www.sec.gov. Information contained on the Company’s website does not constitute a part of this report and other information about our business and operations on our web site.report.

ITEM 2. PROPERTIES

The twelvethirteen parcels of real estate owned and utilized by the Company for its operations are described below:

1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building, housingwhich houses its banking facilities and administrative offices, and an adjacent 35-car customer parking lot. The building was renovated in 1998.

2. An office is located onat 111 Main Street, Northeast Harbor, Maine. This property consists of a building constructed in 1974 that underwent interior renovations in 1998 to better meet the Bank’s needs at that location.

3. An office is located onat 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975 that was added to, and renovated in 1989, to better meet the needs at that location.

4. An office is located on Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the needs at that location.

5. An office is located onat 19 Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that underwent renovations in 1989 to better meet the needs at that location.

6. An office is located onat the corner of Main Street,and Bridge Streets, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994, to house an ATM that helps to better meet the needs at that location.

7. An office is located onat 68 Washington Street, Lubec, Maine. This property consists of a building constructed in 1990 and is adequate for the Bank’s needs at that location.

8. An office is located on137 High Street, Ellsworth, Maine. This property consists of a building constructed in 1982. The Bank is currently evaluating expansion of the Ellsworth office.

9. An office is located onat 385 Main Street, Winter Harbor, Maine. This property consists of a building constructed in 1995 and is adequate for the Bank’s needs at that location.

10. An office is located onat 20 Main Street, Machias, Maine. This property consists of a building that was purchased from Key Bank of Maine in May 1990, and was renovated in 1995 to better meet the Bank’s needs at that location.

11. An office is located at 245 Camden St. (Route 1) in Rockland, Maine. The property consists of a building that was purchased from Androscoggin Savings Bank in February 2004. The branch facility was built in 1977 and is adequate for the Bank’s needs at that location.

12. An Operations Center is located on Avery Lane,in Ellsworth, Maine, that houses the Bank’sCompany’s operations departments and data center.centers. The building was constructed in 1996, with occupancy by the Bank taking place in January of 1997. The Operations Center is currently adequate for the Company’s needs.

12. BTI13. The Company owns and occupies a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The Bank, Trust Block,Services, and Dirigo, and the Bank occupy portions of this facility. ThisThe facility was renovated in 2001.

A parcel of land adjacent to the Blue Hill branch was purchased in 1981 but has not been developed. The Company also leases office space for Dirigo, Block, and Trust at One Cumberland Place in Bangor, Maine, under terms and conditions considered by management to be favorable to the Company. Other real estates includeestate includes two out parcels one improved,(one improved) contiguous to the BTICompany’s 135 High Street, Ellsworth location.

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is set forthprovided in Item 8, Note 7 of the financial statementsConsolidated Financial Statements contained in this report on Form 10-K and are incorporated herein by reference.

The Bank also has twelve Automated Teller Machines (ATMs) located at ten of its branch offices, plus three off-site ATMs located on Mount Desert Island, the primary market area it serves.

ITEM 3. LEGAL PROCEEDINGS

The Company previously reported that Paul G. Ahern, a former director of the Company and executive officer and employee of BTI, resigned all of his positions in January 2002 and made monetary demands for severance benefits under his employment agreement. The disputes between the Company and Mr. Ahern regarding his demands under his employment agreement were submitted to a binding arbitration proceeding in order to determine the rights of the parties. On November 4, 2002, the Company received a written "Arbitration Award" in which the independent arbitrator in this matter found in favor of the Company and BTI with regard to all of Mr. Ahern’s claims under his employment agreement. This decision of the arbitrator with regard to Mr. Ahern’s employment agreement claims is binding and final.

The Company previously reported that Bonnie R. McFee, a former officer and employee of BTI and its subsidiary Dirigo Investments, resigned all of her positions in January 2002 and made demands for severance benefits under her employment agreement.

The disputes between the Company and Ms. McFee regarding her demands under her employment agreement have been submitted to a binding arbitration proceeding in order to determine the rights of the parties. The arbitration proceeding for Ms. McFee’s claims under her employment agreement was conducted during the week of March 3, 2003. A decision of the arbitrator has not been issued as of the date of this report.

As previously reported, Roselle M. Neely ("Neely") filed a complaint dated May 31, 2002 in the United States District Court for the District of Maine, (the "Neely Complaint") naming the Company, the Bank, Trust Services, certain other subsidiaries, and certain existing or former management personnel as defendants. The complaint relatesrelated to a trust established by Mrs. Neely, (the "Neely Trust"), for which Trust hasServices had acted as trustee since May 2000 and for which the Bank formerly acted as trustee. Mrs. Neely allegesalleged in part that Trust Services improperly disregarded her investment instructions and that Blockthe defendants engaged in excessive trading of securities for the purpose of generating commissions for its affiliated broker-dealer. She seeks an unspecified amount oftrust. The plaintiff sought money damages and punitive damages, plus interest and costs.

The Company has filed an answer denying all allegationsparties settled this matter in December 2003 without any finding or admission of wrongdoing, and is actively defending against these claims.liability. Pursuant to a joint stipulation, the Court dismissed the case on January 15, 2004. The case presently is scheduled for trial in May 2003.

Mrs. Neely had also filed suit againstsettlement, the Bank and Trust in Probate Court in Penobscot County, Maine in January 2002, seeking to appointterms of which are confidential, involved payment of a new corporate trustee for the Neely Trust. In that suit Mrs. Neely alleged that the Bank failed to give her noticestipulated sum on behalf of the appointment of Trust as a successor trustee.defendants. The suit was amended in June 2002 to add allegations similar to those contained in the Neely Complaint. The Bank and Trust denied all allegations of wrongdoing, and filed a counterclaim seeking declaratory judgment from the Probate Court. The suit was resolved with the consent of all parties in January 2003, through court approval of Trust’s resignation as trustee and pending appointment of a successor trustee.

The Company and its subsidiaries are also party to certain other ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management will havepayment had no material effect on the Company’s consolidated financial statements.condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of the Company’s security holders in the fourth quarter of 2002.

2003.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

High and low trades for each quarterThe common stock of 2002 and 2001 are listed below per records fromthe Company is traded on the American Stock Exchange where the Company’s common stock is traded("AMEX") under the trading symbol BHB. Quarterly stock prices, and dividends paid during the last two years are summarized below. High and low stock prices are based on quotations provided by the American Stock Exchange. Per share data information has been adjusted to reflect the 100% stock dividend described previously in Part I, Item 1 of this report.

QUARTERLY STOCK PRICES
2002 AND 2003

As of March 25,

DIVIDENDS PAID TO SHAREHOLDERS’
2002 AND 2003 there were 1,056 registered holders of record of Bar Harbor Bankshares common stock.

Dividends paid by the Company in 20022003 and 2001:2002:

As of March 19, 2004, the Company had 1,057 registered shareholders of record. The Company declared and distributed dividends totaling $0.76 per share during 2003, representing an earnings payout ration of 45.8%. In the first quarter of 2004 the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholders of record as of the close of business on February 20, 2004.

The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including its needs for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.

As more fully enumerated under Item 7 of this report on Form 10-K, in November 1999 the Company announced a stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. As of the date of termination of this plan on December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The Company records repurchased shares as treasury stock.

In March 2004, the Company announced a second stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005.

Share Repurchase Program

The following table represents the total shares purchased during 2003 as part of the Share Repurchase plan:

Incentive Stock Option Plan

The following table provides information as of December 31, 2003 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.

American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15^th Avenue, 3^rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: http://www.amstock.com.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data for the last five years

(Dollars in thousands, except per share data):

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the three-yearsthree years ended December 31, 2002,2003, should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Form 10-K. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years, and provide supplemental information and analysis.

Certain information discussed below is discussedpresented on a fully taxable equivalent basis. Specifically, included in 2003, 2002 2001 and 20002001 net interest income was $1,602, $1,488 $499 and $327$499 of tax-exempt interest income from certain tax-exempt investment securities and loans, which effectively resulted in a reductiontax-equivalent adjustments of the Company’s income tax expense of$684, $613, $193, and $123$193 thousand, respectively. The analysis of net interest income tables included on pages 30-32 ofin this Form 10-K provide a reconciliation of tax-equivalent financial information to the Company’s consolidated financial statements, which have been prepared in accordance with Generally Accepted Accounting Principles. Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company’s results of operations.

Certain amounts in the 20012002 and prior yearsyears' financial statements have been reclassified to conform with the presentation used in 2002.2003.

Unless otherwise noted, all dollars are expressed in thousands except per share data.

FORWARD LOOKING STATEMENTS DISCLAIMEREXECUTIVE OVERVIEW

General Information

Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2003 the Company had consolidated assets of $584 million and was one of the larger independent community banking institutions in Maine.

The foregoing discussion, as well as certain other statements contained in this Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaningCompany’s principal asset is all of the Private Securities Litigation and Reform Actcapital stock of 1995 (the "PSLRA"). You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them byBank, incorporated in the fact that they do not relate strictly to historical or current facts. For these statements,late 19^th century. With eleven branch office locations, the Company claims the protectionis a diversified financial services provider, offering a full range of banking services and products to individuals, businesses, governments, and not-for-profit organizations throughout Down East and Mid Coast Maine. These include commercial banking, consumer banking, trust, investment management, and brokerage services.

Major Sources of Revenue

The principal source of the safe harbor for forward-looking statements provided by the PSLRA.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

(i) the Company’s successrevenue is dependant to a significant extent upon general economic conditions in Maine and Maine’s ability to attract new business;

(ii) the Company’s earnings depend to a great extent on the level of net interest income (thegenerated by the Bank, representing the difference or spread between interest and loan fee income earned on loans and investmentsfrom its earning assets and the interest expense paid on deposits and borrowings)borrowed funds. The Bank’s earnings are supplemented with investment securities income while its source of funds is supplemented with borrowings from the Federal Home Loan Bank. The Company’s non-interest income is principally derived from service fees on deposit accounts generated by the Bank and thusfees received for trust, investment management and brokerage accounts generated from financial services.

Business Strategy

The Company, as a diversified financial services provider, pursues a strategy of achieving long-term sustainable growth, profitability, and shareholder value, without sacrificing its soundness. The Company works toward achieving this goal by focusing on increasing the Bank’s loan and deposit market share in the coastal communities of Maine, either organically or by way of strategic acquisitions. The Company believes one of its more unique strengths is an understanding of the financial needs of coastal communities and the businesses vital to Maine’s coastal economy, namely: tourism, hospitality, retail establishments and restaurants, seasonal lodging and campgrounds, fishing, lobstering, boat building, and marine services. Consistent with this strategy, in the fourth quarter of 2003 the Company announced the Bank’s expansion into Knox County, Maine, by acquiring an existing branch banking office in the vibrant community of Rockland, with approximately $21 million in deposits and $12 million in loans.

The Company’s key strategic focus is vigorous financial stewardship, deploying investor capital safely yet efficiently for the highest possible returns. The Company strives to provide unmatched service to its customers, while maintaining strong asset quality and a focus towards improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well-defined credit, investment, interest-rate and liquidity guidelines. In managing its balance sheet the Company seeks to preserve the sensitivity of net interest income to changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and expected conditions, and strives to maintain a balanced and appropriate mix of loans, core deposits, and borrowed funds.

Material Risks and Challenges

In its normal course of its business, the Company faces many risks inherent with providing banking and financial services. Among the more significant risks managed by the Company are losses arising from loans not being repaid, commonly referred to as "credit risk", and losses of income arising from movements in interest rates, commonly referred to as "interest rate and market risk". The Company is also exposed to national and local economic conditions, downturns in the economy, or adverse changes in real estate markets, which could negatively impact its financial condition and results of operations.

Management has numerous policies and control processes in place which provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions, which if were changed or altered, could impact the Company’s financial condition and results of operations. The foregoing matters are more fully enumerated and discussed throughout this report on Form 10-K.

Summary Financial Condition

• Assets - Led by strong loan growth in both the consumer and commercial loan portfolios, total average assets amounted to $560,837 during 2003, representing an increase of $41,898, or 8.1%, compared with 2002. Total assets ended the year at $583,746, representing an increase of $29,928, or 5.4%, compared with December 31, 2002.
• Loans: Total average loans increased $41,989 or 12.9% during 2003, ending the year at $383,408. Loan growth was led by exceptionally strong consumer real estate lending. Origination activities benefited from a favorable market interest rate environment, a stable local economy, and initiatives designed to expand the Company’s product offerings and attract new customers, while continuing to leverage and serve its existing customer base. Consumer real estate loans, including home equity loans, averaged $229,615 during 2003, representing an increase of $34,100, or 17.1% compared with the prior year. The commercial loan portfolio also posted solid growth during 2003, ending the year at $127,901, or 10.0% higher than December 31, 2002.
• Investment Securities: The investment securities portfolio, including Federal Funds Sold and time deposits with other banks, continued to serve as a key source of revenue for the Company during 2003. This portfolio averaged $153,040 during 2003, representing a decline of $1,247 or 0.8% compared with the prior year. In light of the historically low interest rate environment, the Company chose not to increase the size of the portfolio during 2003, and directed cash flows and funding sources in support of strong loan growth.
• Deposits: The primary source of funding for the Company’s earning assets continued to be core customer deposits, gathered through a network of ten banking offices throughout Down East Maine. Total average deposits amounted to $322,414 during 2003, representing an increase of $18,939 or 6.2%, compared with 2002. While all categories of deposits posted year-over-year increases, the growth in 2003 was led by non-maturity transaction accounts, specifically, demand deposit, money market and NOW accounts.
• Borrowings: Borrowed funds principally consist of advances from the Federal Home Loan Bank, and to a lesser extent, securities sold under agreements to repurchase. Borrowings are principally utilized to support the Company’s investment securities portfolio and, to a lesser extent, fund loan growth. Average borrowed funds amounted to $176,810 during 2003, representing an increase of $19,660 or 12.5%. The increase in borrowed funds was entirely utilized to fund loan originations, as loan growth outpaced deposit growth throughout the year, while the investment portfolio declined.
• Shareholders' Equity: During 2003 the Company continued to exceed regulatory requirements for "well capitalized" institutions, which it considers vital in promoting depositor and investor confidence and promoting a solid foundation for future growth. At December 31, 2003, the Company’s Tier I Leverage, Tier I Risk Based and Total Risk Based Capital ratios stood at 8.9%, 13.4%, and 14.7%, compared with 5.0%, 6.0% and 10.0% for "well capitalized" financial institutions, respectively.

Summary Results of Operations

Net income for the year ended December 31, 2003, amounted to $5,207, or $1.63 per fully diluted share of capital stock, compared with $4,565 or $1.40 per fully diluted share in 2002, representing increases of 14.1% and 16.4% respectively.

• Net Interest Income: Net interest income continued to be the principal component of the Company’s income stream. The Company’s net interest income amounted to $19,504 in 2003, representing an increase of $215, or 1.1%, over the amount recorded in 2002. Driven by historically low interest rates, and consistent with industry-wide trends and the Company’s asset sensitive balance sheet, the Company’s net interest margin remained under pressure throughout the year, as yields on earning assets declined at a faster pace than deposit rates and other funding sources. The increase in net interest income was entirely attributed to average earning asset growth of $40,742 during 2003, as the net interest margin declined 27 basis points to 3.75%, compared with 2002. On a tax equivalent basis, the 2003 net interest margin amounted to 3.88%, compared with 4.15% during 2002.
• Provision for Loan Losses / Credit Risk: The Company expensed a provision for loan losses totaling $540 during 2003, representing a decrease of $560 or 50.9% compared with 2002, significantly contributing to the Company’s 2003 earnings growth. The decrease in the 2003 provision reflects an overall strengthening in credit quality, aided by a continuation of low net charge-off experience. At December 31, 2003 the Company’s total non-performing loans amounted to $1,494, or 0.39% of total loans, and the reserve for loan losses expressed as a percent of non-performing loans stood at 353%. Net charge-offs remained at low levels during 2003, totaling $237, or 0.06% of average loans outstanding, following $294 in 2002. At year-end, the allowance for loan losses amounted to 1.38% of total loans, compared with 1.42% at December 31, 2002.
• Non-interest Income: Total non-interest income amounted to $7,339 in 2003, compared with $6,701 earned in the prior year, representing an increase of $638, or 9.5%. The growth in non-interest income was principally attributed to an $807 increase in net gains on the sale of investment securities compared with the prior year, significantly contributing to the Company’s 2003 earnings growth. Service charges on deposit accounts amounted to $1,509, representing a modest increase of $26, or 1.8%, compared with 2002. Income from trust and other financial services amounted to $2,192, a decline of $69, or 3.1%, compared with 2002.
• Non-interest Expense: Total non-interest expense amounted to $19,204 in 2003, compared with $18,336 in 2002, representing an increase of $868, or 4.7%. Salaries and employee benefit expenses increased $599 or 6.5%, reflecting strategic adjustments to the Company’s workforce, some one-time employee severance payments, employee compensation increases, and higher subsidized health and retirement benefits. Non-interest expenses also included a variety of non-recurring charges recorded at BTI during 2003, principally relating to corporate restructuring activities, operating cost improvements, legal proceedings, and a write-down of goodwill at Dirigo.
• Performance Ratios: Return on average assets (ROA), and return on average equity (ROE) are two industry measures by which the financial performance of a banking institution is generally measured. During 2003 the Company’s ROA amounted to 0.93%, compared with 0.88% in 2002, representing an improvement of 5.7%. The Company’s ROE amounted to 9.66% in 2003, compared with 8.64% in the prior year, representing an improvement of 11.8%.

BTI Restructuring Plan

As more fully enumerated in Part I, Item 1 of this report, in the fourth quarter of 2003 the Company’s Board of Directors approved a re-structuring plan for BTI. While the corporate structure and legal entities will change, all financial services provided will essentially remain the same. As more fully discussed under Item 7, segment reporting, and Item 8, Note 8 of the Consolidated Financial Statements, Line of Business Reporting, the 2003 net loss at BTI amounted to $759 compared with a 2002 net loss of $1,133, representing a reduction in loss of $374, or 33.6%. The Company believes the changes outlined in the BTI re-structuring plan will improve operating efficiencies and future performance.

Other Matters and Events

• Legal Proceedings: During 2003 all previously reported legal proceedings were resolved, none of which had a material impact on Company earnings.

• Stock Repurchase Plan: As more fully enumerated under Item 7 in this report on Form 10-K, in the first quarter of 2004 the Company announced its second stock repurchase plan under which the Company may purchase up to 10% of its outstanding shares of common stock.

• Cash Dividends: In the first quarter of 2004 the Company increased its quarterly dividend by 5.3%, to 20 cents per share.

• Tangible Book Value: At December 31, 2003 the Company’s tangible book value amounted to $16.85 compared with $16.04 at December 31, 2002.

Outlook

Reflecting trends in the National and Regional economies, the Company’s market area generally witnessed little economic growth during 2003, and interest rate decreases in 2002 and 2003 compressed the Company’s net interest margin. Though these developments have not had a materially adverse affect on the Company to date, the Company continues to monitor them closely as discussed throughout this report. The economies and real estate markets in the Company’s primary market areas will continue to be significant determinants of the quality of the Company’s assets in future periods and, thus, its results of operations, may be adversely affected by increases or decreasesliquidity, and financial condition. The Company believes future economic activity will in interest rates;

(iii) the bankingpart depend on stronger employment, consumer confidence, personal consumption expenditures, and business is highly competitive and the profitability of the Company depends on the Bank’s ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and nontraditional institutions such as credit unions and finance companies;

(iv) a significant portion of the Bank’s loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other more intangibleexpenditures for new capital equipment. Other factors which are considered in making commercial loans and, accordingly,could effect the Company’s profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults,financial performance and the abilitythat of certain borrowers to repay such loans during a downturn in general economic conditions;

(v) a significant delay in or inability to execute strategic initiatives designed to grow revenues and or control expenses; and

(vi) significant changesits common stock, are more fully enumerated in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter"Forward-Looking Statements" discussion at the Company’s business environment or affect its operations.

The forward looking statements contained herein represent the Company’s judgment as of the datebeginning of this report on Form 10-K, and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the foregoing discussion, or elsewhere in this Form 10-K, except to the extent required by federal securities laws.10-K.

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of the Company’s financial condition are based on the consolidated financial statementsConsolidated Financial Statements, which are prepared in accordance with accounting principles generally accepted in the United States. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates, including those related to the allowance for loan losses and review of goodwill for impairment, on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:

Allowance for Loan Losses - Management believes the allowance for loan losses is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance for loan losses, which is established through a charge to the provision for loan losses,loss expense, is based on management’s evaluation of the level of allowance required in relation to the probableestimated loss exposure in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of properties to be foreclosed. The use of different estimates or assumptions could produce different provisions for loan losses. Refer to the discussion of Credit Risk in the Risk Management section and Note 1 of the Notes to Consolidated Financial Statements for a detailed description of management’s estimation process and methodology related to the reserve for loan losses.

Income Taxes – The Company estimates its income taxes for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary timing differences, resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that the recovery is not likely a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2003, there was no valuation allowance for deferred tax assets.

Interest Income Recognition on Loans - Interest income on loans is included in income as earned based upon the unpaid principal balance of the loan. The Company’s policy is to discontinue the accrual of interest, and to reverse and uncollected interest recorded on loans, when scheduled payments become contractually past due in excess of 90 days or, in the judgment of management, the ultimate collectibility of principal or interest becomes doubtful.

Goodwill and Other Intangible Assets - Management utilizes numerous techniques to estimate the value of various intangible assets held by the Company. Management utilized various methods to determine the appropriate carrying value of goodwill as required under Statement of Financial Accounting Standards ("SFAS") No. 142. At decemberDecember 31, 2002,2003, the carrying value of goodwill amounted to $375.$300. Goodwill from a purchase acquisition is subject to ongoing periodic impairment tests. Goodwill is evaluated for impairment using several standard valuation techniques including discounted cash flow analyses, as well as an estimation of the impact of business conditions. Different estimates or assumptions are also utilized to determine the appropriate carrying value of other intangible assets including but not limited to, premises and equipment, mortgage servicing rights, and overall collectibility of loans and receivables.mortgage-servicing rights. The use of different estimates or assumptions could produce different estimates of carrying value.

SUMMARY FINANCIAL OVERVIEWCONDITION

Net income for the year ended December 31, 2002, amounted to $4,565, or $1.40 per fully diluted share of capital stock, compared with $3,511 or $1.06 per fully diluted share in 2001, representing increases of 30% and 32% respectively.

Summary financial highlights for 2002 follow:

• Total average assets amounted to $518,939, representing an increase of $50,690, or 10.8%, compared with 2001. Total assets ended the year at $553,818, representing an increase of $66,615, or 13.7%, compared with December 31, 2001.
• Led by exceptionally strong consumer real estate lending, total loans at December 31, 2002 stood at $351,535, representing an increase of $53,565, or 18.0%, compared with the prior year.
• The Company’s investment securities portfolio averaged $162,099 in 2002, representing an increase of $10,417 or 6.9%, compared with 2001.
• Deposit growth continued in 2002 ending the year at $322,015, or 10.3% higher than December 31, 2001. Growth was experienced in both personal and non-personal deposit accounts.
• On a tax-equivalent basis, the Company’s net interest income before the provision for loan losses amounted to $20,190, representing an increase of $1,856, or 10.1%, over that recorded in 2001. The increase in net interest income was entirely attributed to $52,401 in average earning asset growth between periods, as the 2002 net interest margin declined seven basis points to 4.14% compared with 2001.
• The Company expensed a provision for loan losses totaling $1,100, representing a decrease of $900 or 45.0% compared with 2001. The Bank continued to maintain its non-performing loans at significantly lower levels than in prior years and attributes this improvement to the strengthening of its credit administration process and underwriting standards, aided by a healthy local economy. At December 31, 2002, total non-performing loans amounted to $1,174, or 0.33% of total loans, compared with $2,342, or 0.79% at the same date last year. Net charge offs to average outstanding loans during 2002 amounted to 0.09% compared with 0.73% in 2001. At December 31, 2002, the Company’s allowance for loan losses expressed as a percent of non-performing loans stood at 424%, compared with 178% at the same date last year.
• Non-interest income amounted to $6,413 compared with $7,520 earned in 2001, representing a decrease of $1,107, or 14.7%. These results were principally attributed to revenue declines at BTI Financial Group, as fees generated from the market value of assets under management and retail brokerage transactions were depressed by the sharp declines in the stock market, restrained investor confidence, and an overall slowdown in retail investor activities.
• BTI Financial Group recorded a net after tax loss of $1,133 for 2002, representing an increase in net loss of $118 thousand compared with 2001. During the first half of 2002 the Company completed implementation of SFAS No. 142, "Goodwill and Other Intangible Assets," which requires goodwill to be tested for impairment rather than amortized over a period of time. Included in BTI’s 2002 net loss is an after tax charge of $247 thousand recorded in the first quarter, resulting from a write down of goodwill related to the acquisition of Dirigo Investments, Inc. In response to depressed market conditions and declining revenues, BTI adjusted its capacity and reduced expenses in the most recent quarter to align income opportunities more closely.
• The Company’s total non-interest expense for the year amounted to $18,336, representing a decrease of $153 or 0.8%, compared with 2001. The decline in 2002 was aided by a one time restructuring charge of $618 recorded at BTI in the fourth quarter of 2001. Excluding the restructuring charge, non-interest expense in 2002 increased 2.6%, compared with the prior year.
• The Company’s capital grew 2.5% to $53,836 in 2002, after the payment of $2,445 in shareholder dividends and stock repurchases of $1,563. Total 2002 dividends per share were $0.76, the same amount paid in the prior year. The Company continues to exceed regulatory guidelines for "well capitalized" institutions. At December 31, 2002, Tier I leverage, Tier I risk based and total risk based capital ratios stood at 8.9%, 13.2%, and 14.5%, respectively.
• The return on total average shareholders’ equity amounted to 8.64% in 2002 compared with 6.72% in the prior year, representing an increase of 28.6%.

ASSET/LIABILITY MANAGEMENTAsset / Liability Management

In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets were 94.0%, 93.0%,92.9% and 93.1%92.5% of total average assets during 2003 and 2002, 2001 and 2000, respectively.

The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit products offered within the markets served, as well as through the prudent use of borrowed funds.

The Company’s objectives in managing its balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and forecasted economic conditions, and to maintain an efficient and appropriate mix of core deposits and borrowed funds.

EARNING ASSETSEarning Assets

For the year ended December 31, 2002,2003, the Company’s total average earning assets amounted to $487,811,$520,741, compared with $435,410 and $438,878$479,999 in 2001 and 2000,2002, representing an increase of 12.0%$40,742, or 8.5%. The increase in earning assets was entirely attributed to growth in the consumer and a decrease of 0.8%, respectively. commercial loan portfolios, as the investment securities portfolio posted year-over-year decline.

The tax-equivalent yield on total average earning assets amounted to 6.76%6.00% in 2002,2003, compared with 7.83% and 8.08%6.81% in 2001 and 2000,the prior year, representing declinesa decline of 107 and 2581 basis points respectively. Total 2002points. Despite the earning asset growth during 2003, total interest on earning assetsearned amounted to $32,965,$31,263, compared with $34,085 and $35,456$32,677 in 2001 and 2000,the prior year, representing declinesa decline of $1,120 and $1,371,$1,414, or 3.3% and 3.9%, respectively.4.3%.

Over the past twothree years there have been twelvethirteen interest rate decreases resulting in a historical 525550 basis point drop in the federal funds targeted rate overduring this period. Further, during 2002 there was ahave been significant parallel shiftshifts in the U.S. Treasury yield curve, withcurve. This trend was most profound during the 2, 5, 10quarter ended June 30, 2003, when the yield on the benchmark 10-year Treasury note dropped to as low as 3.07% and 30-year Treasury Bonds declining 160, 173, 134 and 78 basis points, respectively. Thethe federal funds targeted rate fell to 1.00%, in both cases representing forty-five year lows. This historically low interest rate environment has caused sharp yield declines on the Company’s variable rate earning assets, and prepayment speeds on fixed rate earning assets to increase dramatically. These were the principal factors underlying the 20022003 decline in earning asset yieldsinterest income.

Total Assets

Led by consumer and total interest income oncommercial loan growth, the Company’s total earning assets.assets ended the year at $583,746, representing an increase of $29,928, or 5.4%, compared with December 31, 2003.

Loan Portfolio

The loan portfolio is primarily secured by real estate in the counties of Washington and Hancock, Maine. The following table summarizes the components of the Bank’s loan portfolio as of December 31^st over the past five years.

LOANSSUMMARY OF LOAN PORTFOLIO AT DECEMBER 31

Total Loans: At December 31, 20022003 total loans amounted to $351,535,$383,408, compared with $297,970 and $271,381$351,535 at December 31, 2001 and 2000,2002, representing increasesan increase of $53,565 and $26,589,$31,873, or 18.0% and 9.8% respectively.9.1%. The 20022003 increase in total loans over 2001 was principally attributed to consumer real estate loans, principally consumer, which grew $35,909$30,958 or 24.0%10.2%, and ended the year at $185,468. Home equity loans were$335,218. Loan growth during 2003 benefited from a favorable market interest rate environment, a stable local economy, and initiatives to expand the second largest contributorBank’s product offerings and attract new customers while continuing to 2002 loan growth, posting an increase of $13,001 or 61.2% over the December 31, 2001 total of $21,238.leverage its existing customer base.

Construction and Development Loans: Total construction and development loans amounted to $12,639 at December 31, 2003 compared with $16,270 at December 31, 2002, compared with $20,348 at December 31, 2001, representing a decrease of $4,078,$3,631, or 20.0%22.3%. Construction and development loans are principally consumer in nature and represent 4.6%3.3% of the loan portfolio at December 31, 2002,2003, compared with 6.8%4.6% at the prior year-end. The decrease in 20022003 construction and development loans was generally attributable to timing, as the balances from the prior year migrated from construction status to completed homes with permanent financing arrangements. The construction loan volume was not replaced.

Mortgage Loans: Mortgage loans, which include consumer real estate, home equity and commercial, accounted for 81.9%84.1% of total loans at year-end, compared with 77.1%81.9% at December 31, 2001.2002. At December 31, 2002,2003, total mortgage loans amounted to $287,990,$322,579, compared with $229,634 and $208,815$287,990 at December 31, 2001 and 2000,2002, representing increasesan increase of $58,356 and $20,819,$34,589, or 25.4% and 10.0% respectively.12.0%. The increase in mortgage loans was principally attributed to strong consumer mortgage loan originations driven by historically low interest rates, accelerated refinancing activity, and a robust demand for real estate in the Company’s primary market area, Hancock County. Commercial mortgage

At December 31, 2003, real estate loans increased $3,926 between periodscomprised 87.4% of the loan portfolio, compared with 86.6% at December 31, 2002. The continued strength in the local real estate markets, both residential and commercial, has led to $71,184,record property values in the Bank’s market area. Recognizing the impact this trend may have on the loan portfolio, the Bank periodically reviews its underwriting standards to ensure that the quality of the loan portfolio is not jeopardized by unrealistic loan to value ratios or 5.8%.debt service levels. To date there has been no significant deterioration in the performance or risk characteristics in the real estate portfolio.

Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $11,719 at December 31, 2003 compared with $11,053 at December 31, 2002, compared with $7,149 at December 31, 2001, representing an increase of $3,904$666 or 54.6%6.0%. This category of loans represented 3.1% of the portfolio at December 31, 2002,2003, unchanged compared with 2.4% at the prior year-end. The increasesame date in 2002 balances was principally attributed to an increase in loans related to the blueberry industry in Washington County.2002.

Commercial and Industrial Loans: Commercial and industrial loans represented 5.7%5.0% of the year-end loan portfolio, compared with 7.4% and 8.7%5.7% at December 31, 20012002. Included in this category of loans are certain loans related to the blueberry industry. The Banks market area demographics generally limit the size and 2000 respectively.growth potential in this particular category of loans. At December 31, 20022003 commercial and industrial loans totaled $20,010,$19,167, compared with $22,158$20,010 at the prior year-end,same date in 2002, representing a decrease of $2,148,$843, or 9.7%4.2%. The decrease in commercial and industrial loans was principally attributed to certain loan payoffs that were not replaced with new loan growth. AAdditionally, continued tighteningstrengthening of credit standards generally reducedhas somewhat limited the amount of unsecured or partially secured loansloan growth in this category of the portfolio.

Loans to Individuals for Household, Family and Other Personal Expenditures: Personal consumer loans, including credit card loans and student loans, totaled $11,775 at December 31, 2003 compared with $12,818 at December 31, 2002, compared with $13,918 at December 31, 2001, representing a decrease of $1,100,$1,043, or 7.9%8.1%. This category of loans represented 3.6%3.1% of the portfolio compared with 4.7%3.6% at December 31, 2001.2002. The decline in balances from 20012002 was generally attributed to the application of stricter credit underwriting standards, pay-downs, and customer debt consolidation resulting from a two yearthe continued declining rate environment. AggressiveThe Bank has not campaigned aggressively for these types of loans over the past couple of years, while competition from the financing affiliates of consumer durable goods manufacturers has also tempered the growth in this particular category of loans.been strong.

All Other Loans: All other loans represented 0.8%1.2% of the portfolio at December 31, 20022003 compared with 1.2% at the prior year-end.0.8% in 2002. The balance of all other loans at December 31, 20022003 totaled $2,684$4,554 compared with $3,699$2,684 at December 31, 2001,2002, representing a decreasean increase of $1,015,$1,870, or 27.4%69.7%. This category of loans principally includeincludes loans to government municipalities and notnot-for-profit organizations. The Bank competed aggressively for profit organizations.government municipality loans during 2003, given their typically short maturities and interest rate risk characteristics. Municipality relationships also presented opportunities for providing a variety of other products and services.

Real Estate Loans Under Foreclosure: Real estate loans under foreclosure represented 0.2%0.3% of the December 31, 20022003 loan portfolio compared with 0.4%0.2% at the prior year-end.same date in 2002. At December 31, 2002,2003, real estate loans under foreclosure totaled $710$975 compared with $1,064$710 at December 31, 2001,2002, representing a decreasean increase of $354, or 33.3%.$265. At December 31, 2002,2003, real estate loans under foreclosure were represented by onesix commercial mortgage loans amounting to $5$544 and ten consumer mortgage loans totaling $705.$431. Anticipated losses are provided for in the Company’sBank’s allowance for loan losses.

Loan Concentrations: Loan concentrations continued to reflect the Company’sBank’s business region. At December 31, 2002,2003, approximately 9.9%8.2% or $34,943$31,493 million of the loan portfolio is represented by loans to the hospitality industry compared with 11.6%9.9% or $34,464$34,943 at December 31, 2001.2002. While not necessarily a concentration, at December 31, 2003 loans related to Maine’s wild blueberry industry amounted to approximately $7,116, or 1.86% of total loans.

Loan Interest Income Summary: During 20022003 the total average tax-equivalent yield on loans amounted to 7.30%6.48%, compared with 8.58% and 8.85%7.30% in 2001 and 2000,2002, representing declinesa decline of 128 and 2782 basis points, respectively.points. Over the past twothree years there have been twelvethirteen interest rate decreases in the Federal Funds targeted rate totaling 525550 basis points.points, the last being 25 basis points during the second quarter of 2003. Consequently, the yields on short-term and variable rate loan products have declined precipitously during this period. Furthermore, during 2002 a significant parallel shift in the yield curve occurred with the five, ten and thirty year Treasury Bonds declining to 2.73%, 3.81% and 4.78% at year-end, respectively. The historically low interest rate environment, including a significant downward parallel shift in the U.S. Treasury yield curve during 2003, following a similar shift during 2002, caused a dramatic increase in both consumer and commercial loan refinancing activity. Consequently, a largesizeable portion of the Company’sBank’s higher yielding loans werewas replaced with new loans at prevailing low interest rates.

Total tax-equivalent interest income from loans amounted to $23,813 in 2003, compared with $23,788 in 2002, compared with $24,355 in 2001, representing a decrease of $567,$25, or 2.3%0.1%. The decrease in interest rates contributed $7,334$2,857 to this decline, while the increase in loan volume offset this amount by $6,767.$2,882.

Other Real Estate Owned: At December 31, 20022003 other real estate owned amounted to $80$36 compared with $54 and $108$80 at December 31, 2001 and 2000 respectively. Two2002. One residential properties compriseproperty comprises the December 31, 20022003 balance. When a real estate loan goes to foreclosure and the CompanyBank purchases the property, the propertya transfer is transferredmade from the loan portfolio to the Other Real Estate Owned (OREO) portfolio at its fair value. If the loan balance is higher than the fair value of the property, the difference is charged to the allowance for loan losses prior to the time of the transfer. Other Real Estate Owned is classified on the balance sheet with Other Assets.

Mortgage Loan Servicing: As more fully disclosed in Note 6 to the financial statements, the CompanyBank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the CompanyBank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2002,2003, the unpaid balance of mortgage loans serviced for others totaled $18,306$12,334 compared with $45,800 and $52,800$28,569 at December 31, 2001 and 2000,2002, representing decreasesa decrease of 60.0% and 13.2%, respectively.56.8%. The decline in 20022003 balances was attributed to accelerated serviced mortgage loan prepayments, resulting from 20022003 loan refinancing activity prompted by historically low interest rates. Pursuant to the Company’sBank’s asset and liability management strategy, and in light of its strong capital position, this run-off was not replaced with additional sold loans. Rather, loans originated during 2003 were held in the Bank’s loan portfolio.

SUMMARY OF LOAN PORTFOLIO AT DECEMBERThe following table shows fixed rate loans and leases reported by remaining maturity, and floating rate loans by next repricing date, for the years ending December 31, 2003, and 2002.

INVESTMENT SECURITIESInvestment Securities

The investment securities portfolio, including Fed Funds Sold, money market funds and time deposits with other banks, represented 33.2%29.4% of the Company’s average interest earning assets during 20022003 and generated 27.8%23.8% of total interest income.income, compared with 32.1% and 27.2% during 2002, respectively.

The investment securities portfolio primarily consists of mortgaged-backed securities, United States Government agency securities, obligations of state and political subdivisions, and corporate bonds, and mortgage backed securities.bonds. The overall objective of the Company’sBank’s investment strategy for this portfolio is to maintain an appropriate level of liquidity, diversify earning assets, manage interest rate risk, and generate acceptable levels of net interest income. The investment securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.

On January 1, 2001, the Company, as allowed under Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," repositioned a significant part of the investment portfolio from held to maturity to available for sale.

Total Investment Securities: At December 31, 20022003 total investment securities amounted to $162,300$159,297 compared with $142,073 and $154,464$162,300 at December 31, 2001 and 2000,2002, representing an increase of $20,227 and a decrease of $12,391,$3,003, or 14.2% and 8.0%, respectively.1.9%. The 20022003 average investment securities balance amounted to $162,099,$153,040, compared with $151,682$154,287 in 2001,2002, representing an increasea decrease of $10,417,$1,247, or 6.9%0.8%. Given the historically low interest rate environment, interest rate risk and strong loan demand, the Bank exercised restraint by not increasing the investment portfolio footings during 2003, despite its strong capital position and appetite for net interest income.

The 2002During 2003 the financial markets experienced significant interest rate volatility with the two, five and ten year U.S. Treasury’s reaching lows of 1.10%, 2.07%, and 3.13%, and highs of 2.12%, 3.63%, and 4.61%, respectively. This interest rate environment prompted accelerated pay-downs on mortgage-backed securities and the exercise of callable features on other securities. These securities the resultingwere replaced pursuant to a strategy that focused on maintaining a portfolio run-off from which was more than replaced. During 2002 the Company principally invested in securities with relatively short duration, and average lives, andthereby reducing exposure to sustained increases in interest rates. This was achieved through investments in securities with variable rate features.predictable cash flows and relatively short average lives; 10-year fully amortizing mortgage-backed securities and high coupon securities, for example. While sacrificing some yield in the near term,near-term, the Company’s objective wasBank’s objectives were to maintain a reasonable level of net interest income, manage longer-term interest rate risk and market risk, and position the portfolio for a rising interest rate environment in the near future.and an improving economy.

Securities Available for Sale: The securities available for sale portfolio is managed on a total return basis with the objective of exceeding the return that would be experienced if investing solely in U.S. Treasury instruments. This category of investments is used for liquidity purposes while simultaneously producing earnings. The designation of "available for sale" is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments.

Investment securities classified as available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity. Gains and losses on the sale of securities available for sale are determined using the specific-identification method and are shown separately in the statement of income. Premiums and discounts are recognized in interest income using the interest method over the estimated life of the security. Premiums paid on mortgaged backed securities are amortized proportionate to the three month trailing average Constant Payment Rate (CPR) of each securitized pool of mortgages.

Securities available for sale totaled $124,422 at December 31, 2003, compared with $128,826 at December 31, 2002, compared with $106,743 at December 31, 2001, representing an increasea decrease of $22,083,$4,404, or 20.7%3.4%. Securities available for sale represented 79.4%78.1% of total investment securities at December 31, 2002,2003, compared with 75.1%79.4% at December 31, 2001. 2002.

The December 31, 2002 and 2001 balances of securities held for sale are stated net of fair value adjustments reflecting net unrealized gains of $692, and $3,284 at December 31, 2003 and $2,587,2002, respectively. The 2003 decline in unrealized gains was primarily due to higher interest rates at December 31, 2003 compared with the same date last year, sales of securities during 2003, and accelerated pay-downs of high yielding securities during 2003.

The following table summarizes the available for sale portfolio over the past three years:

INVESTMENTS AVAILABLE FOR SALE AT DECEMBER 31
(at fair value)

Net Securities Gains: For the year ended December 31, 2002,2003, net gains on the sale of securities amounted to $450$1,257 compared with none$450 in 2001 and 2000. The majority2002. As more fully discussed under the Results of 2002 sales were corporate securities amounting to $12,024. ChangesOperations section of this report, changes in market interest rates during 2003 and 2002 presented attractive opportunities for repositioning a relatively small portion of the investment securities portfolio, while maintaining an informed and reasonable level of balance sheet interest rate risk.

Securities Held to Maturity: The securities held to maturity portfolio is managed for yield and earnings generation, liquidity through cash flow, and interest rate risk characteristics within the framework of the entire balance sheet.

Investment securities held to maturity are those where the CompanyBank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts that are recognized in interest income using the interest method. Premiums are amortized to the earliest call date, while discounts are accreted to maturity.

Securities held to maturity totaled $33,965 at December 31, 2003, compared with $31,545 at December 31, 2002, compared with $26,866 at December 31, 2001 and $116,306 at December 31, 2000, representing an increase of $4,679,$2,420, or 17.4% and $89,440, or 76.9%7.7%. Securities held to maturity represented 19.4%21.3% of total investment securities as of December 31, 2002,2003, compared with 18.9% and 75.2%19.4% at December 31, 2001 and 2000, respectively.

The decreasethe same date in securities2002. Securities held to maturity in 2001 compared with 2000 was attributed to a transfer of securities totaling $113,856 from held to maturity to available for sale in January 2001, offset by the addition of $25,109 ofpredominately represent tax-exempt, bank qualified, municipal bond purchasesbonds, the majority of which were purchased in the fourth quarter of 2001 that were classified as held to maturity.2001.

At December 31, 2002,2003, investments held to maturity had net unrealized gains of $532,$1,128, compared with unrealized losses of $1,923 and $61$532 at December 31, 2001 and 2000, respectively.

2002.

At December 31, 2002,2003, investments held to maturity portfolio had a weighted average expected life of 9.7 years, a modified duration of 8.611.1 years, and was yieldinggenerating a tax-equivalent yield of 7.10%.

The following table summarizes the held to maturity portfolio over the past three years:

INVESTMENTS HELD TO MATURITY AT DECEMBER 31
(at book value)

Other Securities: Other securities consist of money market funds, overnight Federal fundsFunds sold, and time deposits with other banks and other non-marketable securities. The 2002 average balance ofbanks. At December 31, 2003, other securities amounted to $6,461,totaled $910 compared with $11,530$1,929 at the same date in 2001,2002, representing a decrease of $5,069,$1,019, or 44.0%52.8%.

Credit Risk: The 2002 decrease was principally attributed toBank evaluates and monitors the temporary investmentcredit risk of excess liquidity in 2001 resulting from seasonal deposit flows and acceleratedits investments utilizing a variety of resources including external credit rating agencies. At December 31, 2003, 94.3% of the investment portfolio run-off.was rated "AAA", principally consisting of mortgage-backed securities. The Bank held no investment securities below a credit rating of "A" at that date.

Investment Securities Interest Income: During 20022003 the total aggregate tax-equivalent yield on the investment securities portfolio amounted to 5.66%4.93%, compared with 6.41% and 6.83%5.91% at the same date in 2001 and 2000, representing declines of 75 and 42 basis points, respectively.2002. The declining interest rate environment over the past two years has resulted in a significant increase in prepayment speeds on high coupon mortgage backed securities, an acceleration of premium amortization, and the exercise of call features on certain securities. Securities replaced or added to the investment securities portfolio in 2002 were primarily variable rate orduring 2003 had relatively short average lives or were variable rate and consequently, lower yields.yielding.

Total tax-equivalent interest income from investment securities amounted to $9,177$7,450 in 2003, compared with $8,889 in 2002, compared with $9,730 in 2001, and $11,464 in 2000, representing decreasesa decrease of $553,$1,439, or 5.7%, and $1,734, or 15.1%, respectively.16.2%. The decrease in interest rates contributed $1,462yields accounted for the decline, as year-over-year volume essentially remained the same.

Investment Securities Maturity Distribution: The following tables summarize the maturity distribution of the held to maturity and available for sale portfolios at December 31, 2003, based upon the 2002 decline, whilefinal maturity date of the increase in volume offset this amount by $909.security. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers may have the right to prepay.

INVESTMENTS HELD TO MATURITY AT DECEMBER 31
(at book value)

INVESTMENTS AVAILABLE FOR SALE AT DECEMBER 31
(at fair value)

MATURITY SCHEDULE FOR INVESTMENTS
HELD TO MATURITY AT DECEMBER 31, 20022003
(at book value)

MATURITY SCHEDULE FOR INVESTMENTS
AVAILABLE FOR SALE AT DECEMBER 31, 20022003
(at fair value)

Available for sale securities are included based upon the final maturity date of the security.

Investment Securities Concentrations: The CompanyBank does not hold any securities for a single issuer, other than U. S. Government agencies, where the aggregate book value of the securities exceed 10% of the Bank’sCompany’s shareholders’ equity.

Impaired Investments: The investment securities portfolio contains certain investments where amortized cost exceeds fair market value, which at December 31, 2003 amounted to $648. Unrealized losses that are considered other-than-temporary are recorded as an impairment expense on the Company’s Income Statement. In evaluating whether impairments are other-than-temporary, management considers a variety of factors including the nature of the investment(s), the cause of the impairment(s), the number of investment positions that are in an unrealized loss position, and the severity and duration of the impairment(s). Other data considered by management includes, for example, industry analyst reports, sector credit ratings, volatility of the security’s market price, and or any other information considered relevant.

At December 31, 2003, management determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.

The following table summarizes temporarily impaired investment securities and their approximate fair values at December 31, 2003. All securities referenced are debt securities. At December 31, 2003 the Bank did not hold any common stock or equity securities in its investment securities portfolio.

FUNDING SOURCESTEMPORARILY IMPAIRED INVESTMENT SECURITIES

DECEMBER 31, 2003

At December 31, 2003 the total unrealized losses on temporarily impaired investments amounted to $648, representing, 1.4% of their carrying value. Unrealized losses on investment securities that have been in an unrealized loss position for more than twelve months amounted to $277 thousand, or 2.0% of their carrying value.

At December 31, 2003 the total number of investment positions in an unrealized loss position amounted to 72, represented by 57 mortgage backed-securities, 6 municipal bonds, 5 government agency bonds and 4 corporate bonds. At that same date there were no individual investment positions where the unrealized loss exceeded 3.6% of its carrying value.

Management believes the unrealized losses in the investment portfolio at December 31, 2003 were attributed to interest rates, and particularly resulted from the volatile movements in the U.S. Treasury curve over the past two years. Specifically, certain debt securities were purchased in an interest rate environment lower than where the U.S. Treasury yield curve stood on December 31, 2003. Subsequent to December 31, 2003 the yield curve posted a sharp decline, with the 10-year U.S. Treasury, for example, closing as low as 3.68%, or 57 basis points lower than where it stood at year-end.

Funding Sources

The Bank utilizes various traditional sources of funding to support its earning asset portfolios.portfolios, principally customer deposits and borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member. Average total funding in 20022003 amounted to $460,625,$499,224, compared with $409,959$460,625 in 2001,2002, representing an increase of $50,666,$38,599, or 12.4%8.4%.

Deposits:Deposits

The most significant source of funding for earning assets continued to be customer deposits, gathered throughout the Bank’s branch office network. During 2002,2003, total average deposits accounted for 65.9%61.9% of the funding required to support the Company’s earning asset portfolios.portfolios, compared with 63.2% during 2002.

Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing lines from the FHLB and cash flows from the investment securities portfolio.

Total Deposits: At December 31, 20022003 total deposits amounted to $322,015,$339,080, compared with $291,833 and $278,076$322,015 at December 31, 2001 and 2000, representing increases of $30,182 and $13,757, or 10.3% and 4.9%, respectively. Average 2002, deposit balances amounted to $303,475, compared with $279,923 in 2001, representing an increase of $23,552,$17,065, or 8.4%5.3%.

The Total average deposits amounted to $322,414 during 2003, compared with $303,475 during 2002, representing an increase of $18,939 or 6.2%. While all categories of deposits posted year-over-year increases, the growth in 2002 deposits2003 was led by non-maturity transaction accounts; namely: demand deposit, money market and savings accounts, posting a year-over-year increase of $17,842 or 19.6%, and ending the year at $108,982.NOW accounts. Depositor preference during 20022003 appeared to be that of greater liquidity, given general economic and market conditions. NOW accounts also showed solid growth

The following table summarizes the components of the Bank’s total average deposit portfolio:

SUMMARY OF DEPOSIT PORTFOLIO

Demand Deposits: Non-interest bearing demand deposits, which are principally commercial in 2002, ending the yearnature, ended 2003 at $50,172, or 9.8% higher than December 31, 2001.

Time deposits, excluding brokered funds, ended the year at $110,872$49,880 compared with $108,896$46,001 at December 31, 2001,2002, representing an increase of $1,976$3,879, or 1.8%8.4%, compared with December 31, 2002. Total average demand deposits amounted to $45,607 during 2003, representing an increase of $1,934, or 4.4%. Demand deposits represented 14.1% of total average deposits during 2003, compared with 14.4% in the prior year. The Bank offers its business customers with a variety of cash management products including a Cash Management Sweep Account. Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Demand deposits also include balances generated by way of the Bank’s Merchant Credit Card Processing Program.

NOW Accounts: The Bank offersNOW accounts to individuals and not-for-profit organizations. During 2003 the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its elderly and retired customers. At December 31, 2003, total NOW accounts stood at $60,287, representing an increase of $10,115 or 20.2% compared with the same date in 2002. During 2003 total average NOW accounts amounted to $54,221, compared with $48,739 during 2002, representing an increase of $5,482, or 11.2%.

Savings Accounts: Savings accounts, which also include money market accounts, represented 32.2% of total deposits at December 31, 2003, compared with 33.8% at the same date in 2002. The Bank offers statement savings accounts, and as a community oriented financial institution continues to offer the more traditional passbook savings accounts.

The Bank also offers a tiered-rate, competitively priced money market account, Investors Choice, providing businesses and individuals with short-term investment alternatives. During 2003, a period of historically low interest rates, customers appeared to demonstrate a thirst for the higher liquidity offered through the Investors Choice money market account, versus more traditional longer-term certificates of deposit.

At December 31, 2003, total savings accounts amounted to $109,309, compared with $108,982 at the same date in 2002, representing an increase of $327, or 0.3%. Total average savings accounts amounted to $104,275 during 2003, representing an increase of $8,761, or 9.2%, compared with 2002.

Time Deposits: Total time deposits ended 2003 at $119,604 compared with $116,860 at December 31, 2002, representing an increase of $2,744 or 2.4%. Total average time deposits amounted to $118,311 during 2003, representing an increase of $2,762, or 2.4%, compared with 2002. The relatively sluggish growth in this category of deposits was presumablyin part due to depositors’ unwillingnessapparent hesitation to commit toinvest in longer term fixed rate investmentscertificates at historically low rates.

Non-interest bearing demandyields. Additionally, in light of the extended low rate environment and its resulting pressure on the Bank’s net-interest margin, during 2003 the Bank did not compete for time deposits endedas aggressively as it has in the yearpast, with respect to pricing.In pricing non-customer relationship time deposits, the Bank will consider other available sources of funding which may be offered at $46,001, representing a decline of $111, or 0.2%, compared with December 31, 2001. Demand deposits represented 14.2% of total deposits at December 31, 2002, compared with 15.8% at the prior year-end.more attractive terms and prices, including borrowed and brokered funds.

Time deposits in denominations of $100 or greater totaled $18,784 at December 31, 2003 compared with $15,185 at December 31, 2002, representing an increase of $3,599, or 23.7%. Time deposits in denominations over $100 amounted to 5.5% of total deposits at December 31, 2003, compared with $13,9054.7% at the same date last year, representing an increasein 2002. Included in time deposits of $1,280$100 or 9.2%. The 2002 increase was attributed to the purchase of $5,988 in long-termgreater were brokered deposits at rates considered favorable to the Company.deposits. Total brokered deposits at December 31, 20022003 amounted to $5,988, or 1.9%1.8% of total deposits, compared with none in$5,988 and 1.9% at December 31, 2002.

The following schedule summarizes the prior year.maturity distribution of time deposits of $100 or more:

MATURITY SCHEDULE FOR TIME DEPOSITS $100 THOUSAND OR MORE
DECEMBER 31, 2003

Borrowed Funds:

Borrowed funds consist of securities sold under agreement to repurchase and borrowings from the Federal Home Loan Bank (FHLB).FHLB. Advances from the FHLB are secured by stock in the FHLB, U.S. Treasury and Government Agency notes, mortgage-backed securities, and qualifying first mortgage loans.

The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Company’sBank’s ability to select desired amounts, terms and maturities.maturities on a daily basis.

Total Borrowed Funds: At December 31, 2002,2003, total borrowed funds amounted to $170,501,$186,431, compared with $136,059 and $131,318$170,501 at December 31, 2001 and 2000,2002, representing increasesan increase of $34,442 and $4,741,$15,930, or 25.3% and 3.6%, respectively.9.3%. Average 20022003 borrowed funds balances amounted to $157,150,$176,810, compared with $130,036 in 2001,$157,150 during 2002, representing an increase of $27,114,$19,660, or 20.8%12.5%.

The increase in borrowed funds during 20022003 was principally utilized to fund loan growth, and to a lesser extent growth inas the Company’sBank’s investment securities portfolio.portfolio declined on a year-over-year basis.

As of December 31, 2002,2003, total short-term borrowings, including repurchase agreements, amounted to $47,943,$58,525, compared with $46,159 and $86,318$47,943 at December 31, 20012002, or 31.4% and 200028.1% of total borrowings, respectively. Conversely, long-term borrowings at December 31, 20022003 totaled $122,558,$127,906, compared with $89,900 and $45,000$122,558 at December 31, 20012002, or 68.6% and 2000, representing increases71.9% of 36.3% and 99.8%,total borrowings, respectively.

Borrowing maturities are managed in concert with the Bank’s asset and liability management strategy, and are closely aligned with the ongoing management of balance sheet interest rate risk. Over the past twofew years, newthe Bank has added longer term borrowings andto the replacementbalance sheet in order to hedge the interest rate risk associated with the growth in longer-term, fixed rate, earning assets generated during periods of scheduled maturities were predominately redirected to longer- term advances from the FHLB. This strategy was in response to opportunities presented by historically low interest rates. While this strategy has pressured net interest income in the short-term, management believes it positions the Company well for rising interest rates and more importantly, the addition and/or replacement of long-term, fixed rate assets on the balance sheet.an improving economy.

Interest Expense Summary: For the year ended December 31, 2002,2003, total interest expense amounted to $12,775,$11,075, compared with $15,751$12,775 in 2001, and $17,616 in 2000,2002, representing decreasesa decrease of $2,976,$1,700, or 18.9%, and $1,865, or 10.5%, respectively.13.3%. The total cost of the Company’sBank’s interest bearing liabilities amounted to 2.44% in 2003, compared with 3.06% in 2002, compared with 4.29%representing a decline of 62 basis points.

As more fully enumerated under the Results of Operations section of Managements Discussion and 4.70% during 2001 and 2000, representing declines of 123 and 41 basis points, respectively.

DecliningAnalysis, declining interest rates over the past two years was the principal factor underlying the decreases in the Company’sBank’s cost of interest bearing funds and total interest expense. The decline in interest rates contributed $7,091$2,907 to the 20022003 decrease in interest expense, while increased levels of interest-bearing liabilities offset this amount by $4,115.$1,207.

SUMMARY OF DEPOSIT PORTFOLIO

MATURITY SCHEDULE FOR TIME DEPOSITS $100 THOUSAND OR MORE
DECEMBER 31, 2002

CAPITAL RESOURCESCapital Resources

Consistent with its long-term goal of operating a sound and profitable organization, Bar Harbor Banksharesthe Company continues to be a "well capitalized" bank holding company according to regulatory standards. In 2002,2003, the Company continued to maintain a strong capital position, which is vital in promoting depositor and investor confidence and providing a solid foundation for future growth. Historically, most of the Company’s capital requirements have been provided through retained earnings and this continues to be the case.

On December 8, 1998, the board of directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data included in the Form 10-K have been restated to reflect the 100% stock dividend.

Stock Repurchase Plans: In November 1999, Bar Harbor Banksharesthe Company announced a stock buybackrepurchase plan. The Board of Directors of the Company hasat that time authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. The Board of Directors hassubsequently authorized the continuance of thisthat program through December 31, 2003. As of December 31, 2002,2003, the Company had repurchased 269,154339,814 shares of stock under thisthe plan, at a total cost of $4,561$6,151 and an average price of $16.94.$18.10 per share. The share repurchase program terminated on December 31, 2003. The Company holdsrecords the repurchased shares as treasury stock.

In March 2004, the Company announced a second stock repurchase plan. The Board of Directors of the Company authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time-to-time, without prior notice. The Company’s believes that a stock repurchase plan is a prudent use of capital at this time. The Company anticipates that the stock repurchase plan will be immediately accretive to the return on average equity and earnings per share.

Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. In the third quarter of 1999, the Company increased its quarterly dividend from $0.17 per share to $0.19 per share. Quarterly dividends have continued at this rate through 2002.2003. Each quarter the boardBoard of directorsDirectors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook and other relevant factors. In the first quarter of 2004 the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholders of record as of the close of business on February 20, 2004.

The Company’s principal source of funds2003 dividend payout ratio amounted to pay cash dividends and support its commitments is from its banking subsidiary, Bar Harbor Banking and Trust Company. As discussed herein, under "Regulatory Matters" the Bank’s principal regulatory agency, the FDIC, currently limits Bank dividends to current earnings excluding securities gains while maintaining a Tier 1 leverage capital ratio of 8.0%45.8%, without prior approval. The Bank iscompared with 53.6% in full compliance with these requirements and does not anticipate any impact on its ability to pay future dividends at historical levels.2002.

During 2002, the Company’s shareholders’ equity grew $1,298, or 2.5%, after the payment of $2,445 in shareholder dividends, stock repurchases of $1,563, and an increase of $640, net of tax, in value through market appreciation of securities available for sale and derivative instruments.

Capital Ratios: At December 31, 2002,2003, the Company’s total risk based capital was $53,434$56,403 or 14.5%14.7% of risk-weighted assets, compared with $52,950 and 16.8%$53,434, or 14.5% of total risk-weighted assets at December 31, 2001, and $53,235 and 18.0%2002. Tier I capital totaled $51,601 or 13.4% of risk-weighted assets, compared with 48,819, or 13.2% of total risk weighted assets at December 31, 2000. Tier I capital to risk-weighted assets was $48,819 or 13.2% at December 31, 2002, compared with $49,017, or 15.6% at December 31, 2001, and $49,538, or 16.8% at December 31, 2000.2002. The ratio of Tier I capital to average weighted assets, or leverage ratio, at December 31, 20022003 was 8.9%, compared with 10.3%unchanged from the same date in 2001 and 10.6% in 2000.2002.

As more fully depicted in Note No. 13 to the financial statements,Consolidated Financial Statements, during 2003 the Bank maintained its standing as a "well capitalized" institution as defined by regulatory standards. At December 31, 2003, the Bank’s Tier I Leverage, Tier I Risk Based and Total Risk Based capital ratios exceed allexceeded the regulatory requirements for a "well"well capitalized" bank.

Overinstitutions by 3.3%, 6.0% and 2.9%, respectively. At December 31, 2003 the past two years the Company’sCompany’ s capital ratios have shown a moderate decline. The purchase of $2,340 of stock pursuant to the Company’s stock buyback plan, the funding of operating losses at BTI,exceeded regulatory capital adequacy standards by 6.7%, 9.4% and dividend payout ratios of 53.6% and 70.9% in 2002 and 2001 respectively, all contributed to the decline.4.9%, respectively.

Except as may be noted in "Supervision and Regulation" herein above, or "Regulatory Matters" herein below, thereThere are no known trends, events or uncertainties, nor any recommendations by any regulatory authority, that are reasonably likely to have a material effect on the Company’s liquidity, capital resources, or operating results.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the principal component of the Company’s income stream and represents the difference or spread between interest and loan fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.

Total Net interest income is entirely generated by the Bank. Net interest income, after the provision for possible loan losses, represented 74.9% of total 2002 revenue, compared with 68.5% and 70.5% in 2001 and 2000, respectively.

Interest Income: For the year ended December 31, 2002,2003, net interest income on a fully tax- equivalent basis amounted to $20,190$20,188 compared with $18,334$19,902 and $17,840$17,870 in 20012002 and 2000,2001, representing increases of $1,856$286 and $494,$2,032, or 10.1%1.4% and 2.8%11.4%, respectively.

The increase in 20022003 net interest income was entirely attributed to a $52,401$40,742 increase in average earning assets between periods,during the year, as the 20022003 net interest margin declined seven27 basis points to 4.14%3.88%, compared with 2001.2002. The net interest margin in 20002001 amounted to 4.06%4.18%.

Of the $1,856 increase in 2002 net interest income, $3,561 was attributed to increased volume, offset by $1,705 due to changes in interest rates.

As more fully enumerated under the "earning assets" discussion in this report, the declining interest rate environment over the past two years has had a relatively significant impact on the Company’sBank’s earning asset yields and the cost of its interest bearing funds. During 2002,2003, the yield on average earning assets amounted to 6.76%6.00%, compared with 7.83%6.81% and 8.08%7.86% in 20012002 and 2000,2001, representing declines of 10781 and 25105 basis points, respectively. Likewise,Similarly, the cost of interest bearing liabilities amounted to 2.44% in 2003, compared with 3.06% and 4.29% in 2002 compared with 4.29% and 4.70% in 2001, and 2000, representing declines of 12362 and 41123 basis points, respectively.

Over Driven by record loan refinancing activity and accelerated cash flows from the past two yearsinvestment portfolio during 2003, the decline in yields on earning assets outpaced the decline in the cost of interest bearing liabilities has declined atby 19 basis points.

During 2003 the Bank pursued a faster rate than the yields on interest earning assets, 16 basis points faster in 2002 and 16 basis points faster in 2001. These differentials helped support the relative stabilitynumber of the Company’sstrategies to achieve a reasonably stable net interest margin during this period, without increasing itsin an extended low interest rate environment, while it continued to manage exposure to rising rates over the longer term. The Company attributes this success to timelylonger-term horizon. These strategies included a repositioning of a portion of the investment securities portfolio, utilization of interest rate swap agreements, and effective loan and deposit pricing strategies, orchestrated within well-established asset/liability management policies and the overall management of balance sheet interest rate risk.

During 2003 the Bank successfully marketed 10-year, fully amortizing 10-year mortgage products, including a bi-weekly payment 10-year mortgage product. While 10-year fully amortizing products generate lower yields than longer-term products, their cash flow characteristics diminished the degree of long-term interest rate risk, and better-positioned the Bank for rising interest rates in the future.

The Bank continued to utilize longer-term borrowings to fund a portion of earning asset growth during 2003 as it had during 2002. While the use of longer-term borrowing maturities naturally resulted in less net interest income, they more closely matched the maturities of fixed rate earning assets that were added to the Bank’s balance sheet, thereby preserving the sensitivity of net interest income in a rising rate environment.

The Bank has been deliberate in its efforts to hedge the interest rate risk associated with the addition of fixed rate earning assets to the balance sheet during a period of historically low interest rates. As more fully enumerated under the Market Risk section of this report, the Bank maintained its asset sensitive balance sheet during 2003, and believes it is positioned to benefit from rising rates and an improving economy.

The following tables summarize the Company’s average balance sheets and the components of net interest income, including a reconciliation of tax equivalent adjustments, for the years ended December 31, 2003, 2002 and 2001:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 20022003

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

AVERAGE BALANCE SHEETS AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 20012002

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 20002001

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

RATE/VOLUMEInterest Margin: The net interest margin, expressed on a tax-equivalent basis, is determined by dividing tax-equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average tax-equivalent yield earned on interest earning-assets and the average rate paid on interest bearing liabilities. The net interest margin is generally higher than the interest rate spread due to the additional income earned on those assets funded by non-interest bearing liabilities, primarily demand deposits and shareholders’ equity.

As previously discussed, the tax-equivalent net interest margin amounted to 3.88% in 2003, compared with 4.15% and 4.18% during 2002 and 2001, respectively.

The following table summarizes the net interest margin components, on a quarterly basis, over the past two years. Factors contributing to the changes in net interest income and the net interest margin are outlined in the succeeding discussion and analysis.

NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED

As depicted on the foregoing table, the net interest margin peaked at 4.25% during the first quarter of 2002, and reached a two year low of 3.73% during the third quarter of 2003, representing a decline of 52 basis points. The margin decline in the third quarter of 2003 immediately followed the peak of loan re-financing activity, in part triggered by the sharp second quarter drop in the U.S. Treasury yield curve, at which time longer-term interest rates dipped to historical lows. Accelerated prepayments on fixed rate loans and investment securities, combined with accelerated amortization of premiums in the investment portfolio, drove this decline. During the fourth quarter of 2003, the net interest margin began to strengthen, and loan prepayments and investment securities cash flow began to slow. In line with the current interest rate environment, management anticipates the net interest margin will continue to stabilize into the first quarter of 2004.

Rate / Volume Analysis: As previously discussed, the Bank’s tax-equivalent net interest income increased $286 during 2003 compared with 2002. The volume of interest earning assets added to the balance sheet during 2003 contributed $1,764 to this increase, but was offset by $1,478 due to the impact of lower yields and interest rates.

The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing a uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each.

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
TWELVE MONTHS ENDED DECEMBER 31, 2003 VERSUS DECEMBER 31, 2002
INCREASES (DECREASES) DUE TO:

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For purposes of these computations, reported on a tax-equivalent basis.

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
TWELVE MONTHS ENDED DECEMBER 31, 2002 VERSUS DECEMBER 31, 2001
INCREASES (DECREASES) DUE TO: