UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Commission File Number:Number: 0-13666
BAR HARBOR BANKSHARES

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(g) of the Act:

Title of Class	Name of Exchange on Which Registered
Common Stock, $2.00 par value per share	Name of Exchange on Which Registered American Stock Exchange

 

Indicate by check mark whether the Registrantregistrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: YES: ___ NO: X
                Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act: YES:__  NO: X
Indicate by check mark if 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 registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: YES: X___ NO: ___

X
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’sregistrant’s knowledge, in definitive 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 Registrantregistrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
                                                Large accelerated filer ___   Accelerated filer X   Non-accelerated filer ___
                Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2): YES: X
___  NO: ___

X
As of June 30, 2004,2005, the aggregate market value of the 3,044,7383,023,766 shares of Common Stock of the Registrant issued and outstanding on such date, excluding the approximately 59,27754,329 shares held by all directors and executive officers of the Registrant as a group (which does not include unexercised stock options), was $3,044,738.$80,885,741. This figureaggregate market value is based on the last sale price of $26$26.75 per share of the Registrant’s Common Stock on June 30, 2004,2005, as reported in The Wall Street Journal on July 1, 2004.2005. Although directors of the Registrant and executive officers of the Registrant and its subsidiaries were assumed to be "affiliates" of the Registrant for purposes of this calculation, the classification is not to be interpreted as an admissionaffirmation of such status.

Number of shares of Common stockStock par value $2.00 outstanding as of March 7, 2005:   3,076,7482006: 3,055,641

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the part of the Form 10-K into which the document is incorporated.

Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2005on May 16, 2006 are incorporated by reference into Part III, Items 10-14 of this Form 10-K.

FORWARD-LOOKING STATEMENTS DISCLAIMER

Certain statements, as well as certain other discussions contained in this Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. 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.

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 CompanyBar Harbor Bankshares (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:

The forward-looking statements contained herein represent the Company's judgment as of the date of this Annual 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 succeeding discussion, or elsewhere in this Annual Report on Form 10-K, except to the extent required by federal securities laws.

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

ORGANIZATIONOrganization

Bar Harbor Bankshares (the "Company") was incorporated January 19, 1984. As of March 7, 2005,2006, the Company’s securities consisted of one class of common stock, par value of $2.00 per share, of which there were 3,076,7483,055,641 shares outstanding held of record by approximately 1,0511,042 shareholders. The Company has one, wholly owned first tier operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), a community bank, which offers a wide range of deposit, loan, and related banking products, as well as brokerage services provided through a third-party brokerage arrangement. In addition, the Company offers trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services"), a Maine chartered non-depository trust company. These products and services are offered 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").

Bar Harbor Bank & Trust

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 eleven branch offices located throughout Down Eastdowneast and Mid Coastmidcoast Maine, including its principal office located at 82 Main Street, Bar Harbor. The Bank’s offices are located in Hancock, Washington, and Knox Counties, representing the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in 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 also has a loan production office located in Bangor, Maine. The Bank delivers its operations and technology support services from its operations center located in Ellsworth, Maine. The Bank has publicly announced its plan to open a new Bank branch located in Somesville, County of Hancock, Maine. It is anticipated that this new Somesville branch location will be operational by the end of the first quarter 2006.

The Bank is a retail bank serving individual and business customers, retail establishments and restaurants, seasonal lodging and campgrounds, and a large contingent of retirees. As a coastal bank, it serves the tourism, hospitality, lobstering, fishing, boat building and marine services industries. It also serves Maine’s wild blueberry industry through its Hancock and Washington County offices. The Bank operates in a competitive market that includes other community banks, savings institutions, 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. 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.Bank or its liquidity position. Approximately 86%88% 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 all of the deposit account 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 to which the Bank offers a wide variety of products and services.

Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include checking accounts, interest bearing checkingNOW accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, 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 line of 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 box rental, wire transfers, check collection services, foreign currency exchange, money orders, Travelers Checks, and U.S. Savings Bonds.

The Bank staffs a customer service center, providing customers with telephone and e-mail responses to their questions and needs. Free bank-by-mail services are also offered.

Retail Brokerage Services: During 2004 theThe Bank retainedretains Infinex Investments, Inc, ("Infinex") as a full service third-party broker-dealer, conducting business as Barunder the assumed business name "Bar Harbor Financial Services." Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other any government agency, are not guaranteed by the bankBank or any affiliate, and may be subject to investment risk, including possible loss of value.

Bar Harbor Financial Services 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. Infinex was formed by a group of member banks, and is currently the largest provider of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.

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 http://www.bhbt.com.www.BHBT.com. Additionally, the Bank offers TeleDirect, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Automated Teller Machines (ATMs) are located at each of the elevenBank’s branch locations, as well as twothree machines in non-Bank locations. These ATM’sATMs access major networks throughout the United States, including Plus, NYCE, and other major ATM and credit card companies. The Bank is also a member of Maine Cash Access, providing customers with surcharge-free access to over 150 ATM’s193 ATMs throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.

Commercial Products and Services: The Bank serves the small business market throughout Down Eastdowneast and Mid Coastmidcoast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate purchases,and equipment financing, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and individualssole proprietors in the tourist, hospitality, health care, blueberry, shipbuilding,boatbuilding, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with correspondent banks,other financial institutions, 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 cash 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. The Bank also offers Premier E-corpBusiness On Line Direct ,("BOLD") an on-lineon line real-time Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and order both domestic and foreign wire transfers. Other commercial banking services include merchant credit card processing, night depository, and coin and currency handling.

Bar Harbor Trust Services

Bar Harbor Trust Services ("Trust Services") is a Maine chartered, non-depository trust company and a wholly owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities of varying asset size.

Trust Services serves as trustee of both living trusts and trusts under wills, including revocable and irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Custody, estate settlement, and fiduciary tax services, among others, are also offered. Additionally, Trust Services offers employee benefit trust services for which it acts as trustee, custodian, administrator and/or investment advisor, among other things, for employee benefit plans and for corporate, self employed, municipal and not-for-profit employers located throughout the Company’s market areas.

The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2004,2005, Trust Services served 720735 client accounts, with assets under management and held in custody amounting to $196$221 million and $25$28 million, respectively.

ECONOMYEconomy

Maine is a state of approximately 1.3 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 is growing older and it is growing unevenly. Poverty rates are relatively high at 11.5%, but vary dramatically by region, ranging from 8.0% in York County to 20.9% in Washington County. The market place 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 dependantdependent 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 dependantdependent 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 and technology.

TheAccording to a recent report issued by the Maine State Planning Office, the Maine economy has shown slow but steadygrew slowly in 2005. While there were some areas of improvement over 2004, the major measures still found Maine ranked below the average state in a numberterms of key areasgrowth. Economic positives were essentially limited to significant improvements in the housing permit and residential construction sectors. Sales tax revenue through August 2005 was up only 2.9% over the past year, including employment, income, investmentsame period in 2004 and consumer sales. By mid-2004, Maine recovered all ofwas considerably slower than the jobs lost during the most recent recession, well ahead of the nation and other New England states except5.3% measured for Rhode Island. The latest data for Maine’s gross state product and personal income growth were well above the national averages, helping to raise Maine’s per capita income ranking from 35^th to 30^th over this period. However, the Maine Consensus Economic Forecasting Commission (October 2004 forecast) calls for relatively slower growth in 2005, including annual growth in personal income of 4.0% and wage and salary employment of 1.7%.as a whole.

According to a January 2005 jointrecent report publishedissued by Maine Revenue Services, the State Planning Office and the Maine Department of Labor, a number of key economic indicators used to monitor the state of Maine economy remained positive during 2004. Among these:

• Personal income grew 5.4% for the first three quarters of the year versus the same period last year, slightly outperforming New England (5.3%)between December 2004 and the U.S. (5.2%).

• December 2005, Maine’s seasonally adjusted unemployment rate stood at 4.5% in November 2004, having droppedrose from 5.1% a year earlier, and remained below the national rate of 5.4%. Payroll employment numbers showed the addition of almost five thousand net new jobs through November of 2004. The largest job gains came in health care and social assistance, retail trade, construction, and leisure and hospitality sectors. The manufacturing sector showed job losses during this period, continuing a long-term trend. Maine’s unemployment rate has been below4.6% to 4.8%, compared with the national average forof 4.9%. The major industry groups creating the past 5 years, andmost jobs over the 2000-2003 period, payroll employment grewyear were education and health services, while it declinedthe largest declines were in manufacturing and financial services. The personal income growth rate in Maine ranked 47th among the 50 states. Personal income in Maine is affected by retirements among the Maine population, currently the oldest in the nation.

  Oil and gas prices were persistently high during 2005. Energy is particularly expensive in Maine and other New England states. The combination of high energy prices and slow income growth has impacted retail sales. Businesses are also feeling the U.S.

• Wage disbursements increased 4.2% during the first two quarterseffect of 2004 and were on a faster pace than the 3.5% increase during all of 2003. Annual average total wages paid in Maine showed exceptionally strong gains of 6.4% between 2001 and 2003 while comparable wage gains for the U.S. were reported at 2.8% and the New England region reported at 0.8%.

• Maine’s retail sales year-to-date growth through the third quarter of 2004 was 6.1% over the same period of last year. Growth in 2003 was 4.6%. Business operating sales, including business-to-business transactions, increased by 10% during the July to September 2004 quarter. Growth for the 2004 calendar year through September was 11% higher the same period last year.

• Residential construction awards were strong throughout 2004, with year-over-year growth in the August through October period up nearly 18% from the same period last year.

Changes in the economy 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 Eastdowneast and Mid Coastmidcoast Maine, is improving or will continue to strengthen. A downturn in 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.

COMPETITIONCompetition

The Company competes principally in Down Eastdowneast and Mid Coastmidcoast Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be in Hancock, Knox, and Washington counties, each in the state of Maine. According to the most recent Census Bureau Report (2003), the population of these three counties is 52,792, 40,406 and 33,479 respectively, representing a combined population of approximately 126,677. 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 financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.

Like most financial institutions in the United States of America, the Company competes with an ever-increasing array of financial service providers. As the national economy moves further towards a concentration of service companies and the overall health of the financial services industry continues to be strong, competitive pressures will mount.

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, regulationregulations that limitslimit 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 financial services industry is undergoing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Further technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Company’s future success will depend in part on its ability to address customer needs by using technology. There is no assurance that the Company will be able to develop new technology-driven products and services or be successful in marketing these products to our customers. Many of the Company’s competitors have far greater resources to invest in technology.

The Company 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, no assurance can be given that the BankCompany will continue to be able to compete effectively with other financial institutions in the future.

No material part of the Company’s 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 EMPLOYEESManagement and Employees

The Company has two principal officers: Joseph M. Murphy, President and Chief Executive Officer, and Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer.

Joseph M. Murphy also serves as President and Chief Executive Officer of the Bank. Gerald Shencavitz also serves as Chief Financial Officer, Chief Operating Officer and Treasurer of the Bank. Mr. Dean S. Read formerly served as PresidentBank, and Chief Financial Officer of the Bank through 2004, but has resigned that position effective as of February 25, 2005.Trust Services. Other senior operating positions in the Company include a President of Trust Services, and Senior Vice Presidents in charge of retail banking, commercial lending, credit administration, / risk management, operations, human resources and human resources.marketing.

As of December 31, 2004,2005, the Bank employed 140139 full-time equivalent employees, Trust Services employed 12 full-time equivalent employees, and the holding company employed 43 full-time employees, representing a full-time equivalent complement of 156 154 employees of the Company.

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. Certain officers and employees of the Company and its subsidiaries also participate in the Company’s 2000 Stock Option Plan and/or have incentive bonus compensation plans, deferred compensation arrangements, Supplemental Executive Retirement Agreementssupplemental executive retirement agreements and change in control, confidentiality and noncompetenon-compete agreements.

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

SUPERVISION AND REGULATIONSupervision 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 -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 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 -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.institution. 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 -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 ActGLBA 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 BHC’sBHCs 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 BHC’sBHCs that have not elected to be treated as FHC’s, 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, 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. 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, 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 - -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 -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.

Until June 30, 2003, Maine law previously provided that a corporation’s board of directors could 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 preceding 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 limitations were repealed effective as of July 1, 2003. Under current Maine corporation law, the directors of a corporation may make distributions to its shareholders (subject to restriction by the articles of incorporation) if, (1) the corporation’s assets exceed its liabilities (plus any amounts payable to preferred classes of stock), and (2) the corporation is 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: 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, 2004,2005, 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, 2004,2005, and at the time of this report.

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 1312 "Shareholders’ Equity," each in this Annual Report on Form 10-K for the year ended December 31, 2004.2005.

Activities and Investments of Insured State-Chartered 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: 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 written notice to customers and regulatory authorities before closing any branch.

Community 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.October 3, 2005.

Customer Information 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: 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: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, together with the implementing regulations of various federal regulatory agencies, havehas caused financial institutions, including the Bank and Trust Services, to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer 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 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 recentpotential 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.

Federal Deposit Insurance Reform Act of 2005: The federal Deposit Insurance Reform Act of 2005 (the "FDI Reform Act") was adopted by Congress as a part of the Deficit Reduction Act of 2005 and signed into law by President Bush on February 8, 2006. The FDIC Reform Act when effective will (i) merge the two deposit insurance funds, currently the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF") (the new combined fund will be called the Deposit Insurance Fund or "DIF"), (ii) index the $100,000 insurance level to reflect inflation (the first adjustment for inflation is scheduled to be effective January 1, 2011 and thereafter adjustments will occur every 5 years), (iii) increase deposit insurance coverage for retirement accounts to $250,000, (iv) offer credits to eligible banks that capitalized the FDIC which can be used to offset premiums otherwise due, (v) impose a cap on the level of the deposit insurance fund and provide for dividends when the fund grows beyond a specified threshold, (vi) adopt the historical basis concept for distributing the aforementioned one-time credit and dividends and (vii) authorizes revisions to the current risk-based system for assessing premiums. The merger of the two deposit insurance funds is effective 90 days after enactment. Final rules for the rest of the provisions become effective 270 days after enactment.

Securities 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 –2002: On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley actAct of 2002 ("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. Among other things the S-O Act provides for:

1. The creation on an independent, public company accounting oversight board which is empowered to set 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 Financial Accounting Standards Board, giving it full financial independence from the accounting industry.
2. The strengthening of auditor independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer public company audit clients.
3. A heightened responsibility of public company directors and senior managers for the quality of the financial reporting and disclosures made by their companies. Among other things, the new legislation provides for a strong public company audit committee that will be directly responsible for the appointment, compensation, and oversight of the work performed by the public company auditors.
4. 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 a 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.
5. Requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the Company.
6. 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;
7. The imposition of a broad range of new corporate disclosure requirements. Among other things, the new legislation requires public companies to report all off balance sheet transactions and conflicts, as well as to present any pro forma disclosures in a 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, which now generally must be reported by the end of the second business day following a covered transaction; requires that annual reports filed with the SEC include a statement by management asserting that they are responsible for creating and 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 term which has been defined by the SEC in accordance with specified requirements. The new legislation also requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings.

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.

Taxation: The Company is subject to those rules of federal income taxation generally applicable to corporations under the Internal Revenue Code. The Company is also subject to state taxation under the laws of the State of Maine.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTSFinancial Information About Industry Segments

The information required under this item is included in the Company'sCompany’s financial statements, which appear in Part II, Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.

Guide 3 Information

Information required by Industry Guide 3, relating to statistical disclosure by bank holding companies, is contained in the information incorporated by reference to Item 7 of this Annual Report on Form 10-K.

AVAILABILITY OF INFORMATION - COMPANY WEBSITEAvailability of Information – Company Website

The Company maintains a website on the World Wide WebInternet at http://www.bhbt.com.www.BHBT.com. The Company makes available, free of charge, on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the 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.

ITEM 1A. RISK FACTORS

In its normal course of business, the Company is subject to many risks and uncertainties inherent with providing banking and financial services. Although the Company continually seeks ways to manage these risks, and has established programs and procedures to ensure controls are in place and operating effectively, the Company ultimately cannot predict the future. Actual results may differ materially from the Company’s expectations due to certain risks and uncertainties. The following discussion sets forth the most significant risk factors that the Company believes could cause its actual future results to differ materially from expected results.

The risks and uncertainties discussed below are not all inclusive. Additional risks and uncertainties that the Company is unaware of, or that it currently deems immaterial, may also become important factors relating to the Company’s future operating results and financial condition.

The Bank’s allowance for loan losses may not be adequate to cover loan losses.

A significant source of risk for the Company arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Bank are secured, but some loans are unsecured based upon management’s evaluation of the creditworthiness of the borrowers. With respect to secured loans, the collateral securing the repayment of these loans principally includes a wide variety of real estate, and to a lesser extent personal property, either of which may be insufficient to cover the obligations owed under such loans.

Collateral values and the financial performance of borrowers may be adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates and debt service levels, changes in oil and gas prices, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events, which are beyond the control of the Bank. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards might create the impression that a loan is adequately collateralized when in fact it is not. Although the Bank may acquire any real estate or other assets that secure defaulted loans through foreclosures or other similar remedies, the amounts owed under the defaulted loans may exceed the value of the assets acquired.

The Bank has adopted underwriting and credit monitoring policies and procedures, including the establishment and ongoing review of the allowance for loan losses and regular review of borrower financial statements and collateral appraisals, that management believes are appropriate to mitigate the risk of loss by assessing the likelihood of borrower non-performance and the value of available collateral. The Bank also manages credit risk by diversifying its loan portfolio. An ongoing independent review, subsequent to management’s review, of individual credits is performed by an independent loan review function, which reports to the Audit Committee of the Board of Directors. However, such policies and procedures have limitations, including judgment errors in management’s risk analysis, and may not prevent unexpected losses that could have a material adverse effect on the Company’s business, financial condition and results of operations. Refer to Part II, Item 7, "Allowance for Loan Losses," for a more complete discussion of credit risk.

Interest rate volatility could significantly reduce the Company’s profitability.

The Company’s earnings largely depend on the relationship between the yield on its earning assets, primarily loans and investment securities, and the cost of funds, primarily deposits and borrowings. This relationship, commonly known as the net interest margin, is susceptible to significant fluctuation and is affected by economic and competitive factors that influence the yields and rates, and the volume and mix of the Bank’s interest earning assets and interest bearing liabilities.

Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. The Company is subject to interest rate risk to the degree that its interest bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than its interest earning assets. Significant fluctuations in interest rates could have a material adverse impact on the Company’s business, financial condition, results of operations, or liquidity.

The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of its balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet, in order to preserve the sensitivity of net interest income to actual or potential changes in interest rates. For additional information regarding interest rate risk, refer to Part II, Item 7, "Quantitative and Qualitative Disclosures About Market Risk."

The Company is exposed to a variety of operational risks that could result in significant financial losses.

The Company is exposed to many types of operational risk, including reputation risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.

Negative public opinion can result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Company’s ability to attract and keep customers and can expose it to litigation and regulatory action.

Given the volume of transactions at the Company, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process its transaction volumes may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical telecommunication outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.

The Company regularly assesses the level of operational risk throughout the organization and has established systems of internal controls that provide for timely and accurate information. Testing of the operating effectiveness of these control systems is performed regularly. While not providing absolute assurance, these systems of internal controls have been designed to manage operational risks at appropriate, cost-effective levels. Procedures exist that are designed to ensure policies relating to conduct, ethics, business practices are followed. From time to time losses from operational risk may occur, including the effects of operational errors. Such losses are recorded as non-interest expense.

While the Company continually monitors and improves its system of internal controls, data processing systems, and corporate-wide risk management processes and procedures, there can be no assurances that future losses arising from operational risk will not occur and have a material impact on the Company’s business, financial condition, results of operations, or liquidity.

The Bank’s loans and deposits are concentrated in certain areas of Maine and adverse economic conditions in those markets could adversely affect the Company’s operations.

The Company's success is dependent to a significant extent upon general economic conditions in the United States and, in particular, the local economies of downeast and midcoast Maine, the primary markets served by the Company. The Company’s success is also dependent on Maine's ability to attract new business, as well as factors that affect tourism, a major source of economic activity in the Company’s immediate market areas. The Company is particularly exposed to real estate and economic factors in the downeast and midcoast areas of Maine, as virtually the entire loan portfolio is concentrated among borrowers in these markets. Furthermore, because a substantial portion of the Bank’s loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions. An economic downturn in the markets served by the Company, or the nation as a whole, could negatively impact household and corporate incomes. This impact could lead to decreased demand for both loan and deposit products and increase the number of borrowers who fail to pay the Bank interest or principal on their loans, and accordingly, could have a material adverse effect on the Company’s business, financial condition, results of operations, or liquidity.

The Company may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures.

Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and standing in the marketplace, and general economic conditions.

The Bank’s primary source of funding is retail deposits, gathered throughout its network of eleven banking offices. Wholesale funding sources principally consist of borrowing lines from the Federal Home Loan Bank of Boston of which it is a member, and brokered certificates of deposit obtained from the national market. The Bank’s securities and loan portfolios provide a source of contingent liquidity that could be accessed in a reasonable time period through sales. The Bank could also borrow through the Federal Reserve’s discount window.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.

The Bank actively manages its liquidity position through target ratios established under its Asset Liability Management Policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity.

Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows. For further information about the Company’s liquidity position, refer to Part II, Item 7, "Liquidity Risk."

The Company’s information technology systems may be vulnerable to attack or other technological failures, exposing it to significant loss.

The Company depends upon data processing software, communication and information exchange on a variety of computing platforms and networks including the Internet. Despite instituted safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerably to attack or other technological difficulties or failures. The Company also relies on the services of a variety of third party vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be misappropriated, services and operations may be interrupted and the Company could be exposed to claims from customers, suffer loss of business and suffer loss of reputation in its marketplace. Any of these results could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.

Strong competition within the Company’s markets may significantly impact its profitability.

The Company competes with an ever-increasing array of financial service providers. As a bank holding company and state-chartered financial institution, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulations that limit 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 mount in the Company’s markets.

The financial services industry is undergoing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Furthermore, technological advances are likely to intensify competition by enabling more companies to provide financial resources. Accordingly, the Company’s future success will depend in part on its ability to address customer needs by using technology. There is no assurance that the Company will be able to develop new technology driven products and services, or be successful in marketing these products to its customers. Many of the Company’s competitors have far greater resources to invest in technology.

Regional, national and international competitors have far greater assets and capitalization than the Company and have greater access to capital markets and can offer a broader array of financial services than the Company.

No assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future. Furthermore, developments increasing the nature or level of competition could have a material adverse affect on the Company’s business, financial condition, results of operations or liquidity. For further information on competition, refer to Part I, Item 1, "Competition" and "Supervision and Regulation."

The business of the Company and the Bank is highly regulated and impacted by monetary policy, limiting the manner in which the Company and the Bank may conduct its business and obtain financing.

The Company and the Bank are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Company and the Bank conducts its business, undertakes new investments and activities, and obtains financing. These laws and regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Company’s shareholders. These laws and regulations may sometimes impose significant limitations on the Company’s operations. The more significant federal and state banking regulations that affect the Company and the Bank are described in Part I, Item 1, "Supervision and Regulation." These regulations, along with the existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.

The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations, or specific actions of regulators, could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Furthermore, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit risk and interest rate risk conditions for the Company, and any unfavorable change in these conditions could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.

Non-compliance with the Bank Secrecy Act and USA Patriot Act could result in significant fines or sanctions.

The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent them from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Crimes Enforcement Network. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts or conduct transactions.

Non-compliance with the Bank Secrecy Act, the USA Patriot Act and related laws and regulations could result in significant fines or sanctions. These particular laws and regulations have significant implications for all financial institutions, establish new crimes and penalties, and require the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money-laundering and terrorist activities. Even innocent non-compliance and inconsequential failure to follow the regulations, may result in significant fines or other penalties, which could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.

The Bank could be held responsible for environmental liabilities relating to properties acquired through foreclosure, resulting in significant financial loss.

In the event the Bank forecloses on a defaulted commercial or residential mortgage loan to recover its investment, it may be subject to environmental liabilities in connection with the underlying real property, which could significantly exceed the value of the real property. Although the Bank exercises due diligence to discover potential environmental liabilities prior to acquiring any property through foreclosure, hazardous substances or wastes, contaminants, pollutants, or their sources may be discovered on properties during its ownership or after a sale to a third party. There can be no assurance that the Bank would not incur full recourse liability for the entire cost of any removal and clean up on an acquired property, that the cost of removal and clean-up would not exceed the value of the property, or that it could recover any of the costs from any third property. Losses arising from environmental liabilities could have a material adverse impact on the Company’s business, financial condition, results of operations, or liquidity.

The preparation of the Company’s financial statements requires the use of estimates that could significantly vary from actual results.

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that effect the financial statements. The most critical estimate is the allowance for loan losses. Due to the inherent nature of estimates, the Company cannot provide absolute assurance that it will not significantly increase the allowance for loan losses and or sustain credit losses that are significantly higher than the provided allowance, which could have a material adverse effect on the Company’s business, financial condition, results of operations, or liquidity. For further information on the use of estimates, refer to Part II, Item 7, "Application of Critical Accounting Policies."

Changes in accounting standards could significantly impact the Company’s reported earnings.

The accounting standard setters, including the FASB, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes can be difficult to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

The Company’s stock price has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future.

These factors include but are not limited to:

• Actual or anticipated variations in earnings or financial condition.
  
• Changes in analyst’s recommendations or projections.
  
• The Company’s announcements of developments related to its business.
  
• Operating and stock performance of other companies deemed to be peers.
  
• New technology used or services offered by traditional and non-traditional competitors.
  
• News reports of trends, concerns and other issues related to the financial services industry.

The Company’s stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to the Company’s performance. General market price declines or market volatility in the future could adversely affect the price of the Company’s common stock, and the current market price may not be indicative of future market prices.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The thirteen 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, which houses its banking facilities and administrative offices, and an adjacent 35-car customer parking lot.offices. The building was renovated in 1998.

2. An office is located at 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 at 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975, along with a parcel of land adjacent to the branch.1975. The branch office was added to, and renovated in 1989, to better meet the Bank’s needs at that location.

4. An office is located onat 25 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 Bank’s needs at that location.

5. An office is located at 21 Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that underwent renovations in 1989 to better meet the Bank’s needs at that location. A parcel of land adjacent to the Blue Hill branch was purchased in 1981, but has not been developed. A second improved parcel of land contiguous to this branch was purchased in 2005. The Bank is currently evaluating expansion at its Blue Hill location.

6. An office is located at 2 Bridge Street, 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 at 68 Washington Street, Lubec, Maine. This property consists of a building constructed in 1990 and is considered adequate for the Bank’s needs at that location.

8. An office is located 137 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 at 385 Main Street, Winter Harbor, Maine. This property consists of a building constructed in 1995 and is considered adequate for the Bank’s needs at that location.

10. An office is located at 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 StStreet (Route 1), 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 considered adequate for the Bank’s needs at that location.

12. An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data processing centers. The building was constructed in 1996 and is currently adequate for the Company’s needs.

13. The Company ownsBank and occupiesits wholly owned subsidiary, Trust Services, own and occupy a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The Bank and its wholly owned subsidiary, Trust Services, occupy this facility. The facility was renovated in 2001.

Other real estate owned includes two out parcels (one improved) contiguous to the Company’sBank’s 135 High Street, Ellsworth location.

The Bank’s new Somesville branch office located at 1055 Main Street, Somesville, Maine, is a leased property. The Bank and Trust Services also lease office space at One Cumberland Place in Bangor, Maine.

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 76 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of Management based upon currently available information will have no material effect on the Company's consolidated financial statements.

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 2004.

2005.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The common stock of the Company is traded on the American Stock Exchange ("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.

QUARTERLY STOCK PRICES
20042005 AND 20032004

High and low stock prices are based on quotations provided by the American Stock Exchange. Prices of transactions between private parties may vary from the ranges quoted above.

DIVIDENDS PAID TO SHAREHOLDERS
20042005 AND 20032004

Dividends paid by the Company in 2005 and 2004 and 2003:are summarized below:

As of March 7, 2005,2006, the Company had 1,0511,042 registered shareholders of record. The Company declared and distributed dividends totaling $0.80$2.58 million or $0.84 per share during 2004,2005, representing an earnings payout ratio of 43.2%40.2%. In the first quarter of 20052006 the Company increased its quarterly dividend by 5.0%4.8% to $0.21$0.22 per common share. The dividend waswill be paid March 15, 20052006 to shareholders of record as of the close of business on February 18, 2005.17, 2006.

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 the Company’s financial condition, earnings, 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.

Stock Repurchase Plan

As more fully enumerated under Part II 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 recorded 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 willwere to continue through December 31, 2005. In December 2005, the Company announced the continuance of this plan through December 31, 2006. 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. As of December 31, 2004,2005, the Company had repurchased 49,920103,732 shares of stock under the plan, at a total cost of $1,349 and an average price of $27.03$27.21 per share. The Company records repurchased shares as treasury stock.

The following table sets forth information with respect to any purchase made by or on behalf of the Company or any "affiliated purchaser," as defined in Sec. 240.10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during the periods indicated:

(1)  In February 2004, the Company’s Board of Directors approved a program to repurchase up to 10% of the Company’s outstanding shares of common stock,
       or approximately 310,000 shares. Purchases began March 4, 2004. This repurchase program is scheduled to terminate December 31, 2005, unless otherwise
       extended by the Company.

Incentive Stock Option Plan

On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and itsAnd Its Subsidiaries Incentive Stock Option Plan of 2000, thatwhich is described more fully in Part II, Item 8, Notes 1 and 14 to13 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

The following table provides information as of December 31, 20042005 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.

Transfer Agent Services

American Stock Transfer & Trust Company provides transfer agent services for the Company. Inquiries may be directed to: American Stock Transfer & Trust Company, 6201 15^th15th Avenue, 3^rd3rd Floor, Brooklyn, NY, 11219, telephone: 1-800-937-5449, Internet address: http://www.amstock.com.www.amstock.com.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The supplementary financial data presented in the following tables contain information highlighting certain significant trends in the Company’s financial condition and results of operations over an extended period of time.

The following information should be analyzed in conjunction with Item 7 - - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and with the audited consolidated financial statements included in this Annual Report on Form 10-K.

FIVE YEAR SUMMARY OF FINANCIAL DATA
At or For the Years Ended December 31,
(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 years ended December 31, 2005, 2004 2003 and 20022003 should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on 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 amounts in the 20032004 and prior yearsyears’ financial statements have been reclassified to conform to the presentation used in 2004.2005.

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

Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in 2005, 2004 2003 and 20022003 net interest income was $1,653,$1,620, $1,653, and $1,602, and $1,488respectively, of tax-exempt interest income from certain tax-exempt investment securities and loans.

An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income and net interest income totals discussed in this Management’s Discussion and Analysis, resulting in tax equivalent adjustments of $682, $721 and $684 in 2005, 2004 and $613, in 2004, 2003, and 2002, respectively. The analysis of net interest income tables included in this Annual Report on 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 U.S. 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. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.

EXECUTIVE 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, 20042005, the Company had consolidated assets of $667$748 million and was one of the larger independent community banking institutions in Maine.

The Company’s principal asset is all of the capital stock of the Bar Harbor Bank & Trust (the "Bank"), a community bank incorporated in the late 19^th19th century. With eleven branch office locations, the Company is 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 Eastdowneast and Mid Coastmidcoast Maine.

The Company attracts deposits from the general public in the markets it serves and uses such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage and home equity loans, and a variety of consumer loans. The Company also invests in mortgage-backed securities, obligations of government-sponsored enterprises, obligations of state and political subdivisions, as well as other securities. In addition to community banking, the Company provides a comprehensive array of trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services") a Maine chartered non-depository trust Company.company.

Major Sources of Revenue

The principal source of the Company’s revenue is net interest income, generated, representing the difference or spread between interest income from its earning assets and the interest expense paid on deposits and borrowed funds. In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. The Company’s non-interest income is principally derived from financial services including trust, investment management and third-party brokerage services, as well as service charges on deposit accounts, merchant credit card transaction processing fees, gains andor losses on the sale of investment securities, and a variety of other miscellaneous product and service fees.

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 its 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 February 2004 the Company expanded into Knox County, Maine, with the Bank’s acquisition of an existing branch banking office in the vibrant community of Rockland.

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 towardstoward improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well-definedwell 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, investment securities, core deposits, brokered 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",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 business, financial condition, and results of operations.operations or liquidity.

Management has numerous policies and control processes in place whichthat 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 business, financial condition, and results of operations.operations or liquidity. The foregoing matters are more fully discussed in Part I, Item 1, "Risk Factors," and throughout this Annual Report on Form 10-K.

Summary Financial Condition

The Company’s total assets increased 14%$81 million or 12% during 2004,2005, ending the year at $667$748 million. Asset growth continued to be driven by consumerConsumer and commercial lending activities.activities continued to drive the Company’s asset growth.

• Loans: Total loans stoodended the year at $448$514.9 million, representing an increase of $66.4 million, or 14.8%, compared with December 31, 2004. Business lending activity was exceptional during 2005, contributing three-quarters of the year-over-year loan growth. At December 31, 2005, consumer loans and commercial loans comprised 59% and 41% of the loan portfolio, compared with 63% and 37% at December 31, 2004, representing an increase of 17% compared with the same date in 2003. Loan growth was split about equally between commercial and consumer loans, and was aided by $12 million in loans acquired in connection with the Bank’s branch office acquisition in the community of Rockland, Maine. Lending activities have benefited from the resilience of the local economy, a favorable market interest rate environment, and initiatives designed to strengthen the Bank’s loan origination and service delivery systems.respectively.

• Allowance for Loan Losses: Non-performingThe Bank’s non-performing loans remained at low levels during 2004.2005. At year-end, total non-performing loans amounted to $723$868 thousand or 0.16%0.17% of total loans, compared with $1.5 million$723 thousand or 0.39%0.16% at December 31, 2003. At December 31, 2004 the allowance for2004. The Bank’s loan losses amountedloss experience showed an improvement during 2005, with net charge-offs amounting to 1.1%$182, or net charge-offs to average loans outstanding of total0.04%, compared with $629 thousand, or net charge-offs to average loans and expressed as a percentoutstanding of non-performing loans, stood at 667%.0.15% during 2004. Reflecting a sustained trend of strong credit quality and the resolution of certain legal proceedings between borrowers engaged in the Maine wild blueberry processing industry and their growers, during 20042005 the Bank recordeddid not record a provision for loan losses, ofcompared with $180 thousand representing a reduction of $360 compared with 2003, and favorably impacting the current year’s earning performance.in 2004.

• Investment Securities: The Total investment securities portfolio continued to serve as a key source of earning assets forended the Bank. Investment securities totaled $176year at $183.3 million, at December 31, 2004, representing an increase of 11%$7.0 million or 4.0% compared with December 31, 2003. Investment2004. In the fourth quarter of 2005, as market yields climbed towards 2005 highs, the Bank added $23.6 million in securities principally consistto the Company’s balance sheet. Average securities amounted to $164.0 million in 2005, representing a decline of mortgage-backed$17.7 million or 9.8% compared with 2004. During the first nine months of 2005, a significant portion of the cash flows from the securities portfolio was redeployed to help support the funding of strong loan growth, which typically generates a higher yielding earning asset base. Throughout most of 2005, Bank management exercised restraint with respect to additional leveraging of the balance sheet with securities during a period of still historically low market yields, a flattening U.S. Treasury yield curve, and obligationsan expectation of state and political subdivisions.higher yields in the near future.
• Deposits: The primary source of funding for the Bank’s earning assets continued to be core customer deposits, gathered through its network of eleven banking offices throughout Down East and Mid Coast Maine. Total deposits stoodended the year at $398$445.7 million, at December 31, 2004, representing an increase of 17%$47.5 million or 11.9% compared with December 31, 2003.2004. Deposit growth was bolstered by accounts acquired in connection with the Rockland branch acquisition, a new institutional money market product, and brokeredprincipally attributed to certificates of deposit obtained fromin the national market. Savingsmarket, as 2005 earning asset growth outpaced retail deposit growth. Retail deposits increased $10.8 million during 2005 or 2.9%, led by increases in certificates of deposit, NOW accounts and money market accounts led 2004 growth with an increase of $30 million, followed by time deposits, demand deposits, amounting to 10.7%, 5.4% and NOW accounts, posting increases of $21, $51.6%, respectively. Since short-term rates began rising in June 2004, management has exercised restraint with respect to overly aggressive deposit pricing strategies, and $3 million, respectively.has sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while protecting the Bank’s net interest margin and liquidity position.
• Borrowings: Borrowed funds principally consist of advances from the Federal Home Loan Bank.Bank of Boston. During 20042005 the Bank continued to utilize borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Advances from the Federal Home Loan Bank totaled $192 million atAt December 31, 2004,2005 total borrowings amounted to $239.7 million, representing an increase of 13%$32.8 million or 15.8% compared with the same date in 2003.December 31, 2004. Total average borrowings amounted to $209.8 million during 2005, representing an increase of $2.4 million or 1.2% compared with 2004. The increase in borrowed fundsborrowings was principally utilized to fund growth in the investment securities portfolio.
help support 2005 earning asset growth.
• Shareholders’ Equity: Consistent with its long-term strategy of operating a sound and profitable organization, during 2004 the Company continued to exceed regulatory requirements for "well-capitalized"institutions. At December 31, 2004,2005, the Company’s Tier I Leverage, Tier I Risk-based, and Total Risk-based Capital ratio was 7.8%ratios amounted to 7.55%, compared with 5.0% for "well-capitalized" institutions. Total shareholders’ equity stood at $56 million, representing an increase of $3 million compared with December 31, 2003.10.88% and 11.30%, respectively.

Summary Results of Operations

Net income for the year ended December 31, 20042005 amounted to $6.4 million, or fully diluted earnings per share of $2.03, compared with $5.7 million or fully diluted earnings per share of $1.79 compared with $5.2 million or fully diluted earnings per share of $1.63 for the year ended December 31, 2003, each2004, representing an increaseincreases of 10%.12.1% and 13.6%, respectively.

The Company’s return on average equity ("ROE") amounted to 10.58% during 2004,11.44% in 2005, compared with 9.66% during 2003.10.58% in 2004.

The Company’s return on average assets ("ROA") amounted to 0.93% in 2005, compared with 0.89% in 2004.

• Net Interest Income: Net interest income continued to be the principal component of the Company’s income stream. Net interest income, on a tax-equivalent basis, amounted to $22.5 million for the year ended December 31, 2004 amounted to $20.4 million,2005, representing an increase of $959 thousand$1.4 million or 5%6.8% compared with 2003.2004. The increase in net interest income was principally attributed to earning asset growth during 2004, as the Company’sof $44.8 million or 7.3%, and was aided by a relatively unchanged net interest margin, declined 35 basis pointswhich in 2005 amounted to 3.45%3.43%, compared with 2003. Following a long period of historically low interest rates, the net interest margin continued under pressure early3.45% in the year, but began to steadily strengthen as the Federal Reserve increased short-term interest rates five times during the second half of the year. The Company continues to maintain an asset sensitive balance sheet, and management believes it is well positioned for a variety of future interest rate scenarios.2004.
  
• Non-interest Income: Non-interest income for the year ended December 31, 20042005 amounted to $6.6$6.4 million, representing a decreasedecline of $502$157 thousand or 7%2.4% compared with 2003.2004. The decline in non-interest income was principally attributed to a reduced level$404 thousand decline in income on interest rate swap agreements, offset in part by increases in other revenues. During the third quarter of 2004 the Bank designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, current period net cash flows representing amounts received from or paid to counter-parties are recorded as interest income. Non-interest income was favorably impacted by 2005 revenue increases generated from net gains on the sale of investment securities, which amounted to $497 thousand during 2004 compared with $1.3 million during 2003. Income fromBank credit card programs, and trust and other financial services declined 12%service fees, amounting to $1.9 million during 2004 compared with 2003, reflecting declines in average managed assets16.7%, 11.2% and revenue from third-party brokerage activities. Included in 2004 non-interest income was $404 thousand in income from interest rate swap agreements, of which $375 thousand represented net cash flows received from counterparties. In 2004, these interest rate swap agreements were de-designated as cash flow hedges and the cash flows received from counterparties were recorded as non-interest income, whereas in 2003 these cash flows were recorded as interest income. In September 2004, the interest rate swap agreements were re-designated as cash flow hedges and, prospectively, the net cash flows received from counterparties are being recorded as interest income. Service charges on deposit accounts declined $46 thousand or 3% during 2004, while credit card and merchant processing fees increased $73 thousand or 5%.3.3%, respectively.
• Non-interest Expense: Non-interest expense for the year ended December 31, 20042005 amounted to $18.9$19.3 million, representing an increase of $61$354 thousand or less than 1%1.9% compared with 2004. The increase in 2005 non-interest expense was principally attributed to a $460 thousand or 4.9% increase in salaries and employee benefits, reflecting overall increases in the level of employee compensation including incentive compensation, as well as the impact and timing of certain staffing changes during 2005 and 2004. Bank credit card program expenses increased $148 thousand or 11.9% during 2005, but were offset by a $189 thousand increase in revenue from these programs. All other categories of non-interest expense posted year-over-year declines during 2005.
• Income Tax Expense: The effective income tax rate for 2005 was 28.7%, compared with 2003. A variety27.0% in 2004. The higher effective tax rate in 2005 was principally attributed to lower levels of factors contributed to 2004 non-interest expense year-over-year results. Included in 2004 non-interest expense were costs associated withnon-taxable income generated from the Company’s corporate re-branding initiative, other-than-temporary impairment write-downs of certain non-marketable equity investments,Bank’s securities and costs related to integration activities associated with the Rockland branch acquisition. Non-interest expenses also included costs related to the Company’s compliance with the sweeping changes in U.S. securities laws enacted under the Sarbanes-Oxley Act of 2002, particularly Section 404, which establishes extensive new requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. The Company’s success in containing the increase in 2004 non-interest expense at less than 1% was attributed in part to a variety of previously reported expenses incurred during 2003 related to organizational restructuring activities in the Company’s financial services division, certain legal settlements, and adjustments to the workforce. Salaries and employee benefits declined $148 thousand to $9.3 million during 2004, reflecting current and prior year changes to staffing levels and compensation mix.loan portfolios.

Other 20042005 Financial Highlights

• Trust and Investment Management Services: Assets under management at Bar Harbor Trust Services ended the year at $220.5 million, representing an increase of $24.5 million, or 12.5%, compared with December 31, 2004.
• Cash Dividends: In the first quarter of 20042005 the Company increased its quarterly cash dividend by 5.3%5.0%, to 2021 cents per share. In the first quarter of 20052006 the dividend was increased by 5.0%4.8%, to 2122 cents per share.
• Branch Acquisition: In February 2004, During 2005 the Bank completed its acquisition of a branch officedividend payout ratio amounted to 40.2% compared with 43.3% in the community of Rockland, Maine. This transaction included approximately $21 million in deposits and $12 million in loans.2004.
• Stock Repurchase Plan: 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. During 2004,In December 2005, the Company announced the continuance of this plan through December 31, 2006. As of December 31, 2005, the Company had repurchased 49.9 thousand103,732 shares of stock under the plan, at an average price of $27.03.$27.21 per share.
• Tangible Book Value: In connection with the Bank’s acquisition of the Rockland branch in February 2004, the Company capitalized $3.2 million in goodwill and other intangible assets on its consolidated balance sheet. At December 31, 20042005, the Company’s tangible book value per share amounted to $17.06$17.30 compared with $17.02$17.17 at December 31, 2003.2004.
• BTI Restructuring Plan:  New Branch Office: In October 2005, the Bank announced that it would open its twelfth branch office in the community of Somesville, further strengthening the Bank’s dominant presence on Mount Desert Island. The Company completed the previously reported restructuring of its wholly owned financial services subsidiary, BTI Financial Group ("BTI") and its three operating subsidiaries:  Bar Harbor Trust Services; Block Capital Management ("Block"), an SEC registered investment advisor; and Dirigo Investments, Inc. ("Dirigo"), a National Association of Securities Dealers (NASD) registered broker-dealer.

Pursuantnew branch is scheduled to this plan, the following actions were taken, all of which were completed during 2004:

• 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.

• Duringopen in the first quarter of 2004 Trust Services became a wholly owned subsidiary of the Bank. All products and services provided by Trust Services remained unchanged.2006.

• In January 2004 the Bank entered into a third-party brokerage arrangement with Infinex Investments, Inc. ("Infinex"). Infinex began offering third party brokerage services in May, 2004 doing business as "Bar Harbor Financial Services." Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or any of its subsidiaries. These products are not deposits, are not insured by the FDIC or any other any government agency, are not guaranteed by the bank or any affiliate, and may be subject to investment risk, including possible loss of value.

• A transfer of customer account assets of Dirigo Investments, Inc. ("Dirigo") to Bar Harbor Financial Services was completed during the third quarter of 2004, at which time Dirigo and BTI were dissolved.

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 also 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.

 

Outlook

The challenges facing the Company as we entered 2005entering 2006 were similar to those identified in the prior year, namely: loan and deposit growth, credit quality, interest rate risk, and risk management processes. In addition to these challenges, the Company must grow revenues and control expenses while managing an increasinga heavy regulatory burden. These are challenges the Company has met for many years while serving the citizens and businesses in the markets it serves, and the Company expectsanticipates similar results over the next twelve months.

The year 2004 brought the banking world was subject to much volatility and uncertainty.uncertainty in 2005. Short-term interest rates increased during 2005 with the Fed tightening eight times or 200 basis points, following five times, whileincreases or 125 basis points during 2004. However, the 10-year10 year U.S. Treasury fluctuated between 3.65%increased only 17 basis points during 2005 and 4.95%, endinghas declined 50 basis points since the year at 4.30%. WhileFed began increasing short-term interest rates were increasing during the second half of the year, the opposite was true for longer term rates,in June 2004, causing a dramatic 375 basis point flattening of the U.S. Treasury yield curve as we ended 2004. As we headat the end of 2005. Heading into 2005,2006, growth in net interest income will depend on many factors including: how quickly, and by how much, the Federal Reserve will continue to tightenincrease short-term interest rates and the effect on the rest of the yield curve; whether the economy will continue on the road to recovery and at what pace; and the impact of a potentiallyan inverted yield curve on the Company’s net interest margin. The current and projected shape of the yield curve will be key factors driving the Company’s net interest income in 2005,2006, and continued earning asset growth will likely be necessary in generating meaningful increases. Though these developments have not had a materially adverse affecteffect on the Company to date, the Company continues to monitor them closely and believes it is adequately positioned for a variety of future interest rate scenarios.

Reflecting trends in the Nationalnational and Regionalregional economies, the Company’s market area generally witnessed steadymild economic growth during 2004. As we head2005. Heading into 2005,2006, 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, liquidity, and financial condition. The Company believes future economic activity will in part depend on stronger employment, consumer confidence, personal consumption expenditures, and business expenditures for new capital equipment.equipment, and a variety of geo-political considerations.

Other factors, which could affect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this Annual Report on Form 10-K.

10-K and the Company’s discussion of certain "Risk Factors" set forth in Part I, Item 1A of this Report.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of the Company’s financial condition are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. 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, 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 Annual Report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:Consolidated Financial Statements:

Allowance for Loan Losses -Losses: Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements.Consolidated Financial Statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss 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 collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when larger provisionsa greater amount of provision for loan losses areis necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.

Income Taxes –Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary 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 historical taxes paid and 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, 20042005 and 2003,2004, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.

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 any 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 -Assets: The valuation technique used by the Company to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors.  Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company's results of operations. Refer to Notes 1 and 8 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.

FINANCIAL CONDITION

Asset / 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 represented 94.7%95.2% and 94.3%94.7% of total average assets during 20042005 and 2003,2004, 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 and brokered 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, brokered deposits, and borrowed funds.

Earning Assets

For the year ended December 31, 2004,2005, the Company’s total average earning assets amounted to $612,031,$656,817, compared with $528,791$612,031 in 2003,2004, representing an increase of $83,240,$44,786, or 15.7%7.3%. The 20042005 increase in average earning assets was led byattributed to average loan growth of $49,255$63,018 or 13.4%15.1%, followedoffset in part by growtha decline in average investment securities amounting to $32,484,$17,751, or 21.8%9.8%.

The tax-equivalent yield on total average earning assets amounted to 5.77% in 2005 compared with 5.33% in 2004, compared with 5.90% in the prior year, representing a declinean increase of 5744 basis points. The declineincrease in earning asset yields was principally attributed to the continuation of historically lowincreases in short-term interest rates particularly during the first six months of 2004 when the federal funds targeted rate stood at 1.00%, representing a forty-five year, low. Long-term interest rates also continued at historically low levels during 2004, with the 10-year U.S. Treasury note yielding below 4.40% for the most of the year, declining to as low as 3.68%, and ending the year at 4.22%. The Bank’s earning asset yields began to strengthen during the second half of 2004 as the Federal Reserve increased the federal funds rate five times, ending the year at 2.25% andwhich favorably impactingimpacted the yields on the Bank’s variablelarge floating rate loan base. In addition, cash flows from the securities and loan portfolios were generally re-invested into higher yielding earning assets.assets throughout 2005.

Total tax-equivalent interest earnedand dividend income during 20042005 amounted to $32,643$37,877 compared with $31,177$32,643 in 2003,2004, representing an increase of $1,466$5,234, or 4.7%, all of which16.0%. The 2005 increase in interest and dividend income was principally attributed to earning asset growth.growth, combined with higher earning asset yields.

Total Assets

The Company’s assets principally consist of loans and investment securities, which at December 31, 20042005 represented 66.5%68.9% and 26.4%24.5% of total assets, respectively.

At December 31, 20042005 the Company’s total assets stood at $666,811,$747,945, representing an increase of $83,065,$81,134, or 14.2%12.2%, compared with December 31, 2003.2004. The increase in total assets was principally attributed to loan growth of $65,070$66,388 or 17.0%14.8%, followed by growthan increase in investment securities amounting to $17,950,$6,963, or 11.3%4.0%.

Investment Securities

The investment securities portfolio represented 25.0% of the Company’s average earning assets during 2005 and generated 20.4% of total tax-equivalent interest and dividend income, compared with 29.7% and 25.1% in 2004, respectively.

The investment securities portfolio is primarily comprised of mortgage-backed securities issued by U.S. government agencies, U.S. Government sponsored enterprises, and other corporate issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other U.S. government-sponsored enterprises.

The overall objectives of the Bank’s strategy for the investment securities portfolio include maintaining an appropriate level of liquidity, diversifying earning assets, managing interest rate risk, leveraging the Bank’s strong capital position, and generating acceptable levels of net interest income. The investment securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.

Total Investment Securities:  At December 31, 2005, totalinvestment securities stood at $183,300 compared with $176,337 at December 31, 2004, representing an increase of $6,963, or 4.0%.

The 2005 average investment securities balance amounted to $164,027, compared with $181,778 in 2004, representing a decline of $17,751, or 9.8%.

As noted above, on a year-over-year basis average investment securities declined while period end balances increased. During the first nine months of 2005, management chose not to reinvest a portion of the cash flows from the securities portfolio. These actions were taken in light of strong loan growth, a flattening U.S. Treasury yield curve, still historically low market yields, and management’s anticipation of higher yields in the near future. In the fourth quarter of 2005, as market yields climbed towards 2005 highs, the Bank added $23,613 in securities to the balance sheet. This action was taken as market yields climbed towards 2005 highs, presenting opportunities for the Bank to increase its earning assets and leverage its strong capital position. In the fourth quarter of 2005 the yield on the 5-year U.S. Treasury note peaked at a three year high, while the 10-year U.S. Treasury note peaked at a fifteen month high.

In light of the historically low interest rate environment over the past few years and the relatively high degree of interest rate volatility, the Bank’s investment strategy has been principally focused on maintaining the majority of the securities portfolio with a relatively short average duration, thereby limiting some of the exposures associated with sustained increases in interest rates. This was accomplished through investments in securities with predictable cash flows and relatively short average maturities. The Bank’s strategy has been to position the majority of the securities portfolio defensively with a steady stream of future cash flows. While this strategy sacrifices some yield in the near-term, the Bank’s objectives were to maintain a reasonable level of net interest income, manage longer-term interest rate and market risks, provide ongoing sources of liquidity, and position the portfolio for a variety of future interest rate scenarios.

Trading Securities: Trading securities are securities bought and held principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price. As of December 31, 2005 and 2004, the Bank did not own any trading securities.

Securities Held to Maturity: Securities held to maturity are debt securities for which the Bank 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. During the years ended December 31, 2005 and 2004, the Bank did not own any securities held to maturity.

As permitted by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", during 2004 the Bank transferred into the available-for-sale securities portfolio all of its held-to-maturity investment securities. Securities transferred consisted of longer term, tax-exempt securities representing obligations of state and political subdivisions. The held-to-maturity securities were transferred to available-for sale at their fair value of $36,100, with an unrealized gain on these securities, net of taxes, amounting to $1,191 recorded in other comprehensive income. Management does not intend to utilize the held-to-maturity classification in the foreseeable future.

Securities Available for Sale: Securities available for sale represented 100% of total investment securities at December 31, 2005 and 2004.

The designation of securities 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.

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. The securities available for sale portfolio is used for liquidity purposes while simultaneously producing earnings.

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.

The balances of securities available for sale are stated on the consolidated balance sheet net of fair value adjustments, reflecting net unrealized losses of $1,856 at December 31, 2005 and net unrealized gains of $1,941 at December 31, 2004. The change in net unrealized gains and losses was principally attributed to higher prevailing market yields at December 31, 2005 compared with the same date in 2004. For example, the yields on 2, 3 and 5-year U.S. Treasury notes were 129, 111, and 70 basis points higher, respectively, at December 31, 2005 compared with the same date in 2004. The unrealized loss position at December 31, 2005 also reflects the fact that a portion of the securities were purchased during periods of historically low interest rates and market yields, but does not give consideration to matched funding sources (e.g., borrowings) acquired during those same periods of historically low interest rates which are not adjusted to current market value.

The following table summarizes the securities available for sale portfolio as of December 31, 2005 and 2004:

	December 31, 2005
Available for Sale:	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Obligations of U.S. Government-sponsored enterprises	$ 23,720	$     12	$   235	$ 23,497
Mortgage-backed securities:
Obligations of U. S. Government agencies	11,134	127	48	11,213
Obligations of Government-sponsored enterprises	90,872	65	2,190	88,747
Other	22,362	4	424	21,942
Obligations of state and political subdivisions	37,068	1,016	183	37,901
	$185,156	$1,224	$3,080	$183,300

	December 31, 2004
Available- for Sale:	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Obligations to U.S. Government-sponsored enterprises	$   6,395	$       2	$ 49	$    6,348
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	116,097	651	258	116,490
Other	16,608	41	245	16,404
Obligations of states of the U.S. and political      subdivisions thereof	34,296	1,806	2	36,100
Other bonds	1,000	---	5	995
Total securities available for sale	$174,396	$2,500	$559	$176,337

Purchase Premiums and Discounts: Securities are typically purchased at premium or discounted price, depending on the coupon of the security and prevailing interest rates. The Company recognizes the amortization of premiums and accretion of discounts in interest income using the interest method over the estimated life of the security. Purchase premiums are amortized to the earliest call date, while purchase discounts are accreted to maturity. Premiums paid on mortgage-backed securities are amortized proportionate to the three-month trailing average Constant Payment Rate (CPR) of each securitized pool of mortgages.

Securities Credit Risk: The Bank evaluates and monitors the credit risk of its investment securities utilizing a variety of resources including external credit rating agencies, predominantly Moody’s and Standard and Poor’s. At December 31, 2005, 97.6% of the securities portfolio was rated "AAA" by Moody’s and or Standard and Poor’s. The Bank held no investment securities having a credit rating below "A1" as of December 31, 2005.

Securities Interest Income: The total aggregate tax-equivalent yield on the securities portfolio amounted to 4.72% in 2005, compared with 4.51% in 2004, representing an increase of 21 basis points. The increase was principally attributed to the availability of higher market yields in 2005 compared with prior years. Securities incrementally added to the securities portfolio during 2005 generally carried higher yields and moderately longer durations. In addition cash flows from the securities portfolio were generally reinvested into securities with higher market yields.

Total tax-equivalent interest income from the securities amounted to $7,746 in 2005, compared with $8,197 in 2004, representing a decline of $451 or 5.5%. The decline in interest income from securities was attributed to the $17,751 or 9.8% decline in average securities during 2005 compared with 2004.

Securities Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost of the Bank’s investment securities and weighted average yields of such securities on a fully tax-equivalent basis as of December 31, 2005, based upon the final maturity date of the securities. 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 in most cases have the right to prepay.

MATURITY SCHEDULE FOR INVESTMENT SECURITIES
DECEMBER 31, 2005
(at fair value)

	One Year Or Less	Greater than One Year to Five years	Greater than Five Years to Ten years	Greater Than Ten Years
Obligations of U.S. Government-sponsored enterprises	$499	$ 9,489	$11,828	$  1,681
Weighted average yield	4.60%	4.68%	5.30%	5.37%
Mortgage-backed Securities:
Obligations of U.S. Government agencies	$ ---	$      120	$     841	$ 10,252
Weighted average yield	0.00%	7.10%	5.19%	5.93%
Obligations of Government-sponsored enterprises	$ 19	$   1,423	$34,684	$ 52,621
Weighted average yield	7.13%	4.25%	3.92%	4.82%
Other mortgage-backed securities	$ ---	$        82	$      ---	$ 21,858
Weighted average yield	0.00%	4.72%	0.00%	4.53%
Obligations of state and political subdivisions	$ 60	$       ---	$    775	$ 37,067
Weighted average yield	5.29%	0.00%	5.96%	6.51%
Total	$578	$11,114	$48,128	$123,480

MATURITY SCHEDULE FOR INVESTMENT SECURITIES
DECEMBER 31, 2004
(at fair value)

	One Year Or Less	Greater than One Year to Five years	Greater than Five Years to Ten years	Greater Than Ten Years
Obligations of U.S. Government-sponsored enterprises	$ ---	$1,985	$ 3,858	$     506
Weighted average yield	0.00%	3.26%	3.37%	2.76%
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	2	1,572	46,881	68,035
Weighted average yield	5.45%	4.65%	3.79%	4.54%
Other mortgage-backed securities	---	---	---	16,404
Weighted average yield	0.00%	0.00%	0.00%	4.40%
Obligations of state and political subdivisions	---	121	358	35,621
Weighted average yield	0.00%	5.24%	5.24%	6.95%
Other debt securities	---	---	---	995
Weighted average yield	0.00%	0.00%	0.00%	4.55%
Total	$    2	$3,678	$51,097	$121,561

Securities Concentrations: At December 31, 2005 and 2004, the Bank did not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceed 10% of the Company’s shareholders’ equity. Management believes U.S. Government-sponsored enterprises have minimal credit risk, as they play a vital role in the nation’s financial markets. At December 31, 2005 and 2004, all securities issued by Government agencies and sponsored enterprises were credit rated "AAA" by Mood’s and Standard and Poor’s.

Impaired Securities: The securities portfolio contains certain investments where amortized cost exceeds fair market value, which at December 31, 2005 amounted to $3,080, compared with $559 at December 31, 2004.

Unrealized losses that are considered other-than-temporary are recorded as a loss on the Company’s consolidated statement of income. In evaluating whether impairment is other-than-temporary, management considers a variety of factors including the nature of the investment security, the cause of the impairment, the severity and duration of the impairment, and the Bank’s ability and intent to hold the security to maturity. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and any other information considered relevant in determining whether other-than-temporary impairment has occurred.

At December 31, 2005 and 2004, 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, 2005. All securities referenced are debt securities. At December 31, 2005, the Bank did not hold any common stock or equity securities in its investment securities portfolio.

TEMPORARILY IMPAIRED INVESTMENT SECURITIES
DECEMBER 31, 2005

	Less Than 12 Months			12 Months or Longer			Total
	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses
Description of Securities:
Obligations of U.S. Government-sponsored       enterprises	$ 13,287	24	$   132	$ 4,203	24	$   103	$ 17,490	48	$  235
Mortgage-backed securities:
Obligations of U.S. Government agencies	3,413	12	26	1,699	8	22	5,112	20	48
Obligations of Government-sponsored           enterprises	66,558	126	1,493	20,472	40	697	87,030	166	2,190
Other	16,673	30	253	4,813	11	171	21,486	41	424
Obligations of state and political subdivisions	8,339	32	176	343	1	7	8,682	33	183
Total temporarily impaired securities	$108,270	224	$2,080	$31,530	84	$1,000	$139,800	308	$3,080

At December 31, 2005, the total unrealized losses on temporarily impaired securities amounted to $3,080, representing 2.2% of their amortized. At December 31, 2005, no individual security had an unrealized loss greater than 5.0% of its amortized cost.

As of December 31, 2005, unrealized losses on securities that had been in a continuous unrealized loss position more than twelve-months amounted to $1,000, or 3.2% of their amortized cost at December 31, 2005. At December 31, 2005, there were a total of 84 investment securities in an unrealized loss position more than twelve months.

For securities with unrealized losses, the following information was considered in determining that the impairments are not other-than-temporary. U.S. government securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government-sponsored enterprises have minimal credit risk, as they play a vital role in the nation’s financial markets. Other bonds and notes are generally comprised of corporate mortgage-backed securities and all investments maintain a credit rating of at least "A1" by one of the nationally recognized rating agencies. Mortgage-backed securities and collateralized mortgage obligations are either issued by federal government agencies and sponsored enterprises, or by private issuers, all with security ratings of AAA.

Management believes the unrealized losses in the investment securities portfolio at December 31, 2005 were attributed to interest rate increases, and reflected the volatile movements in the U.S. Treasury curve over the past few 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, 2005. Because the decline in market value was attributable to changes in interest rates and not credit quality, and because the Bank has the ability and intent to hold these investment securities until a recovery of their amortized cost, which may be at maturity, the Company does not consider these investment securities to be other-than-temporarily impaired at December 31, 2005.

Management believes the extent of unrealized losses on mortgage-backed securities will diminish over time as principal payments and pre-payments are received and durations continue to shorten. In the case of debt securities, management believes unrealized losses will diminish over time as maturity dates continue to shorten. Management also believes that any declines in the U.S. Treasury yield curve will further diminish the extent of unrealized losses in the securities portfolio, as market values typically increase in a declining interest rate environment. Conversely, management believes that upward movements in the U.S. Treasury yield curve will increase the extent of unrealized losses in the securities portfolio over the near term.

Loans

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

SUMMARY OF LOAN PORTFOLIO AT DECEMBER 31

	2004	2003	2002	2001	2000	2005	2004	2003	2002	2001
Real estate loans:
Construction and development	$ 21,339	$ 12,639	$ 16,270	$ 20,348	$ 12,297	$ 27,630	$ 21,339	$ 12,639	$ 16,270	$ 20,348
Mortgage	362,702	322,579	287,990	229,634	208,815	411,059	362,702	322,579	287,990	229,634
Loans to finance agricultural production and other loans to farmers	15,077	11,719	11,053	7,149	6,674	18,962	15,077	11,719	11,053	7,149
Commercial and industrial loans	35,574	19,167	20,010	22,158	23,729	41,291	35,574	19,167	20,010	22,158
Loans to individuals for household, family and other personal expenditures	11,156	11,775	12,818	13,918	15,841	10,653	11,156	11,775	12,818	13,918
All other loans	2,153	4,554	2,684	3,699	3,978	4,459	2,153	4,554	2,684	3,699
Real estate under foreclosure	477	975	710	1,064	47
Real estate loans under foreclosure						812	477	975	710	1,064
TOTAL LOANS	$448,478	$383,408	$351,535	$297,970	$271,381	$514,866	$448,478	$383,408	$351,535	$297,970
Less: Allowance for loan losses	4,829	5,278	4,975	4,169	4,236	4,647	4,829	5,278	4,975	4,169
NET LOANS	$443,649	$378,130	$346,560	$293,801	$267,145	$510,219	$443,649	$378,130	$346,560	$293,801

Total Loans: At December 31, 20042005, total loans amounted to $448,478,$514,866, compared with $383,408$448,478 at December 31, 2003,2004, representing an increase of $65,070,$66,388, or 17.0%14.8%. Commercial loans contributed 54.6%74.7% to this growth;2005 loan growth, consumer loans contributed 48.0% offset in part24.1%, followed by a declinean increase of 2.6%1.2% in tax-exempt loans to municipalities.

The 2004 increase in total loans reflects $12,343 in loans acquired in connection with In general, loan origination activity has benefited from a still-favorable market interest rate environment, a relatively stable local economy, and initiatives designed to expand the Bank’s acquisition of a branch office in the community of Rockland, Maine, principally consumer real estate loans. Excluding the acquired Rockland branch loan portfolio, 2004 loan growth amountedproduct offerings and attract new customers while continuing to $52,727, or 13.8%.leverage its existing customer base.

At December 31, 2005, consumer loans comprised 58.1% of the total loan portfolio while commercial loans comprised 41.4%, compared with 63.1% and 36.5% at December 31, 2004, respectively.

At December 31, 2005, total consumer loans, including consumer real estate loans, amounted to $282,413,$298,930, representing an increase of $31,244$15,944 or 12.4%5.6%, compared with December 31, 2003. 2004. Consumer real estate loans, which consist of residential mortgages and home equity loans, led 2005 consumer loan growth, posting an increase of $16,774 or 6.2% compared with December 31, 2004. Following record refinancing activity over the past few years and a risemoderate increase in long-term interest rates, that began in the latter part of 2003, consumer real estate loan originations slowedcontinued to slow during 2004,2005, but portfolio growth continued as new purchase transactions accounted for an increasing proportion of loan originations. In addition, home equity loan activity has been strong, accounting for 35.3% of the 2004 increase in consumer loans.

At December 31, 20042005, total commercial loans amounted to $163,433,$213,204, representing an increase of $35,532$49,612 or 27.8%30.3% compared with December 31, 2003.2004. The 20042005 growth in commercial loans represented a five year high,an all time high. Bank management attributed this growth, in part, to a mature commercial lending team, a variety of new business development initiatives, and a relatively stable local economy, a still-favorable market interest rate environment, and initiatives designed to strengthen the Bank’s commercial loan origination activities. Commercial loan originations were particularly strong in Knox County, a new market area forged in 2004, by way of the Bank’s acquisition of a branch office in the community of Rockland, Maine.

In April of 2004, the Bank opened a loan production office in Bangor, Maine, augmenting the Company’s long-standing Trust and Financial Services presence in this major market area. During 2004, the Bangor loan production office generated significant new commercial relationships, which benefited from a strong, locally based commercial lender. The Bank anticipates continued loan growth in this market area.economy.

At December 31, 2004,2005, consumer and commercial real estate loans comprised 85.7%85.2% of the loan portfolio, essentially unchanged compared with 87.4%85.6% at December 31, 2003.2004. The continued strength in the local real estate markets, both residential and commercial, has led to historically high property values in the Bank’s market area. Recognizing the impact this trend may have on the loan portfolio and origination pipeline, the Bank periodically reviews its underwriting standards in an effort to ensure that the quality of the loan portfolio is not jeopardized by unrealisticexcessive loan to value ratios or debt service levels. To date, there has been no significant deterioration in the performance or risk characteristics of the real estate loan portfolio.portfolio through the reporting period.

Construction and Development Loans: Construction and development loans are both consumer and commercial in nature and represented 4.8%5.4% of total loans at December 31, 2004,2005, compared with 3.3%4.8% at December 31, 2003.2004.

Total construction and development loans amounted to $27,630 at December 31, 2005, compared with $21,339 at December 31, 2004, compared with $12,639 at December 31, 2003, representing an increase of $8,700,$6,291, or 68.8%29.5%. The increase in these types of  loans was attributed in part to a higher level of commercial construction loan activity at the close of 2004. Construction and development loans generally migrate from construction status to completed projects with permanent financing arrangements within one year.

Mortgage Loans: Mortgage loans, which include consumer real estate, home equity and commercial loans, accounted for 81.0%79.8% of total loans at December 31, 2004,2005, compared with 84.1%81.0% at December 31, 2003.2004.

At December 31, 2004,2005, total mortgage loans amounted to $363,179,$411,059, compared with $322,579$362,702 at December 31, 2003,2004, representing an increase of $40,600,$48,357, or 12.6%13.3%. The increase in mortgageCommercial real estate loans was principallyaccounted for approximately two-thirds of this growth, with the balance attributed to strong commercialconsumer real estate loan originations, loans acquired in connection with the Rockland branch office acquisition, and continued demand for real estate in the communities served by the Bank.home equity loans.

Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $18,962 at December 31, 2005 compared with $15,077 at December 31, 2004, compared with $11,719 at December 31, 2003, representing an increase of $3,358$3,885 or 28.7%25.8%. This category of loans represented 3.4%3.7% of the loan portfolio at December 31, 2004,2005, compared with 3.1%3.4% at the same date in 2003.December 31, 2004. The communities served by the Bank presentgenerally offer limited opportunities for lending in this industry sector.

Commercial and Industrial Loans: Commercial and industrial loans represented 7.9%8.0% of the loan portfolio at December 31, 2004,2005, compared with 5.0%7.9% at December 31, 2003. Included in this category of loans are certain loans related to the Maine’s wild blueberry industry.2004. The Bank’s market area demographics have historically limited the growth potential in this particular category of loans. During 2004 this trend did not continue.loans; however, over the past two years the Bank realized some sporadic opportunities for commercial and industrial lending. At December 31, 2004,2005, commercial and industrial loans totaled $35,574,$41,291, compared with $19,167$35,574 at the same date in 2003,December 31, 2004, representing an increase of $16,407,$5,717, or 85.6%16.1%.

Loans to Individuals for Household, Family and Other Personal Expenditures: Personal consumer loans, including credit card loans and student loans, totaled $10,653 at December 31, 2005 compared with $11,156 at December 31, 2004, compared with $11,775 at December 31, 2003, representing a year-over-year decline of $619,$503, or 5.3%4.5%. This category of loans represented 2.5%2.1% of the loan portfolio at December 31, 2004,2005, compared with 3.1%2.5% at December 31, 2003.2004.

Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank has not campaigned aggressively for consumer installment loans over the past few years.

The Bank continues to be one of relatively few community banks with its own credit card loan portfolio, as large credit card processing companies continue to acquire credit card portfolios and associated sources of non-interest income from smaller organizations, particularly community banks.financial institutions.

All Other Loans: All other loans represented 0.5%0.9% of the loan portfolio at December 31, 20042005, compared with 1.2% in 2002.0.5% at December 31, 2004. The balance of all other loans at December 31, 20042005 totaled $2,153$4,459 compared with $4,554$2,153 at December 31, 2003,2004, representing a decreasean increase of $2,401,$2,306, or 52.7%107.1%.

This category of loans principally includes loans to government municipalities and, to a lesser extent, not-for-profit organizations. Government municipality loans typically have short maturities and low interest rate risk characteristics. Government municipality loans are typically availableoriginated through a bid process among local financial institutions and are aggressively priced, thus generating narrow net interest income margins.

Real Estate Loans Under Foreclosure: At December 31, 2004,2005, real estate loans under foreclosure totaled $477$812 compared with $975$477 at December 31, 2003,2004, representing a declinean increase of $498,$335, or 51.1%70.2%. At December 31, 2005, real estate loans under foreclosure were represented by four consumer mortgage loans totaling $280 and four commercial mortgage loans totaling $532. At December 31, 2004, real estate loans under foreclosure were represented by six consumer mortgage loans totalingamounting to $420 and onecommercial mortgage loan totaling $57. At December 31, 2003, real estate loans under foreclosure were represented by six commercial mortgage loans amounting to $544 and tenconsumer mortgage loans totaling $431. During 2004,2005, foreclosure proceedings were completed on five of these loans totaling $250, and any resulting charge offscharge-offs were recognized.

Loan Concentrations: Loan concentrations continued to reflect the Bank’s business region. At December 31, 2004,2005, approximately 6.8%$29,857 or $30,5355.8% of the loan portfolio was represented by loans to the hospitalitylodging industry, compared with 8.3%$30,535 or $31,493$6.8% at December 31, 2003.  At December 31, 2004 loans related to Maine’s wild blueberry industry amounted to approximately $4,676 or 1.0% of total loans compared with $7,116, or 1.9% at December 31, 2003. 2004.

Other Real Estate Owned: When the Bank takes ownership of collateral property upon foreclosure of a real estate secured loan, the property is transferred from the loan portfolio to Other Real Estate Owned ("OREO") 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 at the time of the transfer. Other Real Estate OwnedOREO is classified on the consolidated balance sheet with Other Assets.other assets. At December 31, 20042005 there was no other real estate ownedOREO, unchanged compared with $34 at December 31, 2003. One residential property comprised the December 31, 2003 balance and this property was sold during 2004.

Mortgage Loan Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank 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, 2004,2005, the unpaid balance of mortgage loans serviced for others totaled $9,935$7,907 compared with $12,334$9,935 at December 31, 2003,2004, representing a decreasedecline of $2,399,$2,028, or 19.5%20.4%. The decline in 20042005 balances was attributed to serviced mortgage loan principal payments, as well as prepayments resulting from loan refinancing activity.

Pursuant to the Bank’s asset and liability management strategy, its need for interest earning assets, and its strong capital position, loans originated during 20042005 were almost entirely held in the Bank’s loan portfolio.

Loan Maturities and Re-pricing Distribution: The following table showssummarizes fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31, 2004,2005, and 2003.2004. Actual maturity dates may differ from contractual maturity dates due to prepayments or loan re-financings.

Maturities	12/31/04		12/31/03	12/31/05		12/31/04
Three months or less	$168,680		$120,309	$189,656		$168,680
Over three months through 12 months	40,409		49,020	29,496		40,409
Over one year through three years	26,841		28,921
Over three years through five years	46,977		28,101
Over 12 months through three years				40,813		26,841
Over three years though five years				64,739		46,977
Over five years through 15 years	98,614		97,259	110,163		98,614
Over 15 years	66,957		59,798	79,999		66,957
Total	$448,478		$383,408	$514,866		$448,478

Loan Portfolio Composition: The following table summarizes the fixed and variable rate composition of the loan portfolio as of December 31, 20042005 and 2003:2004:

	2004	2003
Commercial loans:
Real Estate- variable rate	$97,926	$72,923
Real Estate- fixed rate	6,463	4,595
Other - variable rate	40,235	31,393
Other - fixed and variable rate	18,809	18,990
	163,433	127,901
Tax Exempt Municipal Loans - Fixed Rate	1,950	3,652
Consumer and Residential Real Estate Loans:
Real Estate- variable rate	$ 64,467	$ 51,529
Real Estate- fixed rate	157,223	150,573
Home equity – fixed and variable rate	47,189	35,941
Installment – fixed rate	3,961	4,250
Other – fixed and variable rate	9,573	8,876
	282,413	251,169
Real estate under foreclosure	477	975
Deferred origination costs (fees), net	205	(289)
Allowance for loan losses	(4,829)	(5,278)
	$443,649	$378,130

	2005	2004
Commercial loans:
Real Estate- variable rate	$128,022	$ 97,983
Real Estate- fixed rate	7,247	6,463
Installment - variable rate	12,465	10,337
Installment - fixed rate	8,177	7,491
Lines of credit-variable rate	28,587	29,898
Other - variable and fixed rate	28,275	11,318
Deferred origination costs, net	431	102
Total commercial loans	213,204	163,592
Tax exempt:
Variable rate	$        ---	$        ---
Fixed rate	2,732	1,950
Total tax exempt loans	2,732	1,950
Consumer:
Real Estate- variable rate	$  82,402	$  64,613
Real Estate- fixed rate	154,310	157,497
Home equity - variable rate	42,786	45,192
Home equity - fixed rate	6,435	1,997
Installment - variable rate	94	103
Installment - fixed rate	4,071	3,858
Other - variable and fixed rate	8,400	9,573
Deferred origination costs, net	432	103
Total consumer loans	298,930	282,936
Total loans	$514,866	$448,478
Allowance for loan losses	(4,647)	(4,829)
Loans, net of allowance for loan losses	$510,219	$443,649

Allowance For Loan Losses

Credit Risk: Credit risk is managed through loan officer authorities, loan policies, the Bank's Senior Loan OfficersOfficers’ Committee, oversight from the Bank's Senior Credit Officer, the Director'sDirectors’ Loan Committee, and the Bank's Board of Directors. Management follows a policy of continually identifying, analyzing and grading credit risk inherent in the loan portfolio. An ongoing independent review, subsequent to Management'smanagement's review, of individual credits is performed by an independent loan review function, which reports to the Audit Committee of the Board of Directors.

Management recognizes that early and accurate recognition of risk is the best means to reduce credit losses and maximize earnings. The Bank employs a comprehensive risk management structure to identify and manage the risk of loss. For consumer loans, the Bank identifies loan delinquency beginning at 10-day delinquency and provides appropriate follow-up by written correspondence or personal contact. Non-residential mortgage consumer losses are recognized no later than the point at which a loan is 120 days past due. Residential mortgage losses are recognized during the foreclosure process, or sooner, when that loss is quantifiable and reasonably assured. For commercial loans the Bank applies a risk grading system, which stratifies the portfolio and allows management to focus appropriate efforts on the highest risk components of the portfolio. The risk grades include ratings that correlate with regulatory definitions of Pass, Other Assets Especially Mentioned, Substandard, Doubtful, and Loss.

As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent because collection in full of all outstanding principal and interest is in doubt. Loans are generally placed on non-accrual status when principal and/or interest is 90 days overdue.overdue, or sooner if judged appropriate by management. Consumer loans are generally charged offcharged-off when principal and/or interest payments are 120 days overdue.overdue, or sooner if judged appropriate by management.

Non-performing Loans: Non-performing loans ("NPLs") include loans on non-accrual status, loans that have been treated as troubled debt restructurings, and loans past due 90 days or more and still accruing interest. There were no troubled debt restructurings in the loan portfolio during 2004 and this continued to be the last five years.case during 2005.

The following table sets forth the details of non-performing loans over the last five years.

TOTAL NON-PERFORMING LOANS
AT DECEMBER 31

	2004	2003	2002	2001	2000	2005	2004	2003	2002	2001
Loans accounted for on a non-accrual basis:
Real estate loans:
Construction and development	$   0	$   114	$       4	$       0	$       0	$ ---	$  ---	$   114	$      4	$    ---
Mortgage	453	1,113	905	1,683	5,640	267	453	1,113	905	1,683
Loans to finance agricultural production and
other loans to farmers	13	22	45	45	220	---	13	22	45
Commercial and industrial loans	80	9	10	429	878	593	80	9	10	429
Loans to individuals for household,
family and other personal expenditures	26	37	22	34	169	5	26	37	22	34
Total non-accrual loans	572	1,295	986	2,191	6,907	865	572	1,295	986	2,191
Accruing loans contractually past due 90 days
or more	151	199	188	151	1,206
Accruing loans contractually past due 90 days or more						3	151	199	188	151
Total non-performing loans	$723	$1,494	$1,174	$2,342	$8,113	$868	$723	$1,494	$1,174	$2,342
Allowance for loan losses to non-performing loans	668%	353%	424%	178%	52%	535%	668%	353%	424%	178%
Non-performing loans to total loans	0.16%	0.39%	0.33%	0.79%	2.99%	0.17%	0.16%	0.39%	0.33%	0.79%

AtDuring the year ended December 31, 2004, total2005, non-performing loans amounted to $723 compared with $1,494 as of December 31, 2003, representing a decline of $771, or 51.6%. At December 31, 2004 non-performing loans represented 0.16% of total loans compared with 0.39%remained at December 31, 2003.

During 2004, the Bank maintained its non-performing loans at significantly lower levels compared with prior years.relatively low levels. The Bank attributes this, successin part, to a continued strengthening of itsmature credit administration processes and underwriting standards, aided by a relatively stable local economy and a still favorable interest rate environment.economy. The Bank maintains a centralized loan collection and managed asset department, providing timely and effective collection efforts for problem loans.

At December 31, 2005, total non-performing loans amounted to $868 compared with $723 as of December 31, 2004, representing an increase of $145. At December 31, 2005, non-performing loans represented 0.17% of total loans compared with 0.16% at December 31, 2004.

While the non-performing loan ratios continued to reflect the favorable quality of the loan portfolio during the year endedat December 31, 2004, the2005, Bank management is cognizant of relatively soft economic conditions overall, and believes it is managing credit risk accordingly. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank's customers, including higher interest rates and debt service levels, oil and gas prices, and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.

Potential Problem Loans: In addition to the non-performing loans discussed above, the Bank also has loans that are 30 to 89 days delinquent. These loans amounted to $2,302 and $1,649 at December 31, 2005 and 2004, or 0.45% and 0.37% of total loans, respectively. These loans and delinquency trends are considered in the evaluation of the allowance for loan losses and the related determination of the provision for loan losses.

Allowance forFor Loan Losses: At December 31, 20042005, the allowance for loan losses ("allowance") stood at $4,829,$4,647, compared with $5,278$4,829 at December 31, 2003,2004, representing a decreasedecline of $449,$182, or 8.5%3.8%.

The allowance is available to absorb losses on loans. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated quarterly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The Bank’s Board of Directors reviews the evaluation of the allowance to ensure its adequacy.

The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated losses. Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.

Loan loss provisions are recorded based upon overall aggregate data, and the allowance is increased when, on an aggregate basis, additional estimated losses are identified and deemed likely. No portion of the allowance is restricted to any loan or group of loans, and the entire allowance is available to absorb realized losses. The amount and timing of realized losses and future allowance allocations could vary from current estimates.

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

The following table details changes in the allowance for loan losses and summarizes loan loss experience by loan type over the past five years.

ALLOWANCE FOR LOAN LOSSES
SUMMARY OF LOAN LOSS EXPERIENCE

	2004	2003	2002	2001	2000	2005	2004	2003	2002	2001
Balance at beginning of period	$    5,278	$ 4,975	$  4,169	$  4,236	$ 4,293	$   4,829	$   5,278	$   4,975	$ 4,169	$  4,236
Charge offs:
Charge-offs:
Commercial, financial, agricultural, others	476	75	111	1,416	253	94	476	75	111	1,416
Real estate:
Construction and development	34	4	---	---	---	---	34	4	---	---
Mortgage	66	207	176	434	170	19	66	207	176	434
Installments and other loans to individuals	275	141	195	454	800	125	275	141	195	454
Total charge offs	851	427	482	2,304	1,223
Total charge-offs						238	851	427	482	2,304
Recoveries:
Commercial, financial, agricultural, others	66	24	121	96	136
Commercial, financial agricultural, others						14	66	24	121	96
Real estate:
Construction and development						4	---	---	---	---
Mortgage	51	106	4	74	7	1	51	106	4	74
Installments and other loans to individuals	105	60	63	67	71	37	105	60	63	67
Total recoveries	222	190	188	237	214	56	222	190	188	237
Net charge offs	629	237	294	2,067	1,009
Net charge-offs						182	629	237	294	2,067
Provision charged to operations	180	540	1,100	2,000	952	---	180	540	1,100	2,000
Balance at end of period	$    4,829	$   5,278	$    4,975	$    4,169	$     4,236	$    4,647	$    4,829	$    5,278	$    4,975	$   4,169
Average loans outstanding during period	$416,956	$367,701	$325,712	$283,728	$271,000	$479,974	$416,956	$367,701	$325,712	$283,728
Net charge offs to average loans outstanding during period	0.15%	0.06%	0.09%	0.73%	0.37%
Net charge-offs to average loans outstanding during period						0.04%	0.15%	0.06%	0.09%	0.73%

The Bank's loan loss experience showed an increaseimprovement during 20042005 compared with 20032004 experience. Net charge-offs during 20042005 amounted to $629,$182, representing an increasea decline of $392$447 or 71.1%, compared with 2003. The increase in net charge-offs was principally attributed to two relationships amounting to $506, and these were adequately provided for in the Bank’s previously recorded allowance.

2004. Expressed as a percentage of total average loans outstanding, 20042005 net charge-offs amounted to 0.15%0.04%, compared with 0.06%0.15% in 2003.2004.

The following table presents the five-year summary of the allowance by loan type at each respective year-end.

ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(at December 31)

	2004		2003		2002		2001		2000
	Amount	Percent of Loans in Each Category to Total loans	Amount	Percent of Loans in Each Category to Total loans	Amount	Percent of Loans in Each Category  to Total loans	Amount	Percent of Loans in Each Category to Total loans	Amount	Percent of Loans in Each Category to Total loans
Commercial, financial, and      agricultural	$1,886	11.29%	$2,281	8.06%	$1,737	8.84%	$1,387	9.84%	$1,563	11.20%
Real estate mortgages:
Real estate-construction	135	4.76%	67	3.30%	266	4.63%	135	6.83%	115	4.53%
Real estate-mortgage	2,305	80.98%	1,708	84.39%	1,992	82.12%	1,525	77.42%	1,945	76.96%
Installments and other loans      to individuals	249	2.49%	342	3.07%	531	3.65%	855	4.67%	560	5.84%
Other	---	0.48%	---	1.18%	---	0.76%	---	1.24%	---	1.47%
Unallocated	254	0.00%	880	0.00%	449	0.00%	267	0.00%	53	0.00%
TOTAL	$4,829	100.00%	$5,278	100.00%	$4,975	100.00%	$4,169	100.00%	$4,236	100.00%

At December 31, 2004, the loan loss adequacy analysis resulted in a need for specific reserves of $3,579, general reserves of $982, impaired reserves of $14 and other reserves of $254. Specific reserves are determined by way of individual review of commercial loan relationships in excess of $250, combined with reserves calculated against total outstandings by category using the Bank’s historical loss experience and other observable data.

General reserves account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There were no major changes loan concentrations during 2004.The December 31, 2004 allowance calculation incorporates loss estimates relating to loans to borrowers involved in the Maine wild blueberry industry, principally centered in Washington County, Maine. During the fourth quarter of 2003, certain legal matters developed regarding the blueberry industry, the uncertainties of which warranted recognition of certain increases in credit risk. While recent developments have been favorable, at December 31, 2004 the adequacy analysis of the allowance incorporated management’s estimate of inherent risk of loss with respect to loans associated with this industry segment.

	2005		2004		2003		2002		2001
	Amount	Percent of Loans in Each Category toTotal loans	Amount	Percent of Loans in Each Category to Total loans	Amount	Percent of Loans in Each  Category to Total loans	Amount	Percent of Loans in Each Category to Total loans	Amount	Percent of Loans in Each Category to Total loans
Commercial, financial, and      agricultural	$1,407	11.70%	$1,886	8.84%	$2,281	8.06%	$1,737	8.84%	$1,387	9.84%
Real estate mortgages:
Real estate-construction	186	5.37%	135	4.63%	67	3.30%	266	4.63%	135	6.83%
Real estate-mortgage	2,768	80.00%	2,305	82.13%	1,708	84.39%	1,992	82.12%	1,525	77.42%
Installments and other loans      to individuals	230	2.07%	249	3.65%	342	3.07%	531	3.65%	855	4.67%
Other	---	0.86%	---	0.75%	---	1.18%	---	0.76%	---	1.24%
Unallocated	56	0.00%	254	0.00%	880	0.00%	449	0.00%	267	0.00%
TOTAL	$4,647	100.0%	$4,829	100.00%	$5,278	100.00%	$4,975	100.00%	$4,169	100.00%

Specific reserves for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $593 as of December 31, 2005, compared with $93 as of December 31, 2004, compared with $596 as of December 31, 2003.2004. The related allowances for loan losses on these impaired loans amounted to $14$238 and $190,$14 as of December 31, 20042005 and December 31, 2003,2004, respectively. At December 31, 2005 and 2004, there were no impaired loans that did not have specific reserves. The Bank had no troubled debt restructurings at December 31, 2005 and 2004, and all of its impaired loans were considered collateral dependent and were adequately reserved.

Management reviews impaired loans to ensure such loans are transferred to interest non-accrual status, and written down when necessary. The amount of interest income not recorded on impaired loans amounted to $3$10 and $23$3 for the years ended December 31, 2005 and 2004, respectively.

General reserves account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There was no major change in loan concentrations during 2005.

The December 31, 2004 allowance calculation incorporated loss estimates relating to loans to borrowers involved in the Maine wild blueberry processing industry, principally centered in Washington County, Maine. During the fourth quarter of 2003, respectively. certain legal proceedings developed between borrowers engaged in the Maine wild blueberry processing industry and their growers, the uncertainties of which Bank management believed warranted recognition of certain increases in credit risk. During the first quarter of 2005, these matters were, in the opinion of management, satisfactorily resolved. At December 31, 2005, the adequacy analysis of the allowance incorporated a revised estimate of inherent risk of loss with respect to this industry segment, compared with December 31, 2004.

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, the Company considers the allowance for loan losses at December 31, 20042005 to be appropriate for the risks inherent in the loan portfolio, and resident in the local and national economy as of that date.

Investment Securities

The investment securities portfolio represented 29.7% of the Company’s average earning assets during 2004 and generated 25.1% of total interest income, compared with 23.7% and 26.5% in 2003, respectively.

The investment securities portfolio is primarily comprised of mortgaged-backed securities issued by U.S. government sponsored enterprises and agencies, and other corporate issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other government sponsored enterprises.

The overall objective of the Bank’s strategy for the investment securities portfolio is to maintain an appropriate level of liquidity, diversify earning assets, manage interest rate risk, leverage the Bank’s strong capital position, 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.

Total Investment Securities: At December 31, 2004 totalinvestment securities stood at $176,337 compared with $158,387 at December 31, 2003, representing an increase of $17,950, or 11.3%.

The 2004 average investment securities balance amounted to $181,778, compared with $149,294 in 2003, representing an increase of $32,484, or 21.8%.

Comparing 2004 with 2003, the year-over-year growth in average investment securities outpaced the period end growth, reflecting a redeployment of cash flows from the securities portfolio in support of strong loan growth and expected seasonal deposit outflows.

The 2004 growth in average investment securities principally occurred during the second quarter of 2004. Securities added to the portfolio predominately consisted of mortgage-backed securities with average durations ranging between two and three years. This action was taken as market yields climbed to a two-year high, presenting some patiently awaited opportunities for the Bank to increase its earning assets and leverage its strong capital position. Given the historically low interest rate environment and the associated level of interest rate risk, during 2003 the Bank exercised restraint by not increasing the investment securities portfolio compared with 2002.

In light of the low interest rate environment over the past few years and the historically high degree of interest rate volatility, the Bank’s investment strategy has been focused on maintaining a securities portfolio with an overall relatively short average duration, thereby reducing the exposures associated with sustained increases in interest rates. This was accomplished through investments in securities with predictable cash flows and relatively short average lives such as, 10-year fully amortizing mortgage-backed securities and other high coupon mortgage-backed securities. The Bank’s strategy has been to position the securities portfolio defensively with a steady stream of future cash flows. While sacrificing some yield in the near-term, the Bank’s objectives were to maintain a reasonable level of net interest income, manage longer-term interest rate and market risks, and position the portfolio for a rising interest rate environment and an improving economy.

Trading Securities: Trading securities are securities bought and held principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price. As of December 31, 2004 and 2003, the Bank did not have any trading securities.

Securities Available-for-Sale: The designation of securities "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.

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. The securities available-for-sale portfolio is used for liquidity purposes while simultaneously producing earnings.

Securities available-for-sale totaled $176,337 at December 31, 2004, compared with $124,422 at December 31, 2003, representing an increase of $51,916, or 41.7%. Securities available-for-sale represented 100% of total investment securities at December 31, 2004, compared with 78.6% at December 31, 2003.

As permitted by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", during the fourth quarter of 2004 the Bank transferred into the available-for-sale securities portfolio all of its held-to-maturity investment securities. Securities transferred consisted of longer term, tax-exempt securities representing obligations of state and political subdivisions. The held-to-maturity securities were transferred to available-for sale at their fair value of $36,100, with an unrealized gain on these securities, net of taxes, amounting to $1,191 recorded in other comprehensive income, a separate component of shareholders’ equity.

The transfer of held-to-maturity securities to available-for-sale was consistent with the Bank’s asset and liability management strategies, particularly the management of interest rate risk and the need for adequate liquidity. The majority of the held-to-maturity securities transferred to available-for-sale were purchased in 2001, during a period of higher long-term interest rates, and then-current projections for even higher rates in the near future. Given the current interest rate environment and the shortening of maturities since their date of purchase, the degree of interest rate risk associated with the held-to-maturity securities transferred to available-for-sale has diminished significantly. Management believes the transfer of held-to-maturity securities to available-for-sale will provide the Bank with additional liquidity reserves and a higher degree of flexibility in managing the overall balance sheet. Management does not intend to utilize the held-to-maturity classification in the foreseeable future.

The balances of securities available-for-sale are stated on the consolidated balance sheet net of fair value adjustments, reflecting net unrealized gains of $1,941 and $692 at December 31, 2004 and 2003, respectively. The 2004 increase in unrealized gains was principally attributed to the transfer of held-to-maturity securities to available-for-sale, which at December 31, 2004 amounted to $1,804.

The following table summarizes the securities available-for-sale portfolio as of December 31, 2004, and 2003:

	December 31, 2004
		Gross	Gross	Estimated
	Amortized	Unrealized	Unrealized	Fair
Available- for-Sale:	Cost	Gains	Losses	Value
Obligations to U.S. Government sponsored enterprises	$     6,395	$       2	$   49	$     6,348
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	116,097	651	258	116,490
Other	16,608	41	245	16,404
Obligations of states of the U.S. and political
subdivisions thereof	34,296	1,806	2	36,100
Other bonds	1,000	---	5	995
Total securities available for sale	$174,396	$2,500	$559	$176,337
	December 31, 2003
		Gross	Gross	Estimated
	Amortized	Unrealized	Unrealized	Fair
Available for Sale:	Cost	Gains	Losses	Value
Obligations to U.S. Government sponsored enterprises	$    5,557	$     21	$  50	$   5,528
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	86,498	986	214	87,270
Other	21,658	174	123	21,709
Other bonds	10,017	5	107	9,915
Total securities available for sale	$123,730	$1,186	$494	$124,422

Securities Held to Maturity: The securities held to maturity ("HTM") portfolio has historically been 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 Bank 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.

As previously discussed, during the fourth quarter of 2004 the Bank transferred all securities held-to-maturity to available-for-sale. At December 31, 2003, securities held-to-maturity totaled $33,965 representing 21.4% of total investment securities at that date.

The following table summarizes the securities held-to-maturity portfolio since 2002:

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

	2003	2002
Mortgage backed Securities	$      591	$ 1,363
Obligations of state and political subdivisions	33,374	30,182
Total	$33,965	$31,545

At December 31, 2003, the HTM portfolio consisted exclusively of long-term, tax-exempt municipal bonds, with one exception; namely, one $591 mortgage-backed security ("MBS") originally purchased in 2002 for Community Reinvestment Act ("CRA") benefits, with an original par value of $1,518. The underlying collateral consisted of low-income housing loans in the state of Maine. By their nature, CRA investments typically have higher purchase premiums because of the positive CRA effect. Subsequent to the purchase, the Bank’s primary regulator advised that the MBS did not qualify for CRA credit because the loans were not in the Bank’s immediate market area, in effect diminishing the value of the investment security to the Bank. During 2004, the Bank sold this CRA investment security, which had a then current book value of $476, realizing a gain of $16.

Purchase Premiums and Discounts: Securities are typically purchased at premium or discounted price, depending on the coupon of the security and prevailing interest rates. The Company recognizes the amortization of premiums and accretion of discounts in interest income using the interest method over the estimated life of the security. Purchase premiums are amortized to the earliest call date, while purchase discounts are accreted to maturity. Premiums paid on mortgage backed securities are amortized proportionate to the three-month trailing average Constant Payment Rate (CPR) of each securitized pool of mortgages.

Securities Credit Risk: The Bank evaluates and monitors the credit risk of its investment securities utilizing a variety of resources including external credit rating agencies, predominantly Moody’s and Standard and Poor’s. At December 31, 2004, 95.1% of the investment portfolio was rated "AAA". The Bank held no investment securities having a credit rating below "A" as of December 31, 2004.

Securities Interest Income: During 2004 the total aggregate tax-equivalent yield on the investment securities portfolio amounted to 4.51%, compared with 4.95% in 2003, representing a decline of 44 basis points. The declining interest rate environment over the past few years has prompted increases in prepayment speeds on mortgage backed securities particularly those with higher coupons, an acceleration of premium amortization, and the exercise of call features on certain securities. Securities replaced or incrementally added to the investment securities portfolio during 2003 and 2004 had relatively short average lives and consequently, were lower yielding compared with historical levels.

Total tax-equivalent interest income from investment securities amounted to $8,197 in 2004, compared with $7,385 in 2003, representing an increase of $812, or 11.0%. The impact of the 2004 decrease in yields on interest income was more than offset by a year-over-year increase in the volume of average investment securities.

Securities Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost of the Bank’s investment securities and weighted average yields of such securities an a fully tax-equivalent basis as of December 31, 2004, based upon the final maturity date of the securities. 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 in most cases have the right to prepay.

MATURITY SCHEDULE FOR INVESTMENT SECURITIES
DECEMBER 31, 2004
(at fair value)

	One Year Or Less	Greater than One Year to Five years	Greater than Five Years to Ten years	Greater Than Ten Years
Obligations of U.S. Government sponsored enterprises	$      ---	$1,985	$  3,858	$ 506
Weighted average yield	0.00%	3.26%	3.37%	2.76%
Mortgage backed Securities:
U.S. Government agencies and sponsored enterprises	2	1,572	46,881	68,035
Weighted average yield	5.45%	4.65%	3.79%	4.54%
Other mortgage backed Securities	---	---	---	16,404
Weighted average yield	0.00%	0.00%	0.00%	4.40%
Obligations of State and Political Subdivisions	---	121	358	35,621
Weighted average yield	0.00%	5.24%	5.24%	6.95%
Other debt securities	---	---	---	995
Weighted average yield	0.00%	0.00%	0.00%	4.55%
Total	$      2	$3,678	$51,097	$121,561

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

Impaired Securities: The securities portfolio contains certain investments where amortized cost exceeds fair market value, which at December 31, 2004 amounted to $559, compared with $648 at December 31, 2003, representing a decline of $89 or 13.7%.

Unrealized losses that are considered other-than-temporary are recorded as a loss on the Company’s consolidated statement of income. In evaluating whether an impairment is other-than-temporary, management considers a variety of factors including the nature of the investment, the cause of the impairment, and the severity and duration of the impairment. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and any other information considered relevant in determining whether other-than-temporary impairment has occurred.

At December 31, 2004, 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, 2004. All securities referenced are debt securities. At December 31, 2004 the Bank did not hold any common stock or equity securities in its investment securities portfolio.

TEMPORARILY IMPAIRED INVESTMENT SECURITIES
DECEMBER 31, 2004

	Less Than 12 Months			12 Months of Longer			Total
	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investements	Unrealized Losses	Fair Value	Number of Investements	Unrealized Losses
Description of Securities:
Oblications of U. S. Government       sponsored enterprises	$3,585	7	$ 29	$     983	2	$ 20	$ 4,568	9	$ 49
Mortgage-backed securities:
U.S. Government agencies and           sponsored enterprises	31,665	50	121	11,747	24	137	43,412	74	258
Other mortgage-backed securities	8,973	23	138	3,041	5	87	12,014	29	245
Obligations of state and political       subdivisions thereof	546	2	2	---	--	---	546	2	2
Other - Corporate bonds	995	1	5	---	--	---	995	1	5
Total temporarily impaired securities	$45,764	84	$295	$15,771	31	$244	$61,535	115	$559

At December 31, 2004, the total unrealized losses on temporarily impaired investments amounted to $559, representing 0.9% of their carrying value. At December 31, 2004 there were no individual investment positions where the unrealized loss exceeded 5% of its carrying value.

As of December 31, 2004, unrealized losses on investment securities that had been in an unrealized loss position more than twelve-months amounted to $244, or 1.5% of their carrying value at December 31, 2004. At December 31, 2004 there were a total of thirty-one investment securities in an unrealized loss position more than twelve months, represented by twenty-nine mortgage backed-securities and two debt securities issued by government sponsored enterprises.

For securities with unrealized losses, the following information was considered in determining that the impairments are not other-than-temporary. U.S. government securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government sponsored enterprises have minimal credit risk as they play a vital role in the nation’s financial markets. Other bonds and notes are generally comprised of corporate mortgage-backed securities and all investments maintain a credit rating of at least "A" by one of the nationally recognized rating agencies. Mortgage-backed securities and collateralized mortgage obligations are either issued by federal government agencies and sponsored enterprises, or by private issuers, all with security ratings of AAA.

Management believes the unrealized losses in the investment portfolio at December 31, 2004 were attributed to interest rates, and reflected the volatile movements in the U.S. Treasury curve over the past few 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, 2004.

Management believes the extent of unrealized losses on mortgage-backed securities will diminish over time as principal payments and pre-payments are received and maturities continue to shorten. In the case of debt securities, management believes unrealized losses will diminish over time as maturity dates continue to shorten. Management also believes that any declines in the U.S. Treasury yield curve will further diminish the extent of unrealized losses in the securities portfolio, as market values typically increase in a declining interest rate environment. Subsequent to December 31, 2004 the yield curve posted declines, with the 10-year Treasury, for example, closing as low as 3.99%, or 23 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. Funding sources principally consist of customerretail deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member, and certificates of deposit obtained from the national market.

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.

Among Maine banks, strong loan growth has not been matched by core deposit growth, which accordingAccording to a recentJanuary 2006 report prepared by the Maine Bureau of Financial Institutions, in 2004 through June 2005, Maine banks continued to book loans faster than core deposits, necessitating increased a relatively anemic 4% during the twelve-months ended June 30, 2004, the lowest growth rate in five years.reliance on non-core funding. As a consequence, among Maine banks, the loan-to-core deposit ratio rose to a record high of 117%124%, well above the national average of 90%96% and up from 110%117% one year earlier. During 2004,2005, the Bank’s average loan-to-core depositloan-to-core-deposit ratio amounted to 114%128%, compared with 116%114% in 2003. At December 31, 2004 the Bank’s loan-to-core deposit ratio stood at 120%, in part reflecting the seasonality of customer deposits and fourth-quarter 2004 loan growth of $18,926.2004.

According to the Maine Bureau of FinanicalFinancial Institutions, because core deposit growth has not kept pace with earning asset growth, Maine banks have had to rely increasingly on borrowings and other types of non-core funding, which supported 27%30% of Maine bank assets as of June 30, 2004,2005, compared with the national average of 16%17%. During 20042005 the Bank’s non-core funding averaged 31.8%34.3% of total average assets, compared with 30.3%31.8% in 2003. At December 31, 2004 the Bank’s non-core funding stood at 32.3%, compared with 30.2% at December 31, 2003.2004.

Looking forward, managementManagement believes that the Bank’s future success in growing core funding will be a determinant factor in its ability to grow earning assets and leverage its strong capital position.

Deposits

During 20042005, the most significant source of funding for the Bank’s earning assets continued to be customerretail deposits, gathered throughout its network of eleven banking offices throughout Down Eastdowneast and Mid Coastmidcoast Maine. Total average customerretail deposits accounted for 69.8%57.2% of the funding required in supporting the Bank’s earning asset portfolios during 2004, unchanged2005, compared with 2003.59.8% in 2004.

Total Deposits: At December 31, 20042005 total deposits amounted to $398,272,$445,731, compared with $339,080$398,272 at December 31, 2003,2004, representing an increase of $59,192,$47,459, or 17.5%11.9%.

Savings and money market accounts led 2004 growth with anThe 2005 increase of $29,870 or 27.3%, followed by timein total deposits demand deposits, and NOW accounts, posting increases of $21,375, $4,699, and $3,248, or 17.9%, 9.4%, and 5.4%, respectively, compared with December 31, 2003. Deposit growth was bolstered by $20,459 in deposits acquired in connection with the Rockland branch acquisition, a new institutional money market product accounting for $17,437 of the increase, and $17,712 inprincipally attributed to certificates of deposit obtained from the national market.market ("brokered deposits"), which accounted for $36,686 or 77.3% of total 2005 deposit growth.

Retail deposit growth amounted to $10,773 in 2005, or 2.9%. The rate of retail deposit growth lagged historical norms during 2005. Management believes that competition from banks and non-banks intensified, as savers and investors sought higher returns in an atmosphere of rising short-term interest rates, and that financial institutions in particular have been aggressive in pricing their deposits in order to fund earning asset growth. Since short-term rates began rising in June 2004, management has exercised restraint with respect to overly aggressive deposit pricing strategies, and has sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while protecting the Bank’s net interest margin and liquidity position.

Total average deposits amounted to $377,721$417,950 during 2004,2005, compared with $322,414$377,721 in 2003,2004, representing an increase of $55,307$40,109, or 17.2%10.6%. Total average retail deposits amounted to $376,237 during 2005, compared with $366,063 in 2004, representing an increase of $10,174, or 2.8%.

The following table summarizes the componentschanges in the average balances of deposits during the Bank’s total average deposit portfolio:periods indicated:

SUMMARYAVERAGE DEPOSIT BALANCES BY CATEGORY OF DEPOSIT PORTFOLIO

	2004		2003		2002		2005		2004
	Average Balance	Average Rate	Average Balance	Average Rate	Average Balance	Average Rate	Average Balance	Average Rate	Average Balance	Average Rate
Demand deposits	$ 51,382	---	$ 45,607	---	$ 43,673	---	$ 53,830	---	$ 51,382	---
NOW accounts	63,119	0.24%	54,221	0.34%	48,739	0.60%	66,289	0.15%	63,119	0.24%
Savings accounts	132,091	0.83%	104,275	0.88%	95,514	1.71%
Savings and money market deposits							133,755	1.51%	132,091	0.83%
Time deposits	131,129	2.41%	118,311	2.74%	115,549	3.42%	122,363	1.39%	119,471	2.24%
Brokered time deposits							41,713	3.75%	11,658	4.09%
Total deposits	$377,721		$322,414		$303,475		$417,950		$377,721

Demand Deposits: Non-interest bearing demand deposits, which are principally commercialbusiness accounts in nature, totaled $55,451 at December 31, 2005, compared with $54,579 at December 31, 2004, compared with $49,880 at December 31, 2003, representing an increase of $4,699,$872, or 9.4%1.6%. Total average demand deposits amounted to $51,382$53,830 during 2004,2005, compared with $45,607$51,382 in 2003,2004, representing an increase of $5,775,$2,448, or 12.7%4.8%. Demand deposits represented 13.6%12.8% of total average deposits during 2004,2005, compared with 14.1%13.6% in 2003.2004.

The rate of demand deposit growth lagged historical norms during 2005. Management attributes this, in part, to a lower level of seasonal deposits compared with historical norms, and believes this was consistent with a reportedly slow tourist season in the market areas served by the Bank. Management also believes that competition for demand deposit intensified during 2005, with more financial institutions offering no fee checking accounts.

During the second and third quarters of 2005, the Bank launched a variety of new business and personal demand deposit products, including free checking products, which it believes are highly competitive and designed to satisfy the changing expectations of both individual and business customers. Management believes these products will help increase demand deposits in the foreseeable future.

The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include  Small BusinessPlus, BusinessPlus, and Free Small Business, each designed to help business owners manage the varying financial aspects of their business. The Bank also 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. DemandBusiness demand deposits are also include balances generated by way of the Bank’s Merchant Credit Card Processing Program. The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis.

NOW Accounts:Account Deposits: The Bank offers NOW accounts to individuals, not-for-profit organizations and not-for-profit organizations.sole proprietor businesses. At December 31, 2004,2005, total NOW accounts stood at $63,535,$66,965, compared with $60,287$63,535 at December 31, 2003,2004, representing an increase of $3,248$3,430 or 5.4%. During 20042005 total average NOW accounts amounted to $63,119,$66,289, compared with $54,221$63,119 in 2003,2004, representing an increase of $8,898,$3,170, or 16.4%5.0%. NOW accounts represented 16.7%15.9% of total average deposits during 2004,2005, compared with 16.8%16.7% in 2003.2004.

During 2004,2005, the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its elderlyage 50 and retiredabove customers. The Bank also introduced two new deposit products during 2004, Ideal Checking and Simple Checking, relationship products designed for families and individuals.

Savings Andand Money Market Accounts:Deposits: At December 31, 2004,2005, total savings and money market accounts amounted to $139,179,$133,113, compared with $109,309$139,179 at December 31, 2003,2004, representing an increasea decline of $29,870,$6,066, or 27.3%4.4%. Total average savings and money market accounts amounted to $132,091$133,755 during 2004,2005, compared with $104,275$132,091 in 2003,2004, representing an increase of $27,816,$1,664, or 26.7%1.3%. Savings and money market accounts represented 35.0%32.0% of total average deposits during 2004,2005, compared with 32.3%35.0% in 2003.2004.

The Bank offers statement savings accounts, and as a community oriented financial institution, continues to offersupport the more traditional passbook savings accounts. TheDuring 2005 the Bank also offersoffered a tiered-rate, competitively priced money market account, Investors Choice, providing businesses and individuals with short-term investment alternatives.

During 2004,Bank management attributes the Bank began offering a new institutional money market product to clients of Bar Harbor Trust Services, the Bank’s wholly owned subsidiary. During 2004 the balance of this new money market product averaged $14,449, and at December 31, 2004, totaled $17,437. The 2004sluggish 2005 growth in average savings and money market accounts was also driven by the deposits acquiredto aggressive pricing competition from banks and non-banks, as savers shopped for higher returns in connection with the Bank’s acquisitionan atmosphere of a branch officewell-publicized, rising short-term interest rates. In response to competitive pricing pressures and continuing market demand, in the communityfirst quarter of Rockland, Maine.

During 2004,2006 the Bank introduced its new Prime-based Horizon Money Market Account, which saw a continuationit believes is highly competitive and designed to satisfy the needs of historically low interest rates, customers appeared to demonstrate a desire for the higher liquidity offered through savingsboth small and money market accounts, versus more traditional, longer-term certificates of deposit.large investors alike.

Time Deposits: At December 31, 20042005, total time deposits stood at $140,979,$129,816, compared with $119,604$117,279 at December 31, 2003,2004, representing an increase of $21,375,$12,537, or 17.9%10.7%. Total average time deposits amounted to $131,129$122,363 during 20042005 compared with $118,311$119,471 in 2003,2004, representing an increase of $12,818,$2,892, or 10.8%.2.4 %. Time deposits represented 34.7%29.3% of total average deposits during 2004,2005, compared with 36.7%31.6% in 2003.2004.

Total time deposits include brokered time deposits obtained from the national market, which during 2004 averaged $11,658, representing an increase of $5,670 compared with 2003. At December 31, 2004, time deposits obtained from the national market amounted to $23,700, or 6.0% of total deposits, compared with $5,988 at December 31, 2003, or 1.8% of total deposits at that date. The increase in deposits obtained from the national market was primarily attributed to the funding needs associated with the Bank’s strong earning asset growth, principally loans, which outpaced core customer deposit growth during 2004. The rates of interest paid on time deposits obtained from the national market were generally more favorable than advances from the Federal Home Loan Bank, a secondary source of funding used by the Bank.

Excluding time deposits obtained from the national market, total time deposits at December 31, 2004 represented an increase $3,663, or 3.2%, compared with December 31, 2003. This increase was principally attributed to deposits acquired in connection with the Bank’s acquisition of a branch office in the community of Rockland, Maine.

The sluggish organic growth in customer time deposits was due in part to depositors’ apparent hesitation to invest in longer-term fixed rate certificates of deposits, while yields remained at historically low levels. Additionally, in light of the extended low interest rate environment and its resulting pressure on the Bank’s net interest margin, during 2004 the Bank did not compete for time deposits as aggressively as it has in the past, with respect to pricing. In pricing time deposits, particularly non-relationship time deposits, the Bank will consider other sources of funding which may be offered at more attractive terms and prices, including borrowed funds and time deposits available in the national market.

Bank management attributes the 2005 growth in time deposits to its competitive pricing strategies and customer retention programs. Additionally, given the increase in short-term interest rates and the flattening U.S. Treasury curve, investors and savers appeared attracted to higher yielding certificates of deposit with relatively short-term maturities.

Time deposits in denominations of $100 or greater totaled $25,151 at December 31, 2005, compared with $19,405 at December 31, 2004, compared with $18,784 at December 31, 2003, representing an increase of $621,$5,746, or 3.3%29.6%.

The following scheduletable summarizes the maturity distribution of time deposits of $100 or greater:

MATURITY SCHEDULE
TIME DEPOSITS $100 THOUSAND OR GREATER
DECEMBER 31, 20042005

Maturity
Three months or less	$4,319$   4,546
Over three months to six months	3,3425,940
Over six months to twelve months	5,4166,818
Over twelve months	6,3287,847
	$19,405$25,151

Brokered Time Deposits: At December 31, 2005, total brokered time deposits stood at $60,386, compared with $23,700 at December 31, 2004, representing an increase of $36,686, or 154.8%. Total average brokered time deposits amounted to $41,713 during 2005 compared with $11,658 in 2004, representing an increase of $30,055, or 257.8%. Brokered time deposits represented 10.0% of total average deposits during 2005, compared with 3.1% in 2004.

The increase in brokered time deposits was primarily attributed to the funding needs associated with the Bank’s strong earning asset growth, principally loans, which outpaced retail deposit growth during 2005. In addition, during 2005 the Bank modified its funding and liquidity strategies, providing more balance between brokered and borrowed funds, which during 2005 posted an average balance increase of only 1.2% compared with 2004. The rates of interest paid on brokered time deposits were generally more favorable than collateralized advances from the Federal Home Loan Bank, the primary source of wholesale funding used by the Bank.

Borrowed Funds

Borrowed funds principally consist of advances from the Federal Home Loan Bank of Boston ("FHLB") and, to a lesser extent, securities sold under agreements to repurchase. Advances from the FHLB are secured by stock in the FHLB, mortgage-backedinvestment securities, and blanket liens on qualifying first mortgage loans and home equity 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 Bank’s ability to select desired amounts, terms and maturities on a daily basis.

Borrowings From the Federal Home Loan Bank: At December 31, 2004,2005, borrowings from the FHLB totaled $191,846,$223,258, compared with $170,506$191,846 at December 31, 2003,2004, representing an increase of $21,340,$31,412, or 12.5%16.4%. During 2004,2005, borrowings from the FHLB averaged $193,927,$195,124, compared with $163,724$193,927 in 2003,2004, representing an increase of $30,203,$1,197, or 18.4%0.6%.

During the fourth quarter of 2004, the Bank replaced a portion of its maturing FHLB borrowings with certificates of deposit obtained in the national market, causing the balance of FHLB borrowings at December 31, 2004 to fall below the 2004 average balance.

The 2004 increase in borrowings from the FHLB was utilized to fund 2005 earning asset growth, particularlywhich outpaced the growth in retail deposits.

During 2005, the Bank re-balanced a portion of its wholesale funding base by utilizing a greater proportion of brokered certificates of deposit obtained in the national market to support earning asset growth. This action was taken to strengthen the Bank’s investment securities portfolio.strategic liquidity reserves, providing a higher level of "just in time" funding afforded by readily available advances from the FHLB.

BorrowingsTotal average borrowings from the FHLB expressed as a percentage of total average assets amounted to 28.8%28.3% during 2005, compared with 30.0% in 2004.

Securities Sold Under Agreements to Repurchase: At December 31, 2005, securities sold under repurchase agreements amounted to $16,438, compared with $15,077 at December 31, 2004, compared with 29.2% at December 31, 2003.representing an increase of $1,361, or 9.0%. Securities sold under repurchase agreements were collateralized by U.S. Government-sponsored agency obligations.

Borrowing Maturities: Borrowing maturities are managed in concert with the Bank’s asset and liability management strategies,strategy, and are closely aligned with the ongoing management of balance sheet interest rate risk. Over the past few years, the

As of December 31, 2005, total short-term borrowings, including securities sold under repurchase agreements, amounted to $131,338, compared with $89,851 at December 31, 2004, or 54.8% and 43.4% of total borrowings, respectively. Conversely, long-term borrowings at December 31, 2005 totaled $108,358, compared with $117,072 at December 31, 2004, or 45.2% and 56.6% of total borrowings, respectively.

The Bank has addedutilized higher cost, longer-term borrowings to the balance sheet in order to hedgemanage the interest rate risk associated with the growth in longer-term, fixed rate, earning assets generated during periods of historically low interest rates. While this strategy has pressured net interest income in the short-term,near-term, management believes it lessens the degree of interest rate risk and better positions the Bank for rising interest rates and an improving economy.

As of December 31, 2004, total short-term borrowings, including securities sold under repurchase agreements, amounted to $89,851, compared with $58,525 at December 31, 2003, or 43.4% and 31.4% of total borrowings, respectively. Conversely, long-term borrowings at December 31, 2004 totaled $117,072, compared with $127,906 at December 31, 2003, or 56.6% and 68.6% of total borrowings, respectively.

Capital Resources

Consistent with its long-term goal of operating a sound and profitable organization, the Company continues to be a "well capitalized" bank holding company according to applicable regulatory standards. In 2004, the Company continuedManagement believes this to maintain a strong capital position, which isbe 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 continued to be the case during the year ended December 31, 2004.2005.

Stock Repurchase Plans: In November 1999, the Company announced a stock repurchase plan. The Board of Directors of the Company at 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 BoardAs of Directors subsequently authorized the continuancedate of that program through December 31, 2003. Astermination 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 share repurchase program terminated on December 31, 2003. The Company recordsrecorded 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 willwere to continue through December 31, 2005. The Company’s Board of Directors subsequently authorized the continuance of this program through December 31, 2006. 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. As of December 31, 2004,2005, the Company had repurchased 49,920103,732 shares of stock under this plan, at a total cost of $1,349$2,822 and an average price of $27.03$27.21 per share.

The Company believes that a stock repurchase plan is a prudent use of its capital at this time. Management anticipates the stock repurchase plan will be accretive to the return on average shareholders’ equity and earnings per share. Management also believes that the stock repurchase plan helps facilitate an orderly market for the disposition of large blocks of stock, and lessens the price volatility associated with the Company’s thinly traded stock.

Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of the balance sheet and other relevant factors.

In the first quarterThe Company’s principal source of 2004,funds to pay cash dividends and support its commitments is derived from Bank operations. During 2005, the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholdersdeclared cash dividends in the aggregate amount of record as of the close of business on February 20, 2004. Quarterly dividends continued at this rate through 2004.

$2,584. The Company’s 2004 dividend2005 earnings payout ratio amounted to 43.2%40.2%, compared with 45.8%43.2% in 2003.2004.

In the first quarter of 2005, the Company increased its quarterly dividend by 5.0% to $0.21 per common share. The dividend was paid March 15, 2005 to shareholders of record as of the close of business on February 18, 2005. Quarterly dividends continued at this rate through 2005.

In the first quarter of 2006, the Company increased its quarterly cash dividend by 4.8% to $0.22 per common share. The dividend is payable to all shareholders of record as of February 18, 2005, and was paid on17, 2006, with a payment date of March 15, 2005.2006.

Capital Ratios: The Company and its banking subsidiarythe Bank are subject to the risk basedrisk-based capital guidelines administered by the Company’s and the Bank's principal regulators. The risk basedrisk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk weighted assets and off-balance sheet items. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk basedrisk-based capital to risk weighted assets of 8%, including a minimum ratio of Tier I capital to total risk weighted assets of 4% and a Tier I capital to average assets of 4% ("Leverage Ratio"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company's financial statements.

As of December 31, 2004,2005, the Company and the Bank arewere considered well capitalized under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a well capitalized institution must maintain a minimum total risk basedrisk-based capital to total risk weighted assets ratio of at least 10%, a minimum Tier I capital to total risk weighted assets ratio of at least 6%, and a minimum Tier I Leverage ratio of at least 5%.

At December 31, 2004,2005, the Company’s total risk basedrisk-based capital was $56,260$56,556 or 13.0%11.3% of risk-weighted assets, compared with $56,403,$56,260, or 14.7%13.0% of total risk-weighted assets at December 31, 2003.2004.

At December 31, 2004,2005, the Company’s Tier I capital totaled $51,431$54,416 or 11.9%10.9% of risk-weighted assets, compared with 51,601,$51,431, or 13.5%11.9% of total risk weighted assets at December 31, 2003.2004. The ratio of Tier I capital to average weighted assets, or Leverage Ratio, at December 31, 20042005 was  7.8%7.5%, compared with 8.9%7.7% at December 31, 2003.2004.

The following table sets forth the Company's regulatory capital at December 31, 20042005 and December 31, 2003,2004, under the rules applicable at that date.

	December 31, 2004			December 31, 2003		December 31, 2005			December 31, 2004
	Amount	Ratio		Amount	Ratio	Amount	Ratio		Amount	Ratio
Total Capital to Risk Weighted Assets	$56,260	13.0%		$56,403	14.7%	$56,556	11.3%		$56,260	13.0%
Regulatory Requirement	34,588	8.0%		30,694	8.0%	40,028	8.0%		34,588	8.0%
Excess	$21,672	��     5.0%		$25,709	6.7%	$16,528	3.3%		$21,672	5.0%
Tier 1 Capital to Risk Weighted Assets	$51,431	11.9%		$51,601	13.4%	$54,416	10.9%		$51,431	11.9%
Regulatory Requirement	17,294	4.0%		15,347	4.0%	20,014	4.0%		17,294	4.0%
Excess	$34,137	7.9%		$36,254	9.4%	$34,402	6.9%		$34,137	7.9%
Tier 1 Capital to Average Assets	$51,431	7.7%		$51,601	8.9%	$54,416	7.5%		$51,431	7.7%
Regulatory Requirement	26,547	4.0%		23,111	4.0%	28,847	4.0%		26,547	4.0%
Excess	$24,884	3.7%		$28,490	4.9%	$25,569	3.5%		$24,884	3.7%

As more fully disclosed in Note 1312 of the Consolidated Financial Statements in this Annual Report on Form 10-K, during 2004 the Bank also maintained its standing as a well capitalizedinstitution as defined by applicable regulatory standards. At December 31, 2004,2005, the Bank’s Tier I Leverage, Tier I Risk BasedRisk-based and Total Risk BasedRisk-based capital ratios stood at 8.0%7.8%, 12.2%11.2% and 12.8%11.7%, respectively.

There 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 capital resources, liquidity, or financial condition.

Contractual Obligations

The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first and second mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.

The Company is also obligated to make payments on an operating leaseleases for its office at One Cumberland Placeoffices in Somesville and Bangor, Maine.

The following table summarizes the Company’s contractual obligations at December 31, 2004.2005. Borrowings are stated at their contractual maturity due dates and do not reflect call features, or principal amortization features, on certain borrowings.

CONTRACTUAL OBLIGATIONS
(Dollars in thousands)

		Payments Due Per Period					Payments Due By Period
Description	Total Amount of Obligations	<1 year	1-3 years	4-5 years	>5 years	Total Amount of Obligations	< 1 Year	1-3 Years	4-5 Years	> 5 Years
Operating Leases	$         24	$       24	$       ---	$       ---	$       ---
Operating leases						$       383	$          73	$     129	$     143	$       38
Borrowings from the Federal Home Loan Bank	191,846	74,774	26,387	43,902	46,783	223,258	114,900	48,070	27,330	32,958
Securities sold under agreements to repurchase	15,077	15,077	---	---	---	16,438	16,438	---		---
Total	$191,870	$89,875	$26,387	$43,902	$46,783	$240,079	$131,411	$48,199	$27,473	$32,996

In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATM, Visa Debit and Credit Card processing, trust services accounting support, student loan servicing, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.

The majority of the Company’s core operating systems and software applications are maintained "in-house" with traditional third party maintenance agreements of one year or less.

Off-Balance Sheet Arrangements

The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors."Off-balance sheetarrangements" include any transactions, agreements, or other contractual arrangements to which an entity unconsolidated with the Company is a party, under which the Company has:

(i) Any obligation under certain guarantee contracts;

(ii) A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;

(iii) Any obligation under certain derivative instruments;

(iv) Any obligation under a material variable interest held by the Company in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging, or research and development services with the Company.

At December 31, 2005 and 2004, the Company had the following Off-Balance Sheet Arrangements:Company’s off-balance sheet arrangements were limited to standby letters of credit.

Standby Letters of Credit: The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third partythird-party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.

At December 31, 2004,2005, commitments under existing standby letters of credit totaled $1,155,$115, compared with $2,205$1,155 at December 31, 2003.2004. The fair value of the standby letters of credit was not significant as of December 31, 2004 and 2003.

Other Off-Balance Sheet Arrangements: At December 31, 2004 and 2003, the Company did not have any other "off-balance sheet arrangements".foregoing dates.

Off Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and certain financial derivative instruments; namely, interest rate swap agreements and interest rate floor agreements.

Commitments to Extend Credit: Commitments to extend credit represent agreements by the Bank to lend to a customer provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clausesprovisions and may require payment of a fee.

Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments, such as loans. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.

The following table summarizes the Bank’s commitments to extend credit as of December 31:

COMMITMENTS TO EXTEND CREDIT

	2004	2003	2005	2004
Commitments to originate loans	$14,435	$32,575	$  40,779	$14,435
Unused lines of credit	$76,482	$62,616	73,190	75,732
Un-advanced portions of construction loans	$ 7,336	$ 3,683	6,110	7,336
Total	$98,253	98,874	$120,079	$97,503

Financial Derivative Instruments / Counter-party Risk:Instruments: As part of the Bank’sits overall asset liability/and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank's interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on net interest income. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swap agreements and interest rate floor agreements. A policy statement, approved by the Board of Directors of the Bank, governs use of derivative instruments.

At December 31, 2004 the Bank had two outstanding derivative instruments, both interest rate swap agreements. The details are summarized as follows:

Description	Maturity	Notional Amount (in thousands)	Fixed Interest Rate	Variable Interest Rate
Receive fixed rate, pay variable rate	09/01/07	$10,000	6.04%	Prime (5.25%)
Receive fixed rate, pay variable rate	01/24/09	$10,000	6.25%	Prime (5.25%)

The Bank is required to pay a counter-party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively, over the term of each respective agreement.

The following table summarizes the contractual cash flows of the interest rate swap agreements outstanding at December 31, 2004, based upon the then-current Prime interest rate of 5.25%:

	Payments Due by Period
	Total	Less Than 1 Year	1-3 Years	3-5 Years
Fixed payments due from counter-party	$4,105	$1,229	$2,206	$669
Variable payments due to counter-party      based on prime rate	3,494	1,050	1,881	562
Net cash flow	$   611	$   179	$   325	$107

The notional amounts of the agreementsfinancial derivative instruments do not represent exposure to credit loss. The Bank is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements. Management does not anticipate non-performance by the counter-party to the agreements, and regularly reviews the credit quality of the counter-party from which the instruments have been purchased.

As more fully enumerated in Part II, Item 8, NotesThe details of the Bank’s financial derivative instruments as of December 31, 2005 are summarized as follows.

INTEREST RATE SWAP AGREEMENTS

Description	Maturity	Notional Amount (in thousands)	Fixed Interest Rate	Variable Interest Rate
Receive fixed rate, pay variable rate	09/01/07	$10,000	6.04%	Prime (7.25%)
Receive fixed rate, pay variable rate	01/24/09	$10,000	6.25%	Prime (7.25%)

The Bank is required to pay a counter-party monthly variable rate payments indexed to Prime, while receiving fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively, over the Consolidated Financial Statements, Note 16, in this Annual Report on report Form 10-K, duringterm of each respective agreement.

The following table summarizes the third quarter of 2004, the Bank designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are being recorded on the consolidated balance sheet in other comprehensive income, while current period netcontractual cash flows representing net amounts received from or paid to counter-parties are recorded in interest income. During the first quarter of 2004, these interest rate swap agreements had been de-designated as cash flow hedges and, from the time of de-designation, changes in their fair value and current period net cash flows related to these agreements were recorded in the consolidated statement of income and included as part of non-interest income.

At December 31, 2004 and December 31, 2003, the unrealized (loss) gain on the interest rate swap agreements was ($225) and $86, respectively, and included in other assets on the consolidated balance sheets.

At December 31, 2004, the unrealized loss on these interest rate swap agreements included in other comprehensive income, net of tax, amounted to $149, compared with an unrealized gain of $57outstanding at December 31, 2003. Also included in other comprehensive income for2005, based upon the year ended December 31, 2004 was a net deferred loss, net of tax, of $15 related to the de-designation and re-designation of these swaps as cash flow hedges in 2004. There were no deferred gains or losses recorded in other comprehensive income in 2003.

During 2004, the net unrealized gains onthen-current Prime interest rate swap agreements recorded in non-interest income amounted to $29 during the period in which hedge accounting was not applied.of 7.25%:

	Payments Due by Period
	Total	Less Than 1 Year	1-3 Years	3-5 Years
Fixed payments due from counter-party	$2,925	$1,229	$1,655	$41
Variable payments due to counter-party       based on Prime rate	3,434	1,450	1,936	48
Net cash flow	$  (509)	$   (221)	$  (281)	$(7)

During, 2004, the totalTotal net cash flows received from counterpartiescounter-parties amounted to $455,$3 in 2005, compared with $455 and $498 in 2004 and $117 in 2003, and 2002, respectively. Of the $455The declines in net cash flows received from counterpartiescounter-parties were attributed to increases in the Prime interest rate during 2004 $375 was recorded in non-interest income (non-hedge period) and $80 in2005.

INTEREST RATE FLOOR AGREEMENTS

Notional Amount	Termination Date	Prime Strike Rate	Premium Paid
$20,000	08/02/10	6.00%	$186
$10,000	11/01/10	6.50%	$ 69

During the third and fourth quarters of 2005, interest rate floor agreements were purchased by the Bank to limit its exposure to falling interest rates on a pool of loans indexed to the Prime interest rate. Under the terms of the agreements the Bank paid up front premiums for the right to receive cash flow payments if the Prime rate falls below the predetermined floor rates, thus effectively ensuring interest income (hedge period).on a pool of prime based loans at a minimum of 6.00% and 6.50% on the $20,000 and $10,000 notional amounts for the duration of the agreements, respectively. The netinterest rate floor agreements were designated as a cash flows received from counterparties during 2003 and 2002 were recordedflow hedges in interest income.accordance with SFAS 133.

Liquidity

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Bank actively manages its liquidity position through target ratios established under its asset/liability management policyAsset Liability Management Policy approved by the Bank’s Board of Directors. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity.

The Bank uses a basic surplus model to measure its liquidity over 30 and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Bank’s policy is to maintain its liquidity position at approximately 5% of total assets. At December 31, 2004,2005, liquidity, as measured by the basic surplus model, was 4.6%6.6 % over the 30-day horizon and 3.8% over the 90-day horizon. Including its available lines from the FHLB, at December 31, 2004 the Bank’s basic surplus amounted to 5.6% over the 30-day horizon and 4.1%4.6% over the 90-day horizon.

The basic surplus model does not incorporate the short-term liquidity generated by cash flows from the investment securities portfolio, which during the first quarter of 2005 are expected to generate approximately $13,000 in additional liquidity, available to absorb anticipated deposit outflows. In this regard, aA portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.

At December 31, 2004,2005, the Bank had unused lines of credit and net unencumbered qualifying collateral availability to support its credit line with the FHLB approximating $48$45 million. The Bank also had capacity to borrow funds on a secured basis utilizing certain un-pledged securities in its investment securities portfolio. The Bank’s loan portfolio and investment portfolio provide a source of contingent liquidity that could be accessed in a reasonable time period through sales. The Bank also has access to the national brokered deposit market.market, and has been using this funding source to bolster its liquidity position.

Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position.

The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company.

Impact of Inflation and Changing Prices

The Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements presented elsewhere in this report have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

Unlike many industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates and the U.S. Treasury yield curve may not necessarily move in the same direction or in the same magnitude as inflation.

While the financial nature of the Company’s consolidated balance sheets and statements of income is more clearly affected by changes in interest rates than by inflation, inflation does affect the Company because as prices increase the money supply tends to increase, the size of loans requested tends to increase, total Company assets increase, and interest rates are affected by inflationary expectations. In addition, operating expenses tend to increase without a corresponding increase in productivity. There is no precise method, however, to measure the effects of inflation on the Company’s financial statements. Accordingly, any examination or analysis of the financial statements should take into consideration the possible effects of inflation.

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 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 market 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: For the year ended December 31, 2004,2005, net interest income on a fully tax- equivalent basis amounted to $21,098$22,541 compared with $21,098 and $20,102 in 2004 and $20,190 in 2003, and 2002, representing an increaseincreases of $1,443 and $996, or 6.8% and 5.0%, andrespectively.

The increase in 2005 net interest income was principally attributed to a decrease of $88$44,786 or 0.4%, respectively.7.3% increase in average earning assets during the year, aided by a relatively unchanged net interest margin, which in 2005 amounted to 3.43% compared with 3.45% in 2004.

The increase in 2004 net interest income was entirely attributed to anaverage earning asset growth of $83,240 or 15.7% increase in average earning assets during the year,, as the 2004 net interest margin declined 35 basis points to 3.45%, compared with 2003. Likewise, the decline in net interest income during 2003 was also entirely attributed to the net interest margin, which declined 34 basis points to 3.80% during 2003, compared with 4.14% in 2002.

Factors contributing to the changes in net interest income and the net interest margin are further enumerated in the following discussion and analysis.

Net Interest Income Analysis: The following tables summarize the Company’s daily average balance sheets and the components of net interest income, including a reconciliation of tax equivalent adjustments, for the years ended December 31, 2005, 2004 2003 and 2002:2003:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 20042005

				Average Balance	Interest	Average Rate
	Average Balance	Interest	Average Rate
Interest Earning Assets:
Loans (1,3)	$416,956	$24,100	5.78%	$479,974	$29,595	6.17%
Taxable investment securities	147,836	5,937	4.02%	132,604	5,592	4.22%
Non-taxable investment securities (3)	33,942	2,260	6.66%	31,423	2,154	6.85%
Total Investments	181,778	8,197	4.51%	164,027	7,746	4.72%
Investment in Federal Home Loan Bank stock	10,571	297	2.81%	10,731	466	4.34%
Fed funds sold, money market funds, and time
deposits with other banks	2,726	49	1.80%
Fed funds sold, money market funds, and time deposits with other banks				2,085	70	3.36%
Total Earning Assets	612,031	32,643	5.33%	656,817	37,877	5.77%
Non Interest Earning Assets:
Non-Interest Earning Assets:
Cash and due from banks	8,308			8,602
Allowance for loan losses	(5,051)			(4,767)
Other assets (2)	30,917			28,992
Total Assets	$646,205			$689,644
Interest Bearing Liabilities:
Deposits	$326,339	$ 4,409	1.35%	$364,120	$ 6,941	1.91%
Securities sold under repurchase agreements	13,427	151	1.12%
Securities sold under repurchase agreements and fed funds purchased				14,637	272	1.86%
Borrowings from the Federal Home Loan Bank	193,927	6,985	3.60%	195,124	8,123	4.16%
Total Borrowings	207,354	7,136	3.44%	209,761	8,395	4.00%
Total Interest Bearing Liabilities	533,693	11,545	2.16%	573,881	15,336	2.67%
Rate Spread			3.17%			3.10%
Non Interest Bearing Liabilities:
Non-Interest Bearing Liabilities:
Demand deposits	51,382			53,830
Other liabilities	6,930			5,801
Total Liabilities	592,005			633,512
Shareholders' Equity	54,200
Shareholders' equity				56,132
Total Liabilities and Shareholders' Equity	$646,205			$689,644
Net Interest Income and Net Interest Margin (3)		21,098	3.45%
Less: Tax Equivalent Adjustment		(721)
Net interest income and net interest margin (3)					22,541	3.43%
Less: Tax equivalent adjustment					(682)
Net Interest Income		$20,377	3.33%		$21,859	3.33%

(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 are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.

 

AVERAGE BALANCE SHEETSSHEET AND
ANALYSIS OF NET INTEREST INCOME
For the year ended December 31, 20032004

				Average Balance	Interest	Average Rate
	Average Balance	Interest	Average Rate
Interest Earning Assets:
Loans (1,3)	$367,701	$23,463	6.38%	$416,956	$24,100	5.78%
Taxable investment securities	118,021	5,252	4.45%	147,836	5,937	4.02%
Non-taxable investment securities (3)	31,273	2,133	6.82%	33,942	2,260	6.66%
Total Investments	149,294	7,385	4.95%	181,778	8,197	4.51%
Investment in Federal Home Loan Bank stock	8,700	265	3.05%	10,571	297	2.81%
Fed Funds sold, money market funds, and time
Fed funds sold, money market funds, and time
deposits with other banks	3,096	64	2.07%	2,726	49	1.80%
Total Earning Assets	528,791	31,177	5.90%	612,031	32,643	5.33%
Non Interest Earning Assets:
Non-Interest Earning Assets:
Cash and due from banks	8,227			8,308
Allowance for loan losses	(5,235)			(5,051)
Other assets (2)	29,054			30,917
Total Assets	$560,837			$646,205
Interest Bearing Liabilities:
Deposits	$276,807	$ 4,336	1.57%	$326,339	$ 4,409	1.35%
Securities sold under repurchase agreements	13,086	173	1.32%
Securities sold under repurchase agreements and fed funds purchased				13,427	151	1.12%
Borrowings from the Federal Home Loan Bank	163,724	6,566	4.01%	193,927	6,985	3.60%
Total Borrowings	176,810	6,739	3.81%	207,354	7,136	3.44%
Total Interest Bearing Liabilities	453,617	11,075	2.44%	533,693	11,545	2.16%
Rate Spread			3.45%			3.17%
Non Interest Bearing Liabilities:
Demand deposits	45,607			51,382
Other liabilities	7,689			6,930
Total Liabilities	506,913			592,005
Shareholders’ Equity	53,924
Total Liabilities and Shareholders’ Equity	$560,837
Net Interest Income and Net Interest Margin (3)		20,102	3.80%
Less: Tax Equivalent Adjustment		(684)
Shareholders' Equity				54,200
Total Liabilities and Shareholders' Equity				$646,205
Net interest income and net interest margin (3)					21,098	3.45%
Less: Tax equivalent adjustment					(721)
Net Interest Income		$19,418	3.67%		$20,377	3.33%

(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 are recorded in other assets.
(3) For purposes of these computations, interest income is reported on a tax equivalent basis.

 

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

	Average Balance	Interest	Average Rate	Average Balance	Interest	Average Rate
Interest Earning Assets:
Loans (1,3)	$325,712	$23,788	7.30%	$367,701	$23,463	6.38%
Taxable investment securities	118,684	6,751	5.69%	118,021	5,252	4.45%
Non-taxable investment securities (3)	29,142	1,984	6.81%	31,273	2,133	6.82%
Total Investments	147,826	8,735	5.91%	149,294	7,385	4.95%
Investment in Federal Home Loan Bank stock	7,812	288	3.69%	8,700	265	3.05%
Fed Funds sold, money market funds, and time deposits with other banks	6,461	154	2.38%	3,096	64	2.07%
Total Earning Assets	487,811	32,965	6.76%	528,791	31,177	5.90%
Non Interest Earning Assets:
Non-Interest Earning Assets:
Cash and due from banks	15,884			8,227
Allowance for loan losses	(4,607)			(5,235)
Other assets (2)	19,851			29,054
Total Assets	$518,939			$560,837
Interest Bearing Liabilities:
Deposits	$259,802	$ 5,880	2.26%	$276,807	$ 4,336	1.57%
Securities sold under repurchase agreements	13,124	288	2.19%	13,086	173	1.32%
Borrowings from the Federal Home Loan Bank	144,026	6,607	4.59%	163,724	6,566	4.01%
Total Borrowings	157,150	6,895	4.39%	176,810	6,739	3.81%
Total Interest Bearing Liabilities	416,952	12,775	3.06%	453,617	11,075	2.44%
Rate Spread			3.69%			3.46%
Non Interest Bearing Liabilities:
Non-Interest Bearing Liabilities:
Demand deposits	43,673			45,607
Other liabilities	5,501			7,689
Total Liabilities	466,126			506,913
Shareholders' Equity	52,813
Total Liabilities and Shareholders' Equity	$518,939
Net Interest Income and Net Interest Margin (3)		20,190	4.14%
Less: Tax Equivalent Adjustment		(613)
Shareholders’ Equity				53,924
Total Liabilities and Shareholders’ Equity				$560,837
Net interest income and net interest margin (3)					20,102	3.80%
Less: Tax equivalent adjustment					(684)
Net Interest Income		$ 19,577	4.01%		$19,418	3.67%

(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 are recorded in other assets.
(3)  For purposes of these computations, interest income is reported on a tax equivalent basis.

Net Interest Margin: The net interest margin, expressed on a tax-equivalent basis, represents the difference between interest and dividends earned on interest-bearinginterest-earning assets and interest paid to depositors and other creditors, expressed as a percentage of average earning assets.

The net interest margin 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.

The Company’s net interest margin amounted to 3.43% in 2005, compared with 3.45% and 3.80% in 2004 and 2003, representing declines of 2 and 35 basis points, 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 the net interest margin are enumerated in the following discussion and analysis.

NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED

										2005					2004
	2004 Average Rates					2003 Average Rates				Average Rate					Average Rate
	4th Qtr	3rd Qtr	2nd Qtr	1st Qtr		4th Qtr	3rd Qtr	2nd Qtr	1st Qtr
										4th Qtr	3rd Qtr	2nd Qtr	1st Qtr		4th Qtr	3rd Qtr	2nd Qtr	1st Qtr
Interest Earning Assets:
Loans (1,2)	5.91%	5.75%	5.63%	5.83%		6.14%	6.18%	6.55%	6.69%	6.34%	6.22%	6.10%	5.97%		5.91%	5.75%	5.63%	5.83%
Taxable investment securities	4.01%	4.00%	3.71%	4.40%		4.22%	4.02%	4.58%	4.86%	4.47%	4.09%	4.11%	4.16%		4.01%	4.00%	3.71%	4.40%
Non-taxable investment securities (2)	6.95%	6.86%	6.91%	5.88%		6.03%	7.06%	7.09%	7.17%	6.62%	6.84%	6.76%	7.19%		6.95%	6.86%	6.91%	5.88%
Total Investments	4.57%	4.51%	4.28%	4.70%		4.61%	4.66%	5.10%	5.31%	4.89%	4.57%	4.62%	4.78%		4.57%	4.51%	4.28%	4.70%
Investment in Federal Home Loan Bank stock	3.49%	3.02%	2.47%	2.17%		2.79%	3.01%	3.16%	3.26%
Fed Funds sold, money market funds, and time
Investment in Federal Home Loan Bank Stock										4.85%	4.41%	4.07%	4.02%		3.49%	3.02%	2.47%	2.17%
Fed funds sold, money market funds, and time
deposits with other banks	2.33%	1.84%	1.28%	2.06%		1.75%	2.27%	1.99%	2.32%	3.92%	3.46%	3.20%	2.28%		2.33%	1.84%	1.28%	2.06%
Total Earning Assets	5.48%	5.30%	5.14%	5.43%		5.63%	5.68%	6.06%	6.20%	5.94%	5.79%	5.70%	5.61%		5.48%	5.30%	5.14%	5.43%
Interest Bearing Liabilities:
Deposits	1.41%	1.34%	1.32%	1.38%		1.37%	1.49%	1.67%	1.79%	2.27%	2.02%	1.76%	1.52%		1.41%	1.34%	1.32%	1.38%
Securities sold under repurchase agreements	1.11%	1.13%	1.15%	1.12%		1.10%	1.21%	1.45%	1.58%	2.15%	1.91%	1.82%	1.45%		1.11%	1.13%	1.15%	1.12%
Borrowings from the Federal Home Loan Bank	3.86%	3.43%	3.41%	3.76%		3.95%	3.93%	3.99%	4.19%
Other borrowings										4.39%	4.27%	4.07%	3.91%		3.86%	3.43%	3.41%	3.76%
Total Borrowings	3.65%	3.33%	3.28%	3.54%		3.70%	3.74%	3.83%	3.99%	4.21%	4.10%	3.93%	3.75%		3.65%	3.33%	3.28%	3.54%
Total Interest Bearing Liabilities	2.23%	2.12%	2.10%	2.25%		2.27%	2.37%	2.53%	2.64%	2.96%	2.76%	2.56%	2.37%		2.23%	2.12%	2.10%	2.25%
Rate Spread	3.25%	3.18%	3.04%	3.18%		3.36%	3.31%	3.54%	3.56%	2.98%	3.03%	3.14%	3.24%		3.25%	3.18%	3.04%	3.18%
Net Interest Margin (2)	3.55%	3.45%	3.28%	3.51%		3.70%	3.66%	3.88%	3.96%	3.36%	3.39%	3.45%	3.54%		3.55%	3.45%	3.28%	3.51%
Net Interest Margin without Tax Equivalent Adjustments	3.43%	3.33%	3.16%	3.40%		3.58%	3.53%	3.74%	3.83%	3.26%	3.30%	3.35%	3.41%		3.43%	3.33%	3.16%	3.40%

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

The prolonged,In June of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") began increasing short-term interest rates. Through December 31, 2005, the Fed funds targeted rate had been increased thirteen times, ending 2005 at 4.25%. However, during this same period of time, the benchmark 10-year U.S. Treasury note declined 48 basis points, causing a dramatic 373 basis point flattening of the U.S. Treasury yield curve.

Preceding the start of the Federal Reserve’s interest rate tightening cycle in June 2004, the Company’s net interest margin had been posting steady declines, as the historically low interest rate environment during the past few years caused sharp yield declines on the Bank’s variable rate earning assets and accelerated prepayment speeds on fixed rate earning assets driven in part by loan refinancing activity and accelerated cash flows from the investment securities portfolio. The interest rateThis environment over the past few years caused considerable margin erosion, given the Bank’s asset sensitive balance sheet; specifically,as the decline in yields on earning assets occurred at a faster pace than the decline in the cost of interest bearing funds.

As short-term interest rates continued to increase during the second half of 2004, the net interest margin began to strengthen, as the Bank’s earning asset base was re-pricing faster than the increases in its funding costs, due in part to a large floating rate loan base, the Bank’s asset sensitive balance sheet, and a variety of pricing strategies implemented by Bank management.

In the second quarter of 2005 the net interest margin began to decline and this decline continued to accelerate through the end of the year. The declining net interest margin during 2005 was principally attributed to the increases in the Bank’s cost of funds outpacing the increases in yields on its earning assets, reflecting the re-pricing of a large portion of the Bank’s funding base during a period of rapidly rising short-term interest rates, combined with highly competitive pricing pressures with respect to loans and deposits, a higher utilization of wholesale funding, and the inherent net interest margin challenges widely associated with a flat U.S. Treasury yield curve.

The yield on average earning assets amounted to 5.33% during 2004,5.77% in 2005, compared with 5.33% and 5.90% in 2004 and 6.76% in 2003, representing an increase of 44 basis points and 2002, representing declinesa decline of 57 and 86 basis points, respectively. Similarly, the cost of interest bearing liabilities amounted to 2.16%2.67% in 2004,2005, compared with 2.16% and 2.44% and 3.06% in 2003 and 2002, representing declines of 28 and 62 basis points, respectively. Driven by loan refinancing activity and accelerated cash flows from the investment portfolio, during 2004 and 2003, representing an increase of 51 basis points and a decline of 28 basis points, respectively.

During 2005, the declinesincrease in the cost of interest bearing liabilities exceeded the increase in yields on earning assets by 7 basis points, whereas in 2004 the decline in yields on earning assets exceeded the declinesdecline in the cost of interest bearing liabilitiesfunds by 29 and 24 basis points, respectively. points.

During 2004 and 2003,Bank management anticipates continued pressure on the Bank pursued a number of strategies to achieve a reasonably stable net interest margin in an extended low interest rate environment, while itduring 2006, and believes that continued to manage exposure to rising rates over the longer-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. In 2004, the loan products of choice included adjustable rate mortgages and commercial loans. While the foregoing types of products typically generate lower yields than longer maturity, fixed rate products, their cash flow and adjustable rate characteristics diminish the degree of long-term interest rate risk, and better positions the Bank for rising interest rates in the future.

The Bank has utilized longer-term borrowingsgrowth will be needed to fund a portion of earning asset growth over the past few years. While the use of longer-term borrowing maturities naturally resulted in higher funding costs and less net interest income, they more closely matched the maturities of fixed rate earning assets that were being added tomeaningfully increase the Bank’s balance sheet, thereby preserving the sensitivity2005 level of net interest income in a rising interest rate environment.

The Bank has been deliberate in its efforts to hedge the interest rate risk associated with the addition of long term, fixed rate earning assets to the balance sheet during a period of historically low interest rates. Management believes the strategy of maintaining an asset sensitive balance sheet has contributed to the net interest margin declines over the past two years. While an asset sensitive balance sheet pressures the net interest margin and net interest income in an extended flat or declining interest rate environment, it typically strengthens it in a rising rate environment, a scenario management anticipated was more likely to occur. The Bank has been deliberate in its efforts to manage 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. Management believes that its strategy of maintaining an asset sensitive balance sheet is important to the Company’s long-term success and such posture better positions it for rising2006, should interest rates and an improving economy.

Duringremain at current levels, or the six-months ended June 30, 2004, the Bank continued to experience considerable margin erosion in the low interest rate environment compared with prior years. In the second half of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") increased short-term interest rates five times, with the Fed funds targeted rate ending the year at 2.25%. As management anticipated, these increases favorably impacted the Bank’s net interest margin during this period of time, with theU.S Treasury yield on average earning assets increasing 34 basis points to 5.48%, and the cost of interest bearing funds increasing only 13 basis points to 2.23%. Consequently, the net interest margin increased to 3.55% in fourth quarter of 2004, compared with the two-year low of 3.28% experienced during the quarter ended June 30, 2004, representing an improvement of 27 basis points. In line with the current interest rate environment, management anticipates the net interest margin will continue to stabilize into the first quarter of 2005.curve become inverted.

The Bank’s interest rate sensitivity position is more fully described in Part II, Item 7a of this Annual Report on Form 10-K, Quantitative and Qualitative Disclosures About Market Risk.

Interest Income: TotalFor the year ended December 31, 2005, total interest income, on a fully tax-equivalent basis, for the year ended December 31, 2004 amounted to $32,643,$37,877, compared with $32,643 and $31,177 in 2004 and $32,965 in 2003, and 2002, representing an increaseincreases of $5,243 and $1,466, or 16.1% and 4.7%, and a decrease of $1,788 or 5.4%, respectively.

Yield declines on the Bank’s earning assets slowed during 2004, compared with the declines experienced in 2003 when loan refinancing activities and prepayment speeds on investment securities reached historical highs.

The increase in 20042005 interest income was principally attributed to average earning asset growth of $83,240, as$44,786 or 7.3%, combined with a 44 basis point increase in the yield on totalweighted average earning assets declined 57 basis points. Comparingasset yield. The increase in 2003 with 2002, the decline in interest income compared with 2004 was principally attributed to an 86earning asset growth of $83,240 or 15.7%, offset in part by a 57 basis point decline in the weighted average earning asset yields, but largely offset by 2003 earning asset growth of $40,980.yield.

As depicted on the rate / volume analysis tables below, the increased volume of average earning assets on the balance sheet during 2005 contributed $3,265 to the increase in 2005 interest income compared with 2004, while the increase attributed to the impact of a higher weighted average earning asset yield amounted to $1,969. In 2004, the increased volume of average earning assets on the balance sheet contributed $4,416 to the increase in 2004 interest income compared with 2003, offset in part by a decline of $2,950 attributed to the impact of a lower yields. During 2003, the decline in interest income attributed to the impact of lower yields amounted to $4,731; offset in part by $2,943 attributed the increased volume ofweighted average earning assets.asset yield.

Interest Expense: Total interest expense forFor the year ended December 31, 20042005, total interest expense amounted to $11,545$15,336, compared with $11,545 and $11,075 in 2004 and $12,775 in 2003, and 2002, representing an increaseincreases of $3,791 and $470, or 4.2%,32.8% and a decrease of $1,700 or 13.3%4.2%, respectively.

The increase in 2005 interest expense was principally attributed to a $40,188 or 7.5% increase in average interest bearing liabilities, combined with a 51 basis point increase in the weighted average rate paid on interest bearing liabilities. The increase in 2004 interest expense compared with 2003 was principally attributed to an $80,076 increase of $36,665 in average interest bearing liabilities, as the cost of average interest bearing liabilities declined 28 basis points compared with 2003. The decline in 2003 interest expense compared with 2002 was principally attributed to a 62 basis point decline in the cost of interest bearing liabilities, offset in part by a $36,665 increase28 basis point decline in the weighted average rate paid on interest bearing liabilities.

The declines in the average cost of interest bearing funds was principally attributed to the historically low interest rate environment, prompting management to reduce rates on non-maturity deposits while maturing time deposits were being replaced at prevailing lower rates.

As depicted on the rate / volume analysis tables below, the increased volume of average interest bearing liabilities on the balance sheet during 2005 contributed $483 to the increase in 2005 interest expense compared with 2004, while the increase attributed to the impact of a higher weighted average rate paid on interest bearing liabilities contributed $3,308. In 2004, the increased volume of average interest bearing liabilities on the balance sheet contributed $1,852 to the increase in 2004 interest expense compared with 2003, but was substantially offset in part by a decline of $1,382 attributed to the impact of the decline in the cost of interest bearing liabilities. During 2003, the decline in interest expense attributed to the impact of the decline in the cost of interest bearing liabilities amounted to $2,908, offset in part by $1,208 attributed to the increased volume ofa lower weighted average rate paid on interest bearing liabilities.

Rate / Volume Analysis: 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 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, 20042005 VERSUS DECEMBER 31, 20032004
INCREASES (DECREASES) DUE TO:

	Average Volume	Average Rate	Net Interest Income	Average Volume	Average Rate	Net Interest Income
Loans (1,2)	$2,969	$(2,332)	$  637	$4,078	$ 1,417	$5,495
Taxable investment securities	1,233	(548)	685	(632)	287	(345)
Non-taxable investment securities (2)	179	(52)	127	(171)	65	(106)
Investment in Federal Home Loan Bank Stock	54	(22)	32	4	165	169
Fed Funds sold, money market funds, and time
deposits with other banks	(19)	4	(15)
Fed Funds sold, money market funds, and time deposits with other banks				(14)	35	21
TOTAL EARNING ASSETS	$4,416	$(2,950)	$1,466	$3,265	$ 1,969	$5,234
Interest bearing deposits	716	(643)	73	428	2,104	2,532
Securities sold under repurchase agreements	4	(26)	(22)	12	109	121
Borrowings from the Federal Home Loan Bank	1,132	(713)	419
Other borrowings				43	1,095	1,138
TOTAL INTEREST BEARING LIABILITIES	$1,852	$(1,382)	$   470	$   483	$ 3,308	$3,791
NET CHANGE IN NET INTEREST INCOME	$2,564	$(1,568)	$   996	$2,782	$(1,339)	$1,443

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

 

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
TWELVE MONTHS ENDED DECEMBER 31, 20032004 VERSUS DECEMBER 31, 20022003
INCREASES (DECREASES) DUE TO:

	Average Volume	Average Rate	Net Interest Income	Average Volume	Average Rate	Net Interest Income
Loans (1,2)	$2,871	$(3,196)	(325)	$2,969	$(2,332)	$ 637
Taxable investment securities	(38)	(1,461)	(1,499)	1,233	(548)	685
Non-taxable investment securities (2)	145	4	149	179	(52)	127
Investment in Federal Home Loan Bank Stock	31	(54)	(23)
Investment in Federal Home Loan Bank stock				54	(22)	32
Fed Funds sold, money market funds, and time deposits with other banks	(66)	(24)	(90)	(19)	4	(15)
TOTAL EARNING ASSETS	$2,943	$(4,731)	$(1,788)	$4,416	$(2,950)	$1,466
Interest bearing deposits	364	(1,908)	(1,544)	716	(643)	73
Securities sold under repurchase agreements	(1)	(114)	(115)	4	(26)	(22)
Other borrowings	845	(886)	(41)
Borrowings from the Federal Home Loan Bank				1,132	(713)	419
TOTAL INTEREST BEARING LIABILITIES	$1,208	$(2,908)	$(1,700)	$1,852	$(1,382)	$ 470
NET CHANGE IN NET INTEREST INCOME	$1,735	$(1,823)	$      (88)	$2,564	$(1,568)	$ 996

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

Provision for Loan Losses

For the year ended December 31, 2004,2005, the Bank recordeddid not record a provision for loan losses, amounting to $180, compared with $180 and $540 in 2004 and $1,100 in 2003, and 2002, representing decreases of $360 and $560, or 66.7% and 50.9%, respectively.

The provision for loan losses reflects the amount necessary to maintain the Allowanceallowance for Loan Lossesloan losses ("allowance") at a level that, in management’s judgment, is appropriate for the amount of inherent risk of loss in the Bank’s current loan portfolio. Non-performingIn prior reporting periods the allowance incorporated loss estimates relating to certain borrowers in the Maine wild blueberry processing industry that were involved in legal proceedings with certain blueberry growers, which management believed warranted recognition of increased credit risk. During the first quarter of 2005, these legal matters were, in the opinion of management, satisfactorily resolved, thus improving the overall credit risk profile of the Bank’s loan portfolio.

The Bank’s non-performing loans remained at low levels during 2005. At December 31, 2005, total non-performing loans amounted to $868, or 0.17% of total loans, compared with $723 or 0.16% at December 31, 2004 amounted to $723, representing a decline of $771, or 51.6% compared with December 31, 2003, and remain at low levels.2004. The allowance for loan losses expressed as a percentage of non-performing loans strengthenedamounted to 535% at December 31, 2005, compared with 668% at December 31, 2004,2004.

The Bank's loan loss experience showed an improvement during 2005, with net charge-offs amounting to $182, or net charge-offs to average loans outstanding of 0.04%, compared with 353% and 424% at December 31, 2003 and 2002. While 2004$629, or net charge-offs to average loans outstanding of $629 have shown an increase of $392 compared 2003, management does not consider these as being reflective of the overall credit quality of the loan portfolio, as $506 of the 2004 charge offs were attributed to two relationships and were adequately provided for in the Bank’s previously recorded allowance for loan losses.0.15% during 2004.

Based upon the continued improvement in the performance of the loan portfolio, combined with certain improvements with respect to specific credit relationships including borrowers engaged in the provision was decreased in 2004 as compared with 2003 and 2002Maine wild blueberry processing industry, as noted above. above the Bank did not record a provision for loan losses in 2005.

Refer to Part II, Item 7, Allowance for Loan Losses, in this Annual Report on Form 10-K for further discussion and analysis regarding the provision for loan losses.

Non-Interest Income

In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations.

For the year ended December 31, 20042005, total non-interest income amounted to $6,572,$6,415, compared with $6,572 and $7,074 in 2004 and $6,322 in 2003, and 2002, representing a decreasedeclines of $157 and $502 or 7.1%2.4% and an increase of $752 or 11.9%7.1%, respectively.

Factors contributing to the changes in non-interest income are enumerated in the following discussion and analysis:

Trust and Financial Services Income: During 2004, incomeIncome from trust and financial services represented 29.4%31.1% of the Company’s total non-interest income in 2005, compared with 29.4% and 31.0% in 2004 and 35.8% in 2003, and 2002, respectively.

For the year ended December 31, 2004, income generated from trust and financial services amounted to $1,929, compared with $2,192 and $2,261 in 2003 and 2002, representing declines of $263 and $69, or 12.0% and 3.1%, respectively.

Income from trust and financial services is principally derived from fee income based on a percentage of the market value of client assets under management and held in custody and, to a lesser extent, revenue from brokerage services conducted through Bar Harbor Financial Services, an independent third-party brokerage services.broker.

The declines in 2004 and 2003 feeFor the year ended December 31, 2005, income generated from trust and financial services reflected declines in average managed assets, combined with pricing strategies designed to remain competitive while attracting new business. During 2004, Trust Services introduced a new high yield money market product for its clients, and eliminated certain 12b-1 fees, which in 2003 and 2002 amounted to $35$1,992, compared with $1,929 and $53, respectively. During the fourth quarter of$2,192 in 2004 assets under management postedand 2003, representing an increase of $16,421, ending the year at $196,070$63 or 3.3% and if sustained, positioned the portfolio for highera decline of $263 or 12.0%, respectively.

The increase in 2005 fee income returns in 2005.

Revenuecompared with 2004 was driven by trust and investment services, as revenue generated from third-party brokerage activities (attributable in 2003 and part of 2004 to activities of the now dissolved BTI Financial Group and in 2004 to the Company’s third-party brokerage relationship withat Bar Harbor Financial Services) alsoServices posted a 2004 revenuemoderate decline, following a moderate increase in 2003, principally reflecting lower trading volumes, including sales of mutual funds and annuity products.

The Company does not anticipate significant future increasesdecline in this source2004 fee income compared with 2003 was attributed to declines in revenue generated from third-party brokerage services and, to a lesser extent, fee income from trust and investment services, reflecting declines in average assets under management and the implementation of revenue.pricing strategies designed to remain competitive while attracting new business.

At December 31, 2005, total managed assets at Bar Harbor Trust Services stood at $220,537, compared with $196,079 at December 31, 2004, representing an increase of $24,458, or 12.5%. In light of the 2005 growth in the managed assets portfolio, management believes the portfolio is positioned to generate higher levels of fee income in 2006.

Service Charges on Deposit Accounts: This income is principally derived from monthly deposit account maintenance and activity fees, overdraft fees, and a variety of other deposit account related fees. Income from service charges on deposit accounts represented 22.3%21.7% of total 20042005 non-interest income, compared with 22.3% and 21.3% in 2004 and 23.5% in 2003, and 2002, respectively.

For the year ended December 31, 2004,2005, income generated from service charges on deposit accounts amounted to $1,463,$1,390, compared with $1,463 and $1,509 in 2004 and $1,483 in 2003, and 2002, representing declines of $73 and $46, or 5.0% and $26, or 3.0% and 2.7%, respectively.

As was the case during 2003, the growth in2004, income generated from service charges on deposit accounts continuedremained under pressure during 2004. Given2005. Bank management attributes the declines, in part, to aggressive competitive pricing in the markets served by the Bank, it has not increased its service charge fees onand believes this will continue in the future as financial institutions compete for deposit accountsmarket share and continue to offer a variety of "no fee" products. Management also believes that over the past fewcouple of years while customers have been closing or consolidating small balance accounts, migrating to relationship products that have lower fees, and reducing their volume of account overdraft activity.

The Bank expects aggressive competitive pricing of deposit products will continue in the future, as financial institutions compete for deposit balances and market share, and continue to offer a variety of "no fee" products. In the first quarter ofDuring 2005, the Bank increased selected fees on deposit accounts and anticipates thislaunched a new Overdraft Honor service which it believes will help stem further declines in this particular source ofincrease non-interest income.income generated from deposit account service charges.

Credit Card Service Charges and Fees: This income is principally derived from the Bank’s merchant credit card transaction processing services and, to a lesser extent, fees associated with its Visa credit card product. Income from credit card service charges and fees represented 25.7%29.2% of total 20042005 non-interest income, compared with 21.3%25.7% and 23.5%22.8% in 20032004 and 2002,2003, respectively.

For the year ended December 31, 2004,2005, income generated from credit card service charges and fees amounted to $1,687,$1,876, compared with $1,687 and $1,614 in 2004 and $1,654 in 2003, and 2002, representing an increaseincreases of $189 and $73, or 4.5%,11.2% and a decrease of $40 or 2.4%4.5%, respectively.

While merchant credit card processing profit margins have generally tightened over the past few years, andwith competition from large regional processors has intensified,intensifying, the Bank has been able to sustain comparable levels ofgrow revenue through new business, increased volumes of transactions, competitive pricing strategies, and the local customer-centric support offered by a community bank.

Net Securities Gains: This source of non-interest income representsis derived from net gains on the sale of investment securities. Net gains on the sale of investment securities represented 7.6%9.0% of total 20042005 non-interest income, compared with 7.6% and 17.8% in 2004 and 7.1% in 2003, and 2002, respectively.

For the year ended December 31, 20042005, net gains on the sale of investment securities amounted to $497,$580, compared with $497 and $1,257 in 2004 and $450 in 2003, representing an increase of $83 or 16.7%, and 2002, representing a declinedecrease of $760 or 60.5%, and an increase of $807 or 179.3%, respectively.

The interest rate environment during 2004, combined with the characteristics of the Bank’s securities portfolio, did not present as much need or opportunity for securities repositioning transactions, as was the case during 2003, when mortgage-backed security pre-payment speeds reached historical highs. The sale of securities during 20042005 was in part driven by a combination of strong loan growth, the timing and extent of seasonal deposit flows, and the Bank’s need for adequate liquidity.liquidity needs, and responses to significant changes in market yields.

There is no assurance that the recording of securities gains will continue in future reporting periods at 2005, 2004 and 2003 levels. It is important to note, however, that the available for sale investment securities portfolio is managed on a total return basis, in concert with well-structured asset/liability management policies. Bank management will continue to respond to changes in market interest rates, changes in securities pre-payment or extension risk, changes in the availability of and yields on alternative investments, and the Bank’s need for adequate liquidity.

Net Income on Interest Rate Swap Agreements: As part of its overall asset liability/management strategy, the Bank periodically uses interest rate swap agreements to minimize significant unanticipated fluctuations in earnings and cash flows caused by interest rate volatility. At December 31, 2005, the Bank had two outstanding interest rate swap agreements with notional principal amounts totaling $20,000.

As more fully enumerated in Part II, Notes 1Item 8, and 16Note 15 of the consolidated financial statementsConsolidated Financial Statements of this Annual Report on Form 10-K, induring the first quarter of 2004, the Bank de-designated its interest rate swap agreements as cash flow hedges. In prior reporting periods,hedges and, from the time of de-designation, changes in thetheir fair value of the interest rate swap agreements were recorded on the consolidated balance sheet in other comprehensive income, whileand current period net cash flows representing net amounts received from or paid to counter-parties were recorded in the consolidated statement of income and included as interest income. From the timepart of their de-designation, changes in their fair value and current period net cash flows were recorded in non-interest income.

In July 2004, the Financial Accounting Standards Board ("FASB") issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:  Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interest-bearing loans, provided all other conditions for a cash flow hedge have been met. During the third quarter of 2004 the Bank re-designateddesignated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are being recorded on the consolidated balance sheet in accumulated other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties are recorded as interest income.

For the year ended December 31, 2004, non-interest income on interest rate swap agreements amounted to $404 (non-hedge accounting period), whereas no such non-interest income was recorded in 2005 and 2003 and 2002.(hedge accounting periods). Of the $404 in non-interest income on interest rate swap agreements recorded during 2004, $375 represented net cash flows received from counterparties,counter-parties, and $29 represented net unrealized gains.

The Bank’s interest rate swap agreements are discussed in further detail under Item 7 of this Annual Report on Form 10-K, Derivative Instruments.

Other Operating Income: Other operating income represented 5.4%5.1% of total 20042005 non-interest income, compared with 5.4% and 4.3% in 2004 and 5.4% in 2003, and 2002, respectively. For the year ended December 31, 20042005 total other operating income amounted to $356,$330, compared with $356 and $302 in 2004 and $340 in 2003, representing a decline of $26 or 7.3% and 2002, representing an increase of $54 or 17.9%, and a decrease of $38 or 11.2%.respectively.

Other operating income is principally derived from bank-owned life insurance ("BOLI"), representing increases in the cash surrender value of life insurance policies on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Income from BOLI amounted to $235 in 2005, compared with $222 and $204 in 2004 compared with $204 and $221 in 2003, and 2002, representing 71.2%, 62.4%, 67.5%, and 65.0%67.5% of other operating income, respectively.

Non-interest Expense

For the year ended December 31, 2004,2005, total non-interest expense amounted to $18,914,$19,268, compared with $18,914 and $18,853 in 2004 and $18,245 in 2003, and 2002, representing increases of $354 and $61, or 1.9% and $508, or 0.3% and 3.3%, respectively.

A variety of factors, both favorable and unfavorable, contributedFactors contributing to 2004the changes in non-interest expense year-over-year results.

As more fullyare enumerated below, included in 2004 non-interest expense were costs associated with the Company’s corporate re-branding initiative, other-than-temporary impairment write-downs of certain non-marketable equity investments, and costs related to integration activities associated with the Rockland branch acquisition. Non-interest expenses also included a variety of costs related to the Sarbanes-Oxley Act of 2002, which, among other things, established extensive new requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting.

The Company’s success in containing the increase in 2004 non-interest expense at less than 1% was attributed in part to a variety of previously reported expenses incurred during 2003 related to organizational restructuring activities in the Company’s financial services division including certain legal expensesfollowing discussion and settlements, an other-than-temporary impairment write-down of goodwill, and adjustments to the workforce including employee severance payments. Salaries and employee benefits declined during 2004, reflecting current and prior year changes to staffing levels and compensation mix.analysis.

Salaries and Employee Benefits: For the year ended December 31, 2004,2005, total salaries and benefit expenses amounted to $9,335,$9,795, compared with $9,335 and $9,483 in 2004 and $9,235 in 2003, representing an increase of $460 or 4.9% and 2004, representing a decreasedecline of $148 or 1.6%, and an increase of $248 or 2.7%, respectively.

Over the past twofew years the Company has made a number of strategic adjustments to the workforce, the results of which continued to be reflected in the 2005 and 2004 and 2003 year-over-yearchanges in salary and employee benefit expense levels.

The 4.9% increase in 2005 salaries and employee benefits expense was principally attributed to overall increases in the level of employee compensation including incentive compensation, increased health insurance subsidies, as well as the impact and timing of certain staffing changes during 2004 and 2005.

The 1.6% decline in 2004 salaries and employee benefits expense compared with 2003 was attributed, in part, to the timing and impact certain staffing adjustments made in 2003, including employee relocation expenses and the payment of employee severance.

As previously reported, on March 2, 2005, Dean S. Read Resigned from his position as President of the Bank.  In conncection with Mr. Read's resignation, the Company and Mr. Read have entered into a severance agreement purusant to which, among other things, the Company will pay Mr. Read a severance payment and a portion of Mr. Read's health benefits for a limited period of time.  The Company estimates that approximately $238payments, offset in salaries and benefits expense will be recorded in the first quarter of 2005 related to Mr. Read's severance agreement.part by normal employee compensation increases during 2004.

Occupancy Expenses: For the year ended December 31, 2004,2005, total occupancy expenses amounted to $1,170,$1,168, compared with $1,170 and $1,058 in 2004 and $1,020 in 2003, representing a decline of $2 or 0.2% and 2002, representing increasesan increase of $112, and $38, or 10.6% and 3.7%, respectively.

The 2004 increase in 2004 occupancy expenses werecompared with 2003 was principally attributed to a number of factors including both initial and ongoing expenses associated with the Bank’s acquisition of the Rockland branch office, and certain expenses associated with the Company’s 2004 re-branding initiative. BothThe non-recurring nature of most of these expenses helped contain the 2004 and 2003 increasesincrease in 2005 occupancy expenses, reflected normal increases in a variety of occupancy related costs.compared with 2004.

Furniture and Equipment Expenses: For the year ended December 31, 2004,2005, total furniture and equipment expenses amounted to $1,716,$1,664, compared with $1,716 and $1,540 in 2004 and $1,535 in 2003, representing a decline of $52 or 3.0%, and 2002, representing increasesan increase of $176 and $5, or 11.4%, respectively.

The decline in 2005 furniture and 0.3%, respectively.equipment expenses compared with 2004, reflects certain costs incurred in connection with the Rockland branch acquisition in 2004 that did not recur in 2005, combined with lower depreciation and maintenance costs associated with the Company’s technology infrastructure.

The increase in 2004 furniture and equipment expenses compared with 2003 was principally attributed to certain costs associated with the Rockland branch acquisition as well asand, to a lesser extent, certain costs associated with upgrades to the Company’s technology infrastructure.

Credit Card Expenses: For the year ended December 31, 2004,2005, total credit card expenses amounted to $1,249,$1,397, compared with $1,249 and $1,187 in 2004 and $1,224 in 2003, and 2002, representing an increaseincreases of $148 and $62, or 5.2%,11.8% and a decrease of $37 or 3.0%5.2%, respectively.

Credit card expenses principally relate to the Bank’s merchant credit card processing activities, and to a lesser extent its Visa credit card portfolio. The $62 increaseincreases in 2005 and 2004 credit card expenses compared with 2003, waswere principally attributed to increases in merchant credit card transaction processing volumes, which favorably impacted the corresponding 2005 and 2004 non-interest income derived from these activities by $73. Likewise, the $37 decrease in 2003 credit card expenses compared with 2002 was principally attributed to declines in merchant credit card processing volumes,$189 and also contributed to the corresponding decline in 2003 non-interest income derived from merchant credit card processing activities.$73, respectively.

Other Operating Expenses: For the year ended December 31, 2004,2005, total other operating expenses amounted to $5,444,$5,244, compared with $5,444 and $5,585 and $5,231 in 20032004 and 2002, representing a decreasedeclines of $200 and $141, or 2.5%,3.7% and an increase of $354 or 6.8%2.5%, respectively.

A variety of factors, both favorable and unfavorable, contributed to the 2004 year-over-year increaseThe $200 decrease in 2005 other operating expenses compared with 2004 was principally attributed to a $300 decline in marketing related expenses.

Included in 2004 other operating expenses were a variety of marketing related costs associated with the Company’s previously announced corporate re-branding and market research initiatives. The Company introduced updated logos and simplified corporate identities, together with a comprehensive marketing program promoting the Company’s new image and certain new banking product packages such as  Home Plus and Ideal Checking. Total 2004 marketing and public relations expenses amounted to $830 compared with $468 in 2003, representing an increase of $361, or 77.2%.packages.

Included in 2005 and 2004 other operating expenses, waswere the write-down of certain non-marketable venture capital equity investment funds considered other-than-temporarily impaired amounting to $197. No impairment write-downs were recorded during 2003 or 2002.impaired. These equity investment funds, originating as far back as 1987 and in some cases qualifying for Community Reinvestment Act credit, generally represent socially responsible venture capital investments in small businesses throughout Maine and New England. The total amount ofDuring 2005, the 2004 impairment write-downs represented 28.1%on these funds amounted to $19 compared with $197 in 2004, representing a decline of their recorded book value.$178 thousand.

IncludedThe $141 decline in 2004 other operating expenses were certain costs related to the Company’s compliance with the sweeping changes in U.S. securities laws and regulations enacted under the Sarbanes-Oxley Act of 2002, particularly Section 404, which establishes extensive new requirements for both management and auditors of public companies with respect to reporting on internal control over financial reporting. Included in 2004 other operating expenses were a variety of audit fees amounting to $425, representing an increase of $133, or 45%, compared with 2003.

The Company’s success in containing the increase in 2004 other operating expenses at 2.5%2003 was principally attributed in part to a variety of previously reported expenses incurred during 2003, related to organizational restructuring activities in the Company’s financial services division, including certain legal expenses and settlements, and an other-than-temporary impairment write-down of goodwill related to its then existing second-tier brokerage subsidiary. The foregoing expenses also represented the major factors underlying the $354 or 6.8% increase in other operating expenses experienced in 2003 compared with 2002, as well as the $508 or 3.3% increase in total non-interest expenses in 2003 compared with 2002.

Income Taxes

For the year ended December 31, 20042005 total income tax expensetaxes amounted to $2,123,$2,582, compared with $2,123 and $1,892 in 2004 and $1,742 in 2003, and 2002, representing increases of $459 and $231, or 21.6% and $150, or 12.2% and 8.6%, respectively. The percentage increase in 2005 income taxes was larger than the increase in pre-tax earnings principally due to non-taxable income generated from the Bank’s securities and loan portfolios bearing a smaller percentage of income before income taxes compared with 2004.

Effective Income Tax Rate: The Company’s effective income tax rate in 20042005 amounted to 27.0%28.7%, compared with 27.0% and 26.7% in 2004 and 26.6% in 2003, and 2002, respectively. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 34% to income before income taxes, principally because of the impact of tax-exempt income on certain investment securities, loans and bank owned life insurance.

Fluctuations in the Company’s effective tax rate can occur based upon the percentage of non-taxable income in relation to income before income taxes, during any given reporting period. The Company’s 2005 effective tax rate was higher than the effective tax rates in 2004 and 2003, principally due to non-taxable income bearing a smaller percentage of income before income taxes.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.

The responsibility for interest rate risk management oversight is the function of the Bank’s Asset/Asset and Liability Committee ("ALCO"), chaired by the Chief Financial Officer and composed of various members of corporate senior management. ALCO meets regularly to review balance sheet structure, formulate strategy in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

Interest Rate Risk: Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's 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 promisepromote sufficient reward for understood and controlled risk.

The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by the Bank’s ALCO and Board of Directors.

The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

Interest rate risk is monitored through the use of two complementary measures: static gap analysis ("gap") and interest rate sensitivity modeling. While each measurement may have its limitations, taken together they form a reasonably comprehensive view of the magnitude of the Bank’s interest rate risk, the level of risk over time, and the quantification of exposure to changes in certain interest rate relationships.

Static Gap Analysis: Interest rate gap analysis provides a static view of the maturity and re-pricing characteristics of the Bank’s on and off-balance sheet positions. Gap is defined as the difference between assets and liabilities re-pricing or maturing within specified periods. An asset-sensitive position, or "positive gap," indicates that there are more rate sensitive assets than rate-sensitive liabilities re-pricing or maturing within a specified time period, which would imply a favorable impact on net interest income during periods of rising interest rates. Conversely, a liability-sensitive position, or "negative gap," generally implies a favorable impact on net interest income during periods of falling interest rates.

The Bank’s static interest rate sensitivity gap is summarized below:

INTEREST RATE RISK
CUMULATIVE STATIC GAP POSITION
December 31, 2005 and 2004

	One Day To Six Months	Over Six Months To One Year	Over One Year To Five Years	Over Five Years
December 31, 2005	$(94,673)	$ (57,896)	$ 76,047	$(10)
December 31, 2004	$ 12,231	$ 43,487	$137,317	$   6
Change ($)	$(106,904)	$(101,383)	$ (61,270)	$(16)

The Bank’s December 31, 2005 cumulative interest rate risk sensitivity static gap position indicated that the Bank’s balance sheet was liability sensitive over the twelve-month horizon and was asset sensitive beyond the twelve-month horizon.

Changes in the Bank’s cumulative static gap position from the prior year principally reflect a higher levels of longer term fixed rate earning assets on the balance sheet funded with higher levels of shorter term funding. Given the steadily rising short-term interest rates over the past year with the yield curve headed towards inversion, borrower preference leaned towards locking in fixed interest rates over longer periods of time. Likewise, the shape of the yield curve did not provide depositors with a yield reward for longer maturities on time deposits.

In addition, pursuant to the Bank’s asset and liability management strategy, management chose not to extend the maturities on its wholesale funding base, believing the Federal Reserve is nearing the end of its tightening cycle, and that an inverted yield curve has historically preceded an eventual decline in short-term interest rates. The static gap position at December 31, 2005 indicated that the Bank’s exposure to declining interest rates beyond the one-year horizon was significantly less than that on December 31, 2004.

There are certain limitations inherent in static gap analysis. These limitations include the fact that it is a static measurement and it does not reflect the degrees to which interest earning assets and interest bearing liabilities may respond non-proportionally to changes in market interest rates. Although the ALCO reviews all assumptionsdata used in the model in detail, assets and liabilities do not always have clear re-pricing dates, and re-pricing may occur earlier or later than assumed in the model.

The Bank’s static interest rate sensitivity gap is summarized below:

INTEREST RATE RISK
CUMULATIVE STATIC GAP POSITION
December 31, 2004 and 2003

	One Day To Six Months	Over Six Months To One Year	One Year To Five Years	Over Five Years
December 31, 2004	$12,231	$43,487	$137,317	$  6
December 31, 2003	$ (3,532)	$30,921	$  75,221	$ (3)
Change ($)	$15,763	$12,566	$ 62,096	$  9

The Bank’s December 31, 2004 cumulative interest rate risk sensitivity static gap position indicates the Bank’s balance sheet is asset sensitive over all future periods. The December 31, 2003 gap position indicated the Bank’s balance sheet was asset sensitive, but not to the same degree as of December 31, 2004. Changes in the Bank’s cumulative static gap position principally reflect a higher level of variable rate earning assets at December 31, 2004 compared with the same date in 2003.

Based in part upon the cumulative static gap position, management believes that the Bank’s balance sheet is favorably positioned for rising rates and an improving economy, but is moderately exposed to declining rates and a stalled economy.

Interest Rate Sensitivity Modeling: The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense offor all balance sheet and off-balance sheet instruments, under different interest rate scenarios, together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposits accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions, are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backedmortgage-backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:

• A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.
• A 100, 200 and 400 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve- monthtwelve-month period together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
• Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
• An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products that will continue to change the balance sheet profile for each of the rate conditions.

Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.

The following table summarizes the Bank's net interest income sensitivity analysis as of December 31, 2004,2005, over one and two year horizons and under different interest rate scenarios. Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken in order to maintain the balance sheet interest rate risk within established policy guidelines.

 

INTEREST RATE RISK
CHANGECHANGES IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31, 20042005

	-100 Basis Points Parallel Yield Curve Shift	+200 Basis Points Parallel Yield Curve Shift	+200 Basis Points Short Term Rates	+400 Basis Points Short Term Rates
					-200 Basis Points Parallel Yield Curve Shift	+200 Basis Points Parallel Yield Curve Shift	-200 Basis Points Short Term Rates
Year 1
Net interest income change ($)	$88	$65	$28	$97	$606	$ (1,094)	$ 971
Net interest income change (%)	0.39%	0.29%	0.12%	0.42%	2.68%	(4.84%)	4.29%
Year 2
Net interest income change vs. year one base ($)	($118)	$1,225	$1,059	$884
Net interest income change vs. year 1 base (%)	(0.52%)	5.40%	4.67%	3.90%
Net interest income change ($)					$226	$ (1,512)	$ 2,269
Net interest income change (%)					1.00%	(6.68%)	10.03%

The foregoing interest rate sensitivity modeling results indicate that the Bank’s balance sheet is about evenly matchedliability sensitive and is favorably positioned for declining interest rates over the one and two-year horizons. The interest rate sensitivity model also suggests that the Bank is moderately exposed to a parallel increase in short-term and long-term rates over the one and two-year horizons but, as discussed below, management believes that this is a scenario that is less likely to occur. Management also believes the balance sheet is adequately positioned for a variety of interest rate scenarios. Accordingly, management believesscenarios and that interest rate risk will not have a material adverse impact on future net interest income.

The foregoingincome during the one and two-year horizons contemplated within the interest rate risk simulation model.

At December 31, 2005, the U.S. Treasury yield curve was slightly inverted, with the two and ten-year U.S. Treasury’s closing at 4.41% and 4.39%, respectively. Given this historical phenomenon, interest rate risk sensitivity modeling results indicateis more challenging than would traditionally be the case. Traditional modeling of parallel movements in the December 31, 2005 yield curve would suggest that the Bank’s balance sheet is about evenly matched over the one-year horizon. Beyond the one-year horizon, the model results indicate the Bank is positively positioned for a risingit would remain flat in either an increasing or declining interest rate environment, without assuminga scenario management believes is not likely and one that has historically never occurred. These challenges are discussed in the following discussion and analysis covering the Bank’s interest rate risk exposure should interest rates remain flat or begin to decline. Accordingly, management believes interest rate risk will not have a material adverse impact on future net interest income. Management also believes the Bank's balance sheet is well positioned for rising interest rates and an improving economy.sensitivity.

Assuming interest rates remain at or near their current levels and the Bank maintains a static balance sheet, the interest rate sensitivity simulation model suggests that the net interest marginincome will slowly trend upward as most ofover the Bank’s asset base has already re-cycled into the current interest rate environment while most of the funding base has already reset to low interest rate levels.one and two-year horizons and beyond. The upward trend principally results from the re-investment of security and loan cash flows into higher current interest rate levels.levels, while loans will "index up" in response to recent interest rate movements more quickly than funding costs. Although short-term market interest rates have risen with the recent increases in the Federal Funds rate, the Bank has successfullygenerally lagged the market with the pricing of deposit rates without anya material run-off in balances. However, marginsMargins could narrow if the Bank is eventually forcedprompted to increase deposit interest rates in response to competitive market pricing pressures. Management anticipates that continued balance sheetearning asset growth will be needed to meaningfully increase the Bank’s current level of net interest income, should interest rates remain at current levels.

Assuming short-term and long-term interest rates decline from current levels (i.e., a parallel yield curve shift) and the Bank maintains a static balance sheet, management believes net interest income will decline slightly but remain relatively stableincrease moderately over the oneone-year horizon and two-year horizons.then begin a slow decline over the two year horizon and beyond. The interest rate sensitivity simulation model suggests that, over the twelve-month horizon, funding cost reductions will essentially keep pace with falling asset yields, without significantly impacting margins and net interest income. While the interest rate sensitivity model suggests that net interest income however, as funding costs reach their assumed floors, asset yields will continuebegin to decline asover the twenty-four month horizon and beyond, driven by accelerated cash flows from securitieson earning assets and loans are reinvested into the low rate environmentre-pricing of the Bank’s earning asset base, management believes this is a scenario that is not likely to occur. In this regard, at December 31, 2005 long-term interest rates continued near historical lows, with the 10-year U.S. Treasury note closing the year at 4.39%. Management believes that a 200 basis point decline in long-term interest rates, or a 10-year U.S. Treasury note of 2.39%, would be unprecedented and variable rate assets will adjust downward, resulting in lower levels of net interest income. Managementunlikely to occur. Notwithstanding, management anticipates continued balance sheetearning asset growth will be needed to sustainmeaningfully increase the Bank’s current level of net interest income over the two-year horizon and beyond, should both long-term and short-term interest rates decline.

While the simulatedThe interest rate decline of 100 basis points would mildly reduce net interest income oversensitivity model is used to evaluate the two-year horizon, Management believes that such a decline in interest rates, to a Federal Funds Targeted rate of 1.25%, represents a scenario that is not likely to occur. Further, a repositioning of the balance sheet to manage such a decline, would likely have an adverse impact on net interest income given certain non-parallel shifts in a risingthe yield curve, including changes in either short-term or long-term interest rates. In view of the flat U.S. Treasury yield curve at December 31, 2005, management modeled alternative future interest rate environment, scenarios management believes are more likely to occur overand the longer term.

In a rising rate environment with the Bank maintaininganticipated impact on net interest income. Assuming a static balance sheet, management anticipateswith the short-term Fed Funds interest rate declining 200 basis points, and with the balance of the yield curve returning to its historical ten-year average, the interest rate sensitivity model suggests that net interest income will begin increasingimprove moderately over the one-yeartwelve-month horizon and continue to acceleratestrengthen over the 24 month horizon. Management believes this scenario is more likely than a parallel 200 basis point decline in year twoshort and subsequent years.long-term interest rates, given the current shape of the yield curve. Management also believes this scenario will increase net interest income without significant earning asset growth.

Assuming that the Federal Reserve continues increasing short-term interest rates by 200 basis points and the balance of the yield curve shifts in parallel with these increases, management believes net interest income will come under significant pressure over the one and two-year horizons, but begin a steady recovery beyond the two-year horizon. The interest rate sensitivity simulation model suggests that as interest rates rise, the Bank’s asset basefunding costs will re-price more quickly than funding costs, principally due to a large floating rate loanits earning asset base combined withover the re-investment of cash flows from the securitiesone and loan portfolios in a higher interest rate environment. Overtwo-year horizons, but this trend will reverse itself beyond the two-year horizon and beyond, the model suggests assets yields will continue to reset at higher levels and margins will widen as funding costs begin to stabilize more quickly.horizon. Management believes rising interest ratesthat strong earning asset growth will be necessary to meaningfully increase the current level of net interest income without continued balance sheet growth.

Since June of 2004 through December 31, 2004,should short and long-term interest rates rise in parallel. Management believes this is a scenario that is unlikely to occur, given that the U.S. Treasury yield curve (the "yield curve")would have to remain flat over the one and two-year horizons, a phenomena that has flattened substantially. Whilehistorically never occurred. Management also believes that the Federal Reserve has increased short-term interest rates by 125 basis points,is nearing the 10-year U.S. Treasury note has declined 65 basis points fromend of its 2004 high, thus flattening the yield curve by 190 basis points. Management models the Bank’s interest rate risk sensitivity position under a variety of future interest rate scenarios, including a flattening of the yield curve. The interest rate sensitivity simulation model suggests that if short-term interest rates continue to rise and the yield curve flattens further, the Bank’s net interest income will increase mildly over the one-year horizon and will continue to accelerate in year two and subsequent years, but not to the same degree as would a parallel shift in the yield curve. This increase is principally attributed to the Bank’s large floating rate loan base. Management believes continued increases in short-term interest rates will increase net interest income, particularly over the two-year horizon, without continued balance sheet growth.

Following the short-term interest rate increases by the Federal Reservetightening cycle, which began in the second half of 2004, as was anticipated by management through use of the interest rate sensitivity model, during the six months ended December 31, 2004 the Bank’s net interest margin increased 27 basis points, compared with the quarter ended June 30, 2004.

The following table summarized the Bank’s net interest income sensitivity analysis as of December 31, 2003,2004, over one and two-year horizons, and assuming a parallel shift in the yield curve. The table also summarized net interest income sensitivity under a non-parallel shift in the yield curve, whereby short-term rates riserose by 200 and 400 basis points.

INTEREST RATE RISK
CHANGE IN NET INTEREST INCOME FROM THE FLAT RATE SCENARIO
DECEMBER 31, 20032004

	-100 Basis Points Parallel Yield Curve Shift	+200 Basis Points Parallel Yield Curve Shift	+200 Basis Points Short Term Rates	+400 Basis Points Short Term Rates	-100 Basis Points Parallel Yield Curve Shift	+200 Basis Points Parallel Yield Curve Shift	+200 Basis Points Short Term Rates
Year 1
Net interest income change ($)	($121)	$171	($83)	$122	$     88	$     65	$     28
Net interest income change (%)	(0.59%)	0.83%	(0.40%)	0.60%	0.39%	0.29%	0.12%
Year 2
Net interest income change vs. year one base ($)	($1,309)	$500	($117)	$341
Net interest income change vs. year 1 base (%)	(6.38%)	2.44%	(0.57%)	1.66%
Net interest income change ($)					$    (118)	$1,225	$1,059
Net interest income change (%)					(0.52%)	5.40%	4.67%

During 2005, the Federal Reserve increased short-term interest rates 175 basis points, while longer-term interest rates remained relatively static. As was anticipated by Managementmanagement through use of the interest rate sensitivity model, the Bank’s 2005 net interest income was moderately impacted and this trend continued intonot significantly impacted. For the first six-months of 2004. Management believes that were it not foryear ended December 31, 2005, the growth in earning assets during this period of time combined with a variety of strategies designed to adjust the posture of the balance sheet,Bank’s net interest income would have posted declines.margin amounted to 3.43% compared with 3.45% in 2004.

The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment / replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment/refinancing levels deviating from those assumed; the impact of interest rate change caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s ALCO and Board of Directors might take in responding to or anticipating changes in interest rates.rates, and the anticipated impact on the Bank’s net interest income.

The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31, 2004,2005, there were no significant differences between the views of the independent consultant and management regarding the Bank’s interest rate risk exposure.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders
Bar Harbor Bankshares:

We have audited the accompanying consolidated balance sheetsheets of Bar Harbor Bankshares and subsidiaries (the Company)"Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, and comprehensive income, changes in shareholders’ equity, comprehensive income, and cash flows for the yearyears then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for the years then ended, in conformity with U. S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 6, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Albany, New York
March 6, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Bar Harbor Bankshares

We have audited the accompanying consolidated statement of income, changes in shareholders’ equity, comprehensive income, and cash flows of Bar Harbor Bankshares and Subsidiaries for the year ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bar Harbor Bankshares and subsidiaries as of December 31, 2004, and theconsolidated results of their operations and theirconsolidated cash flows for the year then ended, in conformity with U. S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Albany, New York
March 14, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Bar Harbor Bankshares

We have audited the accompanying consolidated balance sheet of Bar Harbor Bankshares and Subsidiaries as of December 31, 2003, andfor the related consolidated statements of income, changes in shareholders’ equity, cash flows and comprehensive income for each of the two years in the two-year period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bar Harbor Bankshares and Subsidiaries as of December 31, 2003, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the two-year periodyear ended December 31, 2003, in conformity with U.S. generally accounting principles generally accepted in the United States of America.principles.

/s/ BERRY, DUNN, MCNEIL & PARKER

Portland, Maine
February 19, 2004

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004,2005, AND 20032004
(Dollars in thousands, except share and per share data)

	December 31,		December 31,
	2004		2003	December 31, 2005		December 31, 2004
Assets
Cash and due from banks	$ 8,924		$ 14,199	$ 10,994		$ 8,924
Overnight interest bearing money market funds	647		270	3,006		647
Total cash and cash equivalents	9,571		14,469	14,000		9,571
Securities:
Available for sale, at fair value	176,337		124,422
Held to maturity (fair value $35,093 at December 31, 2003)	---		33,965
Total investment securities	176,337		158,387
Securities available for sale, at fair value				183,300		176,337
Investment in Federal Home Loan Bank stock	10,500		8,969	11,324		10,500
Loans	448,478		383,408	514,866		448,478
Allowance for loan losses	(4,829)		(5,278)	(4,647)		(4,829)
Loans, net of allowance for loan losses	443,649		378,130	510,219		443,649
Premises and equipment, net	11,935		11,410	11,785		11,935
Goodwill	3,158		300	3,158		3,158
Bank owned life insurance	5,710		5,488	5,945		5,710
Other assets	5,951		6,593	8,214		5,951
TOTAL ASSETS	$666,811		$583,746	$747,945		$666,811
Liabilities
Deposits
Demand deposits	$ 54,579		$ 49,880	$ 55,451		$ 54,579
NOW accounts	63,535		60,287	66,965		63,535
Savings and money market deposits	139,179		109,309	133,113		139,179
Time deposits	140,979		119,604	129,816		117,279
Brokered time deposits				60,386		23,700
Total deposits	398,272		339,080	445,731		398,272
Short-term borrowings	89,851		58,525	131,338		89,851
Long-term debt	117,072		127,906	108,358		117,072
Other liabilities	5,574		5,120	6,414		5,574
TOTAL LIABILITIES	610,769		530,631	691,841		610,769
Shareholders' equity
Capital stock, par value $2.00; authorized 10,000,000 shares; issued 3,643,614 shares at December 31, 2004 and December 31, 2003	7,287		7,287
Capital stock, par value $2.00; authorized 10,000,000 shares; issued 3,643,614 shares at December 31, 2005 and December 31, 2004				7,287		7,287
Surplus	4,002		4,002	4,002		4,002
Retained earnings	51,733		48,746	55,181		51,733
Accumulated other comprehensive income:
Net unrealized appreciation on securities available for sale and derivative instruments, net of taxes of $576 and $264 at December 31, 2004 and December 31, 2003, respectively	1,118		514
Less: cost of 564,155 shares and 540,193 shares of treasury stock at December 31, 2004 and December 31, 2003, respectively	(8,098)		(7,434)
Accumulated other comprehensive (loss) income:
Net unrealized (depreciation) appreciation on securities available for sale and derivative instruments, net of taxes of ($895) and $576 at December 31, 2005 and December 31, 2004, respectively				(1,738)		1,118
Less: cost of 583,655 shares and 563,965 shares of treasury stock at December 31, 2005 and December 31, 2004, respectively				(8,628)		(8,098)
TOTAL SHAREHOLDERS' EQUITY	56,042		53,115	56,104		56,042
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$666,811		$583,746	$747,945		$666,811

The accompanying notes are an integral part of these consolidated financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2005, 2004 2003 AND 20022003
(Dollars in thousands, except share and per share data)

	2004	2003	2002	2005	2004	2003
Interest and dividend income:
Interest and fees on loans	$      24,067	$    23,421	$  23,754	$29,553	$24,067	$23,421
Interest and dividends on securities and federal funds	7,855	7,072	8,598
Interest and dividends on securities				7,642	7,855	7,072
Total interest and dividend income	31,922	30,493	32,352	37,195	31,922	30,493
Interest expense:
Deposits	4,409	4,336	5,880	6,941	4,409	4,336
Short-term borrowings	1,026	549	770	2,648	1,026	549
Long-term debt	6,110	6,190	6,125	5,747	6,110	6,190
Total interest expense	11,545	11,075	12,775	15,336	11,545	11,075
Net interest income	20,377	19,418	19,577	21,859	20,377	19,418
Provision for loan losses	180	540	1,100	---	180	540
Net interest income after provision for loan losses	20,197	18,878	18,477	21,859	20,197	18,878
Noninterest income:
Non-interest income:
Trust and other financial services	1,929	2,192	2,261	1,992	1,929	2,192
Service charges on deposit accounts	1,463	1,509	1,483	1,390	1,463	1,509
Other service charges, commissions and fees	236	200	134	247	236	200
Credit card service charges and fees	1,687	1,614	1,654	1,876	1,687	1,614
Net securities gains	497	1,257	450	580	497	1,257
Income on interest rate swap agreements, net	404	---	---
Net income on interest rate swap agreements				---	404	---
Other operating income	356	302	340	330	356	302
Total noninterest income	6,572	7,074	6,322
Total non-interest income				6,415	6,572	7,074
Noninterest expenses:
Non-interest expenses:
Salaries and employee benefits	9,335	9,483	9,235	9,795	9,335	9,483
Occupancy expense	1,170	1,058	1,020	1,168	1,170	1,058
Furniture and equipment expense	1,716	1,540	1,535	1,664	1,716	1,540
Credit card expenses	1,249	1,187	1,224	1,397	1,249	1,187
Other operating expense	5,444	5,585	5,231	5,244	5,444	5,585
Total noninterest expenses	18,914	18,853	18,245
Total non-interest expenses				19,268	18,914	18,853
Income before income taxes and cumulative effect of accounting change	7,855	7,099	6,554
Income before income taxes				9,006	7,855	7,099
Income taxes	2,123	1,892	1,742	2,582	2,123	1,892
Income before cumulative effect of accounting change	5,732	5,207	4,812
Less: cumulative effect of change in accounting for goodwill, net of tax	---	---	247
Net income	$       5,732	$      5,207	$       4,565	$ 6,424	$ 5,732	$ 5,207
Computation of Earnings Per Share:
Weighted average number of common shares outstanding
Weighted average number of capital stock shares outstanding
Basic	3,098,959	3,124,230	3,219,377	3,076,498	3,098,959	3,124,230
Effect of dilutive employee stock options	110,047	78,974	50,743	90,300	110,047	78,974
Diluted	3,209,006	3,203,204	3,270,120	3,166,798	3,209,006	3,203,204
Basic earnings per share before cumulative effect of accounting change	$ 1.85	$ 1.67	$ 1.49
Cumulative effect of change in accounting for goodwill, net of tax	---	---	(0.07)
Basic earnings per share	$ 1.85	$ 1.67	$ 1.42	$ 2.09	$ 1.85	$ 1.67
Diluted earnings per share before cumulative effect of accounting change	$ 1.79	$ 1.63	$ 1.47
Cumulative effect of change in accounting for goodwill, net of tax	---	---	(0.07)
Diluted earnings per share	$ 1.79	$ 1.63	$ 1.40	$ 2.03	$ 1.79	$ 1.63

The accompanying notes are an integral part of these consolidated financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 2003 AND 20022003
(Dollars in thousands, except share and per share data)

				Accumulated
				Other		Total
	Capital		Retained	Comprehensive	Treasury	Shareholders'
	Stock	Surplus	Earnings	Income	Stock	Equity
Balance December 31, 2001	$7,287	$4,002	$43,875	$1,707	$(4,333)	$52,538
Net income	---	---	4,565	---	---	4,565
Total other comprehensive income	---	---	---	640	---	640
Cash dividends declared ($0.76 per share)	---	---	(2,445)	---	---	(2,445)
Purchase of treasury stock (82,840 shares)	---	---	---	---	(1,563)	(1,563)
Stock options exercised, net (5,241 shares)	---	---	(1)	---	102	101
Balance December 31, 2002	$7,287	$4,002	$45,994	$2,347	$(5,794)	$53,836
							Capital Stock	Surplus	Retained Earnings	Accumulated Other Comprehensive Income (Loss)	Treasury Stock	Total Shareholders' Equity
Balance December 31, 2002	$7,287	$4,002	$45,994	$2,347	$(5,794)	$53,836	$7,287	$4,002	$45,994	$2,347	$(5,794)	$53,836
Net income	---	---	5,207	---	---	5,207	---	---	5,207	---	---	5,207
Total other comprehensive loss	---	---	---	(1,833)	---	(1,833)	---	---	---	(1,833)	---	(1,833)
Cash dividends declared ($0.76 per share)	---	---	(2,386)	---	---	(2,386)	---	---	(2,386)	---	---	(2,386)
Purchase of treasury stock (87,535 shares)	---	---	---	---	(1,888)	(1,888)	---	---	---	---	(1,888)	(1,888)
Stock options exercised, net (11,255 shares)	---	---	(69)	---	248	179
Stock options exercised (11,255 shares)							---	---	(69)	---	248	179
Balance December 31, 2003	$7,287	$4,002	$48,746	$    514	$(7,434)	$53,115	$7,287	$4,002	$48,746	$   514	$(7,434)	$53,115
Balance December 31, 2003	$7,287	$4,002	$48,746	$    514	$(7,434)	$53,115	$7,287	$4,002	$48,746	$   514	$(7,434)	$53,115
Net income	---	---	5,732	---	---	5,732	---	---	5,732	---	---	5,732
Total other comprehensive income	---	---	---	604	---	604	---	---	��          ---	604	---	604
Cash dividends declared ($0.80 per share)	---	---	(2,478)	---	---	(2,478)	---	---	(2,478)	---	---	(2,478)
Purchase of treasury stock (50,645 shares)	---	---	---	---	(1,369)	(1,369)	---	---	---	---	(1,369)	(1,369)
Stock options exercised, net (26,683 shares)	---	---	(267)	---	705	438
Stock options exercised (26,683 shares)							---	---	(267)	---	705	438
Balance December 31, 2004	$7,287	$4,002	$51,733	$1,118	$(8,098)	$56,042	$7,287	$4,002	$51,733	$1,118	$(8,098)	$56,042
Balance December 31, 2004							$7,287	$4,002	$51,733	$1,118	$(8,098)	$56,042
Net income							---	---	6,424	---	---	6,424
Total other comprehensive loss							---	---	---	(2,856)	---	(2,856)
Cash dividends declared ($0.84 per share)							---	---	(2,584)	---	---	(2,584)
Purchase of treasury stock (53,622 shares)							---	---	---	---	(1,473)	(1,473)
Stock options exercised (34,122 shares)							---	---	(392)	---	943	551
Balance December 31, 2005							$7,287	$4,002	$55,181	$(1,738)	$(8,628)	$56,104

The accompanying notes are an integral part of these consolidated financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 2003, AND 20022003
(Dollars in thousands)

	2004		2003		2002
Net income	$5,732		$5,207		$4,565
Unrealized appreciation (depreciation) on securities available for sale, net of           reclassification adjustment, net of tax of $425, ($881), and $237 at           December 31, 2004, 2003, and 2002, respectively	824		(1,710)		460
Net unrealized (depreciation) appreciation on interest rate swap agreements,           net of tax of ($106), ($63), and $93, at December 31, 2004, 2003, and 2002,           respectively	(205)		(123)		180
Accretion of net deferred gains related to interest rate swap agreements de-designated           and re-designated, in 2004, net of tax of ($7), at December 31, 2004	(15)		---		---
Total other comprehensive income	604		(1,833)		640
Total comprehensive income	$6,336		$3,374		$5,205

	2005	2004	2003
Net income	$6,424	$5,732	$5,207
Unrealized (depreciation) appreciation on securities available for sale,           net of reclassification adjustment, net of tax of ($1,291), $425, and ($881),           respectively	(2,506)	824	(1,710)
Net unrealized depreciation on interest rate derivatives,           net of tax of $183, $106, and $63, respectively	(355)	(205)	(123)
Amortization (accretion) of net deferred (loss) gain related to interest rate derivatives,           net of tax of $3, ($7), and $0, respectively	5	(15)	---
Total other comprehensive (loss) income	(2,856)	604	(1,833)
Total comprehensive income	$3,568	$6,336	$3,374

The accompanying notes are an integral part of these consolidated financial statements.

 

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 2003 AND 20022003
(Dollars in thousands)

	2004	2003	2002
Cash flows from operating activities:
Net income	$     5,732	$  5,207	$   4,565
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	1,716	1,107	1,117
Deferred income taxes	317	124	(129)
Amortization of core deposit intangible	56	---	---
Provision for loan losses	180	540	1,100
Net realized gains on sale of securities available for sale	(481)	(1,257)	(450)
Net realized gains on sale of securities held to maturity	(16)	---	---
Net realized gains on interest rate swap agreements classified as trading	(29)	---	---
Net amortization of bond premiums	1,105	296	16
Goodwill impairment loss	---	75	375
Venture Capital Fund investment impairment loss	197	---	---
Income on bank owned life insurance	(222)	(204)	(221)
Net change in other assets	(153)	3,160	(306)
Net change in other liabilities	454	(2,346)	693
Net cash provided by operating activities	8,856	6,702	6,760
Cash flows from investing activities:
Net receipt from branch acquisition	4,528	---	---
Purchases of securities held to maturity	(1,906)	(2,857)	(4,527)
Proceeds from maturities, calls and principal paydowns of securities held to maturity	1,489	851	237
Purchases of securities available for sale	(114,639)	(118,883)	(92,391)
Proceeds from maturities, calls and principal paydowns of securities available for sale	54,668	74,905	45,025
Proceeds from sale of securities held to maturity	491	---	---
Proceeds from sale of securities available for sale	42,588	46,337	26,025
Net increase in Federal Home Loan Bank stock	(1,531)	(1,041)	(174)
Net loans made to customers	(53,356)	(32,110)	(53,859)
Capital expenditures	(1,261)	(1,204)	(312)
Net cash used in investing activities	(68,929)	(34,002)	(79,976)
Cash flows from financing activities:
Net increase in deposits	38,092	17,065	30,182
Net (decrease) increase in securities sold under repurchase agreements	(848)	1,982	(1,216)
Proceeds from Federal Home Loan Bank advances	35,100	50,700	74,740
Repayment of Federal Home Loan Bank advances	(13,760)	(36,752)	(39,082)
Purchase of treasury stock	(1,369)	(1,888)	(1,563)
Proceeds from stock option exercises	438	179	101
Payments of dividends	(2,478)	(2,386)	(2,445)
Net cash provided by financing activities	55,175	28,900	60,717
Net increase (decrease) in cash and cash equivalents	(4,898)	1,600	(12,499)
Cash and cash equivalents at beginning of period	14,469	12,869	25,368
Cash and cash equivalents at end of period	$    9,571	$  14,469	$   12,869

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$  11,575	$  11,075	$   12,754
Income taxes, net of refunds	885	2,067	1,382
Non-cash transactions:
Transfer from loans to other real estate owned	$          ---	$         ---	$        100
Transfer investment securities from held to maturity to available for sale	34,296	---	---
Unrealized appreciation on securities transferred from held-to-maturity to                 available for sale, net of taxes of $613, at December 31, 2004	1,804	---	---
Unrealized appreciation(depreciation) on securities available for sale, net of                 tax of $425, ($881) and $237 at December 31, 2004, 2003, and 2002,                 respectively	824	(1,710)	460
Net unrealized (depreciation) appreciation on interest rate swap agreements,                net of tax of ($106), ($63), and $93 at December 31, 2004, 2003, and                2002, respectively	(205)	(123)	180
Accretion of net deferred gains related to interest rate swap agreements                de-designated and re-designated, in 2004, net of tax of ($7), at                December 31, 2004	(15)	---	---
Acquired in branch purchase:
Carrying value of loans	$   12,343	$         ---	$         ---
Carrying value of premises and equipment	980	---	---
Carrying value of core deposit intangible	391	---	---
Carrying value of deposits	(21,200)	---	---
Excess of fair value of assets over liabilities (goodwill)	2,858	---	---
	$    (4,528)	$          ---	$          ---

	2005	2004	2003
Cash flows from operating activities:
Net income	$ 6,424	$ 5,732	$ 5,207
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment	1,394	1,716	1,107
Amortization of core deposit intangible	67	56	---
Provision for loan losses	---	180	540
Net realized gains on sales of securities available for sale	(580)	(481)	(1,257)
Net realized gain on sale of securities held to maturity	---	(16)	---
Unrealized gain on interest rate swap agreements	---	(29)	---
Net amortization of bond premiums	859	1,105	296
Venture capital fund investment impairment loss	19	197	---
Income on bank owned life insurance	(235)	(222)	(204)
Net change in other assets	(1,408)	164	3,359
Net change in other liabilities	840	454	(2,346)
Net cash provided by operating activities	7,380	8,856	6,702
Cash flows from investing activities:
Net cash received from branch acquisition	---	4,528	---
Purchases of securities held to maturity	---	(1,906)	(2,857)
Proceeds from maturities, calls and principal paydowns of securities held to maturity	---	1,489	851
Purchases of securities available for sale	(60,146)	(114,639)	(118,883)
Proceeds from maturities, calls and principal paydowns of securities available for sale	36,709	54,668	74,905
Proceeds from sale of securities held to maturity	---	491	---
Proceeds from sales of securities available for sale	12,398	42,588	46,337
Net increase in Federal Home Loan Bank stock	(824)	(1,531)	(1,041)
Net loans made to customers	(66,570)	(53,356)	(32,110)
Capital expenditures	(1,244)	(1,261)	(1,204)
Net cash used in investing activities	(79,677)	(68,929)	(34,002)
Cash flows from financing activities:
Net increase in deposits	47,459	38,092	17,065
Net increase (decrease) in securities sold under repurchase agreements           and fed funds purchased	1,361	(848)	1,982
Proceeds from Federal Home Loan Bank advances	44,300	35,100	50,700
Repayments of Federal Home Loan Bank advances	(12,888)	(13,760)	(36,752)
Purchases of treasury stock	(1,473)	(1,369)	(1,888)
Proceeds from stock option exercises	551	438	179
Payments of dividends	(2,584)	(2,478)	(2,386)
Net cash provided by financing activities	76,726	55,175	28,900
Net increase(decrease) in cash and cash equivalents	4,429	(4,898)	1,600
Cash and cash equivalents at beginning of year	9,571	14,469	12,869
Cash and cash equivalents at end of year	$ 14,000	$ 9,571	$14,469
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$14,840	$ 11,575	$11,075
Income taxes, net of refunds	2,940	885	2,067
Non-cash transactions:
Transfer investment securities from held to maturity to available for sale	$       ---	$ 34,296	$       ---
Unrealized appreciation on securities transferred from held to maturity to available for              sale, net of tax of $613 at December 31, 2004	---	1,804	---
Unrealized appreciation (depreciation) on securities available for sale, net of              reclassification adjustment, net of tax of ($1,291), $425, and ($881), respectively	(2,506)	824	(1,710)
Net unrealized depreciation on interest rate derivatives, net of tax of $183, $106, and                  $63, respectively	(355)	(205)	(123)
Amortization (accretion) of net deferred loss (gain) related to interest rate derivatives,                 net of tax of $3, ($7) and $0, respectively	5	(15)	---
Acquired in branch purchase:
Carrying value of loans	$      ---	$12,343	$      ---
Carrying value of premises and equipment	---	980	---
Carrying value of core deposit intangible	---	391	---
Carrying value of deposits	---	(21,100)	---
Excess of fair value of assets over liabilities (goodwill)	---	2,858	---
Net cash received from branch acquisition	$      ---	$ (4,528)	$      ---

The accompanying notes are an integral part of these consolidated financial statements.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BAR HARBOR BANKSHARES AND SUBSIDIARIES
(All dollar amounts expressed in thousands, except share and per share data)

Note 1: Summary of Significant Accounting Policies

The accounting and reporting policies of Bar Harbor Bankshares ("the Company"(the "Company") and its wholly owned operating subsidiary, Bar Harbor Bank & Trust (the "Bank"), conform to accounting principlesU.S. generally accepted in the United States of Americaaccounting principles and to general practice within the banking industry.

The Company’s principal business activity is retail and commercial banking and, to a lesser extent, financial services including trust, financial planning, investment management and third-party brokerage services. The Company’s business is conducted through the Company’s eleventwelve banking offices located throughout Down EastDowneast and Mid Coast Maine.

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System. 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 of the Maine Bureau of Financial Institutions. The Bank is subject to the supervision, regulation, and examination of the FDIC and the Maine Bureau of Financial Institutions.

Financial Statement Presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles.

The consolidated financial statements include the accounts of Bar Harbor Bankshares and its wholly owned subsidiary, Bar Harbor Bank & Trust. All significant inter-company balances and transactions have been eliminated in consolidation. Whenever necessary, amounts in the prior years financial statements are reclassified to conform to current presentation. Assets held in a fiduciary capacity are not assets of the Company and, accordingly, are not included in the consolidated balance sheets.

In preparing financial statements in conformity with U. S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, subsequent reviews of goodwill and intangible assets for impairment, and accounting for post-retirement plans, and income taxes.

Cash and Cash Equivalents: For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and other short-term investments with maturities less than 90 days.

The Bank is required to complymaintain an average reserve balance with certain laws and regulations of the Federal Reserve Board, which require that the Bank maintain certain amounts of restricted cash on deposit.  At December 31, 2004, the Bank's reserve requirement at the Federal Reserve Bank or maintain such reserve balance in the form of cash on hand. The required reserve balance at December 31, 2005 was $132.$335, and was met by holding cash on hand.

In the normal course of business, the Bank has funds on deposit at other financial institutions in amounts in excess of the $100 that is insured by the Federal Deposit Insurance Corporation.

Investment Securities: Investments in debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" ("HTM") and reflected at amortized cost. Investments not classified as "held to maturity" are classified as "available-for-sale" ("AFS"). All securities held at December 31, 2005 and 2004 were classified as AFS. Securities available-for-sale consist of debt securities that are available-for-sale in order to respond to: changes in market interest rates and related changes in the security’s prepayment risk; needs for adequate liquidity; changes in funding sources and terms; and changes in the availability of and yield on alternative investments. These securities are specifically identified and are carried at market value. Changes in market value of available-for-sale securities, net of applicable income taxes, are reported as a separate component of shareholders’ equity and comprehensive income.income (loss). The CompanyBank does not have a securities trading portfolio.  In 2004, the Company transferred all HTM securities to the AFS classification and does not intend to utilize the HTM classification in the foreseeable future.

When a decline in market value of a security is considered other-than-temporary, the cost basis of the individual security is written down to market value as the new cost basis and the loss is charged to net securities gains (losses) in the consolidated statements of income.

Premiums and discounts on securities are amortized and accreted over the term of the securities using the interest method. Gains and losses on the sale of securities are recognized at the trade date using the specific-identification method and are shown separately in the consolidated statement of income.

Federal Home Loan Bank Stock:Stock: As a member of the Federal Home Loan Bank of Boston ("FHLB"), the Bank is required to hold stock in the FHLB. FHLB stock is carried at cost since there is notno readily available market value. The stock cannot be sold, but can be redeemed by the FHLB at cost.

Loans: Loans are carried at the principal amounts outstanding adjusted by partial charge-offs and net deferred loan origination costs or fees.

Interest on loans is accrued and credited to income based on the principal amount of loans outstanding. Residential real estate loans are generally placed on non-accrual status when reaching 120 days past due, or in process of foreclosure, or sooner if judged appropriate by management. All consumer loans are generally placed on non-accrual status when reaching 90 days or more past due, or sooner if judged appropriate by management, and any equity line in the process of foreclosure is generally placed on non-accrual status, or sooner if judged appropriageappropriate by management. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management. When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on loans. A loan can be returned to accrual status when collectibility of principal is reasonably assured and the loan has performed for a period of time, generally six months.

Commercial real estate and commercial business loans are considered impaired when it becomes probable the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and collateral value.

Loan origination and commitment fees and direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield, using the level yield method over the estimated lives of the related loans.

Allowance For Loan Losses: 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 ("allowance") is available to absorb losses on loans. The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. The allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off.

Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The ongoing evaluation process includes a formal analysis, which considers among other factors: the character and size of the loan portfolio, business and economic conditions, real estate market conditions, collateral values, changes in product offerings or loan terms, changes in underwriting and/or collection policies, loan growth, previous charge-off experience, delinquency trends, nonperforming loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral.

Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and other observable data.

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

Premises and Equipment: Premises and equipment and related improvements are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of related assets; generally 25 to 40 years for premises and 3 to 7 years for furniture and equipment.

Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated financial statements both goodwill and identifiable intangible assets, such as core deposit intangibles.

The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event as defined by SFAS No. 142, using severalcertain fair value techniques, discounted future cash flows and multiples of revenues/earnings. The valuation techniques contain estimates such as discount rate, projected future cash flows and time period in their calculations, all of which are susceptible to change based upon changes in economic conditions and other factors.techniques.

Identifiable intangible assets consist of core deposit intangibles amortized over their estimated useful lives on a straight linestraight-line method, which approximates the amount of economic benefits to Company. These assets are reviewed for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Furthermore, the determination of which intangible assets have finite lives is subjective, as is the determination of the amortization period for such intangible assets.

Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s consolidated results of operations.

Bank-Owned Life Insurance: Bank-owned life insurance ("BOLI") represents life insurance on the lives of certain retired employees who had provided positive consent allowing the Bank to be the beneficiary of such policies. Increases in the cash value of the policies, as well as insurance proceeds received in excess of the cash value, are recorded in other non-interest income, and are not subject to income taxes. The cash surrender value is included in other assets on the Company’s consolidated balance sheet. The Company reviews the financial strength of the insurance carrier prior to the purchase of BOLI and annually thereafter. The Company’s policy is to limit BOLI with any individual carrier to 10% of capital.

Mortgage Servicing Rights: Mortgage servicing rights are recognized as separate assets when acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to unamortized cost. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the carrying value of the rights.

Other Real Estate Owned: Real estate acquired in satisfaction of a loan is reported in other assets. Properties acquired by foreclosure or deed in lieu of foreclosure are transferred to other real estate owned and recorded at the lower of cost or fair market value less estimated costs to sell based on appraised value at the date actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Subsequent reductions in market value below the carrying costsvalue are charged to other operating expenses.

Derivative Financial Instruments: The Company recognizes all derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.

Changes in fair value of derivative instruments that are highly effective, and qualify as a cash flow hedge, are recorded in other comprehensive income.income or loss. For fair value hedges that are fullyhighly effective, the gain or loss on the hedge would offsetand the loss or gain on the hedged item attributable to the hedged risk. Any difference that does arise would be the result of hedge ineffectiveness, which isrisk are both recognized in earnings.earnings, with the differences (if any) representing hedge ineffectiveness. The Company discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk ofon the hedgehedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

Off-balanceOff-Balance Sheet Financial Instruments:  In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.

Stock Compensation Plan:Based Compensation: On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and its Subsidiaries Incentive Stock Option Plan of 2000 for officers and employees, thatwhich is described more fully in Note 1413 of these consolidated financial statements. Statement of Financial Accounting Standards ("SFAS")

SFAS No. 123, "Accounting for Stock-Based Compensation" encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," whereby compensation cost is the excess, if any, of the quoted market price of the underlying stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock upon exercise of the stock option.

The Company has elected to continue with the accounting methodology in Opinion No. 25 through December 31, 2005 and, as a result, must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The pro forma disclosures include the effects of all awards granted. Had the Company determined cost based on the fair value at the grant date for its stock options and had the Company recorded an expense related to the employee stock option plan under SFAS No. 123, its net income and earnings per share data would have been reduced to the pro forma amounts indicated as follows: below:

		Earnings Per Share
Year Ended December 31, 2004:	Net Income	Basic	Diluted
Net income, as reported	$5,732	$1.85	$1.79
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect	105	0.03	0.03
Pro forma net income	$5,627	$1.82	$1.76
		Earnings Per Share
Year Ended December 31, 2003:	Net Income	Basic	Diluted
Net income, as reported	$5,207	$1.67	$1.63
Deduct: Total stock-based employee compensation expense determined       under fair value based method for all awards, net of related tax effect	95	0.03	0.03
Pro forma net income	$5,112	$1.64	$1.60
		Earnings Per Share
Year Ended December 31, 2002:	Net Income	Basic	Diluted
Net income, as reported	$4,565	$1.42	$1.40
Deduct: Total stock-based employee compensation expense determined      under fair value based method for all awards, net of related tax effect	90	0.03	0.03
Pro forma net income	$4,475	$1.39	$1.37

		Earnings Per Share
Year Ended December 31, 2005:	Net Income	Basic	Diluted
As reported	$6,424	$2.09	$2.03
Deduct: Total stock-based employee compensation expense      determined under fair value based method for all awards,      net of related tax effect.	113	0.04	0.04
Pro forma	$6,311	$2.05	$1.99
		Earnings Per Share
Year Ended December 31, 2004:	Net Income	Basic	Diluted
As reported	$5,732	$1.85	$1.79
Deduct: Total stock-based employee compensation expense      determined under fair value based method for all awards,      net of related tax effect.	105	0.03	0.03
Pro forma	$5,627	$1.82	$1.76
		Earnings Per Share
Year Ended December 31, 2003:	Net Income	Basic	Diluted
As reported	$5,207	$1.67	$1.63
Deduct: Total stock-based employee compensation expense      determined under fair value based method for all awards,      net of related tax effect.	95	0.03	0.03
Pro forma	$5,112	$1.64	$1.60

During the years ended December 31, 2005, 2004, and 2003, the total anti-dilutive stock options amounted to 22, 13, and 6 thousand shares, respectively

401(k) and Other Benefit Plans:Plan: The Company maintains a Section 401(k) savings plan for substantially all of its employees. Employees are eligible to participate in the 401(k) Plan on the first day of any quarter following their date of hire. Under the plan, the Company makes a matching contribution of a portion of the amount contributed by each participating employee, up to a percentage of the employee’s annual salary. The plan allows for supplementary profit sharing contributions by the Company, at its discretion, for the benefit of participating employees.

In addition to the 401(k) plan, theSupplemental Executive Retirement Agreements: The Company has non-qualified supplemental executive retirement plans foragreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations.

The Company also has supplemental executive retirement agreements with certain current executive officers. These agreements provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the participating executive leaves the Company following a change of control event. The Company recognizes the net present value of payments associated with these agreements over the service periods of the participating executive officers.

Post Retirement Benefit Program: The Company sponsors a limited post-retirement benefit program, which funds medical coverage and life insurance benefits to a closed group of active and retired officers. The Company also sponsors a postretirement benefit plan, which provides medicalemployees who meet minimum age and service requirements. It is the Company’s policy to record the cost of post-retirement health care and life insurance coverage to eligible employees.plans based on actuarial estimates, which are dependent on claims and premiums paid. The cost of providing the foregoingthese benefits is accrued during the active service period of the employee.

Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubtindicates that it is more likely than not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Earnings Per Share: Earnings per share have been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share have been calculatedexcludes dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding before any dilution.for the period. Diluted earnings per share incorporates the effect of stock options outstanding at the end of the reporting period, and have been calculated by dividing net income by weighted average shares outstanding after giving effect toreflects the potential dilution that could occur if the potentialsecurities or other contracts to issue common sharesstock were exercised or converted into common stock usingor resulted in the treasuryissuance of common stock method.that then shared in the earnings of the Company, such as the Company’s dilutive stock options.

Segment Reporting: An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance. The Company’s primary business isCompany has determined that its operations are solely in the community banking which provided 95.0%, 94.2%,industry and 94.2%include traditional community banking services, including lending activities, acceptance of its total revenues for the years ended December 31, 2004, 2003,demand, savings and 2002, respectively.time deposits, business services, investment management, trust and third-party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. Accordingly, disaggregated segment information is not presented in the notesNotes to the financial statements.Consolidated Financial Statements.

Note 2: Recently Issued Accounting Pronouncements

The following information addresses new or proposedrecent accounting pronouncements that could have an impact on the Company’s financial condition, results of operations, earnings per share, or cash flows.

Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments: On November 3, 2005, the Financial Accounting Standards Board (FASB") issued FASB Staff Position No. FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (the "FSP"), which addresses the determination of when an investment is considered impaired; whether the impairment is other than temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment loss on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in EITF Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations (principally Statement of Financial Accounting Standards No. 115 and SEC Staff Accounting Bulletin 59). Under the FSP, impairment losses must be recognized in earnings equal to the entire difference between the security’s cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also requires that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The Company does not expect that the application of the FSP will have a material impact on its financial condition, results of operations or financial statement disclosures.

Accounting For Share-Based Payments: In December 2004, the Financial Accounting Standards Board ("FASB")FASB issued SFAS No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R") which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees, including employee stock purchase plans. Current disclosure provisions under SFAS No. 123 are still applicable.continue to apply prior to adoption of SFAS No. 123R. In addition to stock option awards granted after July 1, 2005,the effective date, compensation expense on unvested equity-based awards that were granted prior to the effective date must be recognized in the consolidated income statement.  statement after the effective date.

SFAS No. 123R is effective for interim or annual periodsin the first fiscal year beginning after June 15, 2005.2005 (January 1, 2006 for the Company). The adoption of SFAS No. 123R is expected to decrease earnings per share by approximately $0.02$0.03 in 2005,2006, based upon the current level of investedunvested options. SFAS No. 123R is not expected to have a material effect on the Company's consolidated financial condition or cash flows.

Cash Flow Hedges: In July 2004, the FASB issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:  Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interest-bearing loans (or other interest-bearing financial assets), provided all other conditions for a cash flow hedge have been met.    Entities that choose to use the first-payments-received technique are still required by SFAS No. 133 (as amended) to assess the effectiveness of the cash flow hedging relationship and to recognize ineffectiveness in earnings, if any.   The effective date of the guidance for each reporting entity is the first day of the first fiscal quarter beginning after August 9, 2004.  Early application of the guidance covering this Implementation Issue is permitted.  During the third quarter of 2004, the Company implemented this guidance and designated its prime-rate-based interest rate swap agreements as cash flow hedges. The adoption of this guidance did not have a significant impact on the Company's 2004 consolidated financial position or results of operations.

Other-Than-Temporary Impairment: In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a consensus on Issue 03-1, "The Meaning of Other Than Temporary Impairment (Issue 03-1)". The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an investment is impaired. An investment is considered impaired if its fair value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and debt securities that can contractually be prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost, an impairment is presumed to be other-than-temporary unless: the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. For other debt securities, an impairment is deemed other-than-temporary if: the investor does not have the ability and intent to hold the investment until a forecasted market price recovery (may mean until maturity), or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment loss equal to the difference between the investment's amortized cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and generally cannot be adjusted for subsequent recoveries in fair value.

In December 2004, the FASB announced it would reconsider in its entirety all guidance on disclosing, measuring and recognizing other-than-temporary impairments of debt and equity securities (including such guidance in EITF 03-1). Until new guidance is issued, companies must continue to comply with the disclosure requirements of EITF 03-1 and all relevant measurement and recognition requirements in other accounting literature. Certain guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. steps of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22 have not been deferred and should be applied based on the transition provisions in EITF 03-1. Based on the composition of the investment securities portfolio held at December 31, 2004, EITF 03-1 is not expected to have a material effect on the Company's financial position or results of operations.

Variable Interest Entities: In January 2003, FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities", (or VIEs). The objective of this interpretation is to provide guidance on how to identify a VIE and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in the company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. FIN 46 was effective for all VIE’s created after January 31, 2003. However, the FASB postponed that effective date to December 31, 2003.  In December 2003, the FASB issued a revised FIN 46 (FIN 46 R), which has an effective date of March 31, 2004 for VIE’s created prior to February 1, 2003, except for special purpose entities, which much adopt either FIN 46 or FIN 46 R as of December 31, 2003. The adoption of FIN 46 did not have an impact on the Company's consolidated financial position or results of operations.

Note 3: Business Segments

The Company has determined that its primary business operations are in the community banking industry and include the traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and third party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities.

SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information" requires public companies to report certain financial information about operating segments for which such information is available and utilized by the chief operating decision maker in deciding how to allocate resources and in assessing performance. In prior reporting periods the Company had also included Financial Services as a business segment and, accordingly, provided segment information for that segment. In December 2003 the Company’s Board of Directors approved a restructuring plan for its wholly owned subsidiary, BTI Financial Group ("BTI"). The restructuring plan simplified and aligned BTI’s brand names and operating model with the Bank. During 2004 the plan was completed, with the results of all operations now viewed as a single strategic unit by the chief operating decision maker.

For the years ended December 31, 2004, 2003, and 2002 revenue from Financial Services represented 5.0%, 5.8%, and 5.8% of the Company’s total revenue, respectively. Accordingly, segment disclosures are not required.

Note 4: Securities Available-For-Sale and Held-To-Maturity

A summary of the amortized cost and market values of securities available-for-sale and held-to-maturityavailable for sale follows:

	December 31, 2004
		Gross	Gross	Estimated
	Amortized	Unrealized	Unrealized	Fair
Available- for-Sale:	Cost	Gains	Losses	Value
Obligations of U.S. Government sponsored enterprises	$     6,395	$       2	$   49	$     6,348
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	116,097	651	258	116,490
Other	16,608	41	245	16,404
Obligations of states of the U.S. and political
subdivisions thereof	34,296	1,806	2	36,100
Other debt securities	1,000	---	5	995
Total securities available for sale	$174,396	$2,500	$559	$176,337
	December 31, 2003
		Gross	Gross	Estimated
	Amortized	Unrealized	Unrealized	Fair
Available for Sale:	Cost	Gains	Losses	Value
Obligations of U.S. Government sponsored enterprises	$    5,557	$     21	$  50	$   5,528
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	86,498	986	214	87,270
Other	21,658	174	123	21,709
Other debt securities	10,017	5	107	9,915
Total securities available for sale	$123,730	$1,186	$494	$124,422
Held to Maturity:
Obligations of states of the U.S. and political      subdivisions thereof	$  33,374	$1,265	$154	$ 34,485
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	591	17	---	608
Total securities held to maturity	$  33,965	$1,282	$154	$ 35,093

	December 31, 2005
Available for Sale:	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Obligations of U.S. Government-sponsored enterprises	$ 23,720	$     12	$   235	$ 23,497
Mortgage-backed securities:
Obligations of U. S. Government agencies	11,134	127	48	11,213
Obligations of Government-sponsored enterprises	90,872	65	2,190	88,747
Other	22,362	4	424	21,942
Obligations of state and political subdivisions	37,068	1,016	183	37,901
	$185,156	$1,224	$3,080	$183,300

As permitted by Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", during the fourth quarter of 2004 the Company transferred into the available-for-sale securities portfolio all of its held-to-maturity investment securities. Securities transferred consisted of longer term, tax-exempt securities representing obligations of state and political subdivisions. The held-to-maturity securities were transferred to available-for sale at their fair value of $36,100, with an unrealized gain on these securities, net of taxes, amounting to $1,191 recorded in other comprehensive income. Management does not intend to utilize the held-to-maturity classification in the foreseeable future.

	December 31, 2004
Available- for Sale:	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Obligations to U.S. Government-sponsored enterprises	$   6,395	$       2	$ 49	$    6,348
Mortgage-backed securities:
U.S. Government agencies and sponsored enterprises	116,097	651	258	116,490
Other	16,608	41	245	16,404
Obligations of states of the U.S. and political      subdivisions thereof	34,296	1,806	2	36,100
Other bonds	1,000	---	5	995
Total securities available for sale	$174,396	$2,500	$559	$176,337

Impairment: The following table summarizestables summarize the fair value of investments with continuous unrealized losses for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer as of December 31, 2005 and 2004. All securities referenced are debt securities. At December 31, 2005 and 2004, the Company did not hold any common stock or other equity securities in its investment securities portfolio.

	Less Than 12 Months			12 Months of Longer			Total
	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investements	Unrealized Losses	Fair Value	Number of Investements	Unrealized Losses
Description of Securities:
Oblications of U. S. Government      sponsored enterprises	$3,585	7	$ 29	$     983	2	$ 20	$ 4,568	9	$ 49
Mortgage-backed securities:
U.S. Government Agencies and           sponsored enterprises	31,665	50	121	11,747	24	137	43,412	74	258
Other mortgage-backed securities	8,973	23	138	3,041	5	87	12,014	29	245
Obligations of state and political       subdivisions thereof	546	2	2	---	0	---	546	2	2
Other - debt securities	995	1	5	---	0	---	995	1	5
Total temporarily impaired securities	$45,764	84	$295	$15,771	31	$244	$61,535	115	$559

2005	Less Than 12 Months			12 Months or Longer			Total
	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses
Description of Securities:
Obligations of U.S. Government-sponsored       enterprises	$ 13,287	24	$   132	$ 4,203	24	$   103	$ 17,490	48	$  235
Mortgage-backed securities:
Obligations of U.S. Government agencies	3,413	12	26	1,699	8	22	5,112	20	48
Obligations of Government-sponsored           enterprises	66,558	126	1,493	20,472	40	697	87,030	166	2,190
Other	16,673	30	253	4,813	11	171	21,486	41	424
Obligations of state and political subdivisions	8,339	32	176	343	1	7	8,682	33	183
Total temporarily impaired securities	$108,270	224	$2,080	$31,530	84	$1,000	$139,800	308	$3,080

2004	Less Than 12 Months			12 Months or Longer			Total
	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses	Fair Value	Number of Investments	Unrealized Losses
Description of Securities:
Obligations of U.S. Government sponsored      enterprises	$ 3,585	7	$ 29	$    983	2	$ 20	$ 4,568	9	$ 49
Mortgage-backed securities:
U.S. Government Agencies and      sponsored enterprises	31,665	50	121	11,747	24	137	43,412	74	258
Other mortgage-backed securities	8,973	24	138	3,041	5	87	12,014	29	225
Obligations of state and political      subdivisions thereof	546	2	2	---	0	---	546	2	2
Other – debt securities	995	1	5	---	0	---	995	1	5
Total temporarily impaired securities	$45,764	84	$295	$15,771	31	$244	$61,535	115	$539

In evaluating whether impairments are other-than-temporary, the Company considers a variety of factors including the nature of the investment, the cause of the impairment, and the severity and duration of the impairment. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and or any other information considered relevant. At December 31, 2004, and 2003 the Company determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.

For securities with unrealized losses, the following information was considered in determining that the impairments are not other-than-temporary. U.S. government securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government sponsored enterprises have minimal credit risk as they play a vital role in the nation’s financial markets. Other bonds and notes are generally comprised of corporate mortgage-backed securities and all investments maintain a credit rating of at least "A""A1" by one of the nationally recognized rating agencies. Mortgage-backed securities and collateralized mortgage obligations are either issued by federal government agencies and sponsored enterprises, or by private issuers, all with security credit ratings of AAA."AAA."

Management believes theThe unrealized losses in the investment securities portfolio at December 31, 2005 and 2004 were attributed to interest rates increases, and reflected the volatile movements in the U.S. Treasury curve over the past few 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, 2005 and 2004. Because the decline in market value was attributable to changes in interest rates and not credit quality, and because the Bank has the ability and intent to hold these investment securities until a recovery of their amortized cost, which may be at maturity, the Company does not consider these investment securities to be other-than-temporarily impaired at December 31, 2005 and 2004.

Maturity Distribution: At December 31, 2004,2005, the amortized cost and estimated fair value of securities available-for-sale are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or with or without call or prepayment penalties.

	December 31, 2004		December 31, 2005
	Amortized Cost	Estimated Fair Value	Amortized Cost	Estimated Fair Value
Securities Available for Sale
Due in one year or less	$             2	$             2	$        577	$       578
Due after one year though five years	3,675	3,678	11,245	11,114
Due after five years through ten years	51,090	51,097	49,363	48,128
Due after ten years	119,629	121,560	123,971	123,480
	$174,396	$176,337
Totals			$185,156	$183,300

Realized Gains and Losses:

The following table summarizes realized gains and losses on securities available-for-saleavailable for sale for the years ended December 31, 2005, 2004 2003 and 2002.2003.

	Realized			Realized
	Gains	Losses	Net	Gains	Losses	Net
2005				$    590	$10	$ 580
2004	$   495	$14	$    481	$    495	$14	$ 481
2003	$1,285	$28	$1,257	$1,285	$28	$1,257
2002	$   456	$ 6	$    450

In addition, in 2004 the Company recorded a $16 gain on the sale of a held-to-maturity security of $16.

held to maturity security.

Note 5:4: Loans

The Company’s lending activities are principally conducted in Down Eastdowneast and Mid Coast,midcoast, Maine. The following table summarizes the composition of the loan portfolio as of December 31, 20042005 and 2003:2004:

			2005		2004
Residential real estate mortgages	$ 221,690	$202,102	$236,712		$222,110
Commercial and commercial real estate mortgages	148,356	116,182
Commercial real estate mortgages			135,269		104,446
Commercial and industrial			58,542		43,967
Agricultural and other loans to farmers	15,077	11,719	18,962		15,077
Consumer	13,534	13,126	12,565		13,534
Home equity	47,189	35,941	49,221		47,189
Tax exempt	1,950	3,652	2,732		1,950
Total loans			514,003		448,273
	447,796	382,722
Real estate under foreclosure	477	975
Deferred origination costs (fees), net	205	(289)
Deferred origination costs, net			$        863		$        205
Allowance for loan losses	(4,829)	(5,278)	(4,647)		(4,829)
	$443,649	$378,130
Total loans net of allowance for loan losses			$510,219		$443,649

Nonperforming Loans and Accruing Loans 90 days or more Overdue:Non-performing Loans: The following table sets forth information regarding nonaccruingnon-accruing loans and accruing loans 90 days or more overdue at December 31, 2005, 2004 2003 and 2002.2003.

	2004	2003	2002	2005	2004	2003
Loans accounted for on a non-accrual basis:
Real estate loans:
Construction and development	$ ---	$   114	$    4	$  ---		$  114
Mortgage	453	1,113	905	267	453	1,113
Loans to finance agricultural production and other loans to farmers	13	22	45	---	13	22
Commercial and industrial loans	80	9	10	593	80	9
Loans to individuals for household, family and other personal expenditures	26	37	22	5	26	37
Total non-accrual loans	$572	$1,295	$986	865	572	1,295
Accruing loans contractually past due 90 days or more	$151	$   199	$188	3	151	199
Total non-performing loans				$868	$723	$1,494

During the yearyears ended December 31, 2005, 2004 and 2003, the total interest not recorded on non-accrual loans amounted to $112.$11, $16 and $80, respectively.

Loan Concentrations: Because of the Company’s proximity to Acadia National Park, a large part of the economic activity in the area is generated from the hospitality business associated with tourism. At December 31, 20042005 and 2003,2004, loans to the hospitalitylodging industry amounted to approximately $30,535$29,857 and $31,493,$30,535, respectively.

Loans to Related Parties: In the ordinary course of business, the Company has made loans at prevailing rates and terms to directors, officers and other related parties. AllIn management’s opinion, such loans in management’s opinion, do not present more than the normal risk of collectibility or incorporate other unfavorable features, and were made under terms that are consistent with the Company’s normal lending policies.

Loans to related parties at December 31 are summarized below. Balances have been adjusted to reflect changes in status of directors and officers for each year presented.

	2004	2003
Beginning balance	$ 5,677	$9,390
Changes in Composition	1,016	(5,029)
New loans	5,995	2,477
Repayments	(183)	(1,161)
Ending balance	$12,505	$5,677

	2005		2004
Beginning balance	$12,505		$ 5,677
Changes in composition	(3,432)		1,016
New loans	1,088		5,995
Less: repayments	(987)		(183)
Ending balance	$ 9,174		$12,505

As of December 31, 2004,2005, and 2003,2004, there were no non-performing loans to related parties.

Mortgage Loan Servicing:Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank 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, 2004,2005, the unpaid balance of mortgage loans serviced for others totaled $9,935$7,907 compared with $12,334$9,935 at December 31, 2003.2004.

Note 6:5: Allowance For Loan Losses

A summary of changes in the allowance for loan losses for each of the three years ended December 31 follows:

	2004	2003	2002
Balance, beginning of year	$5,278	$4,975	$4,169
Provision for loan losses	180	540	1,100
Loans charged off	(851)	(427)	(482)
Less: recoveries on loans previously charged off	222	190	188
Net loans charged off	(629)	(237)	(294)
Balance, end of year	$4,829	$5,278	$4,975

	2005	2004	2003
Balance, beginning of year	$4,829	$5,278	$4,975
Provision for loan losses	---	180	540
Loans charged off	(238)	(851)	(427)
Less: recoveries on loans previously charged off	56	222	190
Net loans charged off	(182)	(629)	(237)
Balance, end of year	$4,647	$4,829	$5,278

Impaired Loans: Impaired loans are commercial and commercial real estate loans, for which the Company believes it is probable that it will probably not result in the collection ofbe unable to collect all amounts due according to the contractual terms of the loan agreement. The amount of reservesAllowances for losses on impaired loans isare determined by the difference between the present value of the expected cash flows related to the loan, using the original contractual interest rate, and its recorded value, or in the case of collateralizedsecured loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral less cost to sell.

The majority of the Company'sCompany’s impaired loans are collateral dependent.

Information pertaining to impaired loans at December 31, 2005, 2004 2003 and 20022003 follows:

	2004	2003	2002
Investment in impaired loans	$93	$596	$59
Portion of impaired loan balance for which
an allowance for loan losses is allocated	$93	$596	$59
Portion of allowance for loan losses allocated
to the impaired loan balance	$14	$190	$  9
Interest not recorded on impaired loans during the year	$  3	$  23	$59

	2005	2004	2003
Investment in impaired loans	$593	$93	$596
Portion of impaired loan balance for which      an allowance for loan losses is allocated	$593	$93	$596
Portion of allowance for loan losses allocated      to the impaired loan balance	$238	$14	$190
Interest not recorded on impaired loans at year end	$ 10	$ 3	$ 23

During the yearyears ended December 31, 2005, 2004 and 2003, the total average balance of impaired loans amounted to approximately $300.$385, $300 and $1,429, respectively.

Note 7:6: Premises and Equipment

The detail of premises and equipment as of December 31 follows:

	2004	2003	2005	2004
Land	$   1,774	$  1,321	$ 1,944	$   1,774
Buildings and improvements	12,838	12,453	12,986	12,838
Furniture, fixtures and equipment	7,924	7,522
Furniture and equipment			8,585	7,924
Less: accumulated depreciation	(10,601)	(9,886)	(11,730)	(10,601)
Total net book value	$11,935	$11,410
Total			$11,785	$11,935

 

Note 8:7: Goodwill and Other Identifiable Intangible Assets

Goodwill: A summary of goodwill capitalized on the Company’s consolidated balance sheet follows.

	January 1, 2003		Goodwill Acquired		Goodwill Write-down		December 31, 2003	January 1, 2004		Goodwill Acquired		December 31, 2004
Total	$375		$ --		$(75)		$300	$  300		$2,858		$3,158
	January 1, 2004		Goodwill Acquired		Goodwill Write-down		December 31, 2004
								January 1, 2005		Goodwill Acquired		December 31, 2005
Total	$300		$2,858		$ ---		$3,158	$3,158		$    ---		$3,158

During the first quarter of 2004, the Company recordedacquired $2,858 in goodwill in connection with the Bank'sBank’s acquisition of a branch office in Rockland, Maine.

Goodwill is required to be tested for impairment at least annyally, or more often if certain events occur. The Company estimates the value of goodwill utilizing certain fair value techniques. Management determined the Company's goodwill balance related to the acquisition of Dirigo Investments, Inc., its then second tier broker-dealer subsidiary, was impaired, resulting in an impairment charge of $375, recorded during 2002, and reported as a cumulative effect of change in accounting for goodwill in the consolidated income statement. As of December 31, 2003, the Company completed its annual review of the Dirigo Investments goodwill and recorded additional impairment of $75, recorded as other operating expense in the consolidated statment of income. The Company determined there was no further goodwill impairment as of December 31, 2004.

Core Deposit Intangible Asset: The Company has a finite-lived intangible asset capitalized on its consolidated balance sheet in the form of a core deposit intangible asset related to the Bank’s acquisition of a branch office in Rockland, Maine. The core deposit intangible asset is being amortized over an estimated useful life of six-years,six years, and is included in other assets on the December 31, 2004Company’s consolidated balance sheet. There was no core deposit intangible asset at December 31, 2003.

A summary of the core deposit intangible asset follows as of December 31 2004:follows:

Core deposit intangibles:
Gross carrying amount	$391
Less: accumulated amortization	56
Net carrying amount	$335

	December 31, 2005		December 31, 2004
Core deposit intangibles:
Gross carrying amount	$391		$391
Less: accumulated amortization	123		56
Net carrying amount	$268		$335

Amortization expense on core deposit intangible assets is expected to total $67 each year for years 20052006 through 2009.

Note 9:8: Income Taxes

The following table summarizes the current and deferred components of income tax expense (benefit) for the years ended December 31:

	2004	2003	2002	2005	2004	2003
Current
Federal	$1,695	$1,666	$1,781	$2,271	$1,695	$1,666
State	111	99	90	129	111	102
	1,806	1,765	1,871	2,400	1,806	1,768
Deferred	317	127	(129)	182	317	124
	$2,123	$1,892	$1,742	$2,582	$2,123	$1,892

The following table reconciles the expected federal income tax expense (computed by applying the federal statutory tax rate to income before taxes) to recorded income tax expense, for the years ended December 31:

	2004	2003	2002
Computed tax expense	$2,671	$2,414	$2,229
Increase (reduction) in income taxes resulting from
Officers' life insurance	(74)	(70)	(74)
Tax exempt interest	(518)	(500)	(455)
State taxes, net of federal benefit	82	91	70
Other, net	(38)	(43)	(28)
Recorded income tax expense	$2,123	$1,892	$1,742

	2005	2004	2003
Computed tax expense	$3,062	$2,671	$2,414
Increase (reduction) in income taxes resulting from
Officers' life insurance	(75)	(74)	(70)
Tax exempt interest	(497)	(518)	(500)
State taxes, net of federal benefit	84	82	91
Other, net	8	(38)	(43)
Recorded income tax expense	$2,582	$2,123	$1,892

The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities whichat December 31, 2005 and 2004 are summarized below. The net deferred tax asset is included in other assets, at December 31, 2004 and 2003 are as follows:assets.

	2004		2003
	Asset	Liability	Asset	Liability
Allowance for loan losses	$1,515	$       ---	$1,572	$      ---
Deferred compensation	832	---	745	---
Postretirement benefit obligation	522	---	529	---
Unrealized gain on securities      available for sale	---	660	---	235
Unrealized gain or loss on derivatives	77		---	29
Depreciation	---	522		453
Other	240	585	256	330
	$3,186	$1,767	$3,102	$1,047

	2005		2004
	Asset	Liability	Asset	Liability
Allowance for loan losses	$1,580	$     ---	$1,515	$     ---
Supplemental executive retirement plans	843	---	832	---
Postretirement benefit obligations	529	---	522	---
Unrealized gain or loss on securities available for sale	631	---	---	653
Unrealized loss on derivatives	265	---	77	---
Depreciation	---	427	---	522
Other	224	936	240	592
	$4,072	$1,363	$3,186	$1,767

The Company has determined that a valuation allowance is not required for its net deferred tax asset since it is more likely than not that this asset will is realizable principally through the ability to carry-back to taxable income in prior years, future reversals of existing taxable temporary differences, and future taxable income.

Note 10:9: Deposits

The aggregate amount of short-term jumbo certificates of deposit, each with a minimum denomination of $100 was $19,405$25,151 and $18,784$19,405 at December 31, 20042005 and 2003,2004, respectively.

At December 31, 2004,2005, the scheduled maturities of time deposits were as follows:

2005	$   76,651
2006	19,201
2007	12,304
2008	10,709
2009	3,723
2010 and thereafter	440
Individual Retirement Accounts (IRAs)      without scheduled maturities	17,951
	$140,979

2006	$  90,163
2007	22,566
2008	12,176
2009	3,312
2010	1,371
2011 and thereafter	228
Total time deposits	$129,816

Note 11:10: Short-term Borrowings

The Company’s short-term borrowings consist of borrowings from the Federal Home loanLoan Bank and securities sold under agreements to repurchase. The following table summarizes short-term borrowings at December 31, 2004, 20032005 and 2002.2004.

	2004			2003
	Total Principal	Weighted Average Rate		Total Principal	Weighted Average Rate
Federal Home Loan Bank Advances	$74,774	2.80%		$42,600	1.55%
Securities sold under agreements to repurchase	15,077	1.12%		15,925	1.32%
Total short-term borrowings	$89,851			$58,525

	2005			2004
	Total Principal	Weighted Average Rate		Total Principal	Weighted Average Rate
Federal Home Loan Bank Advances	$114,900	4.37%		$74,774	2.80%
Securities sold under agreements to repurchase	16,438	2.30%		15,077	1.14%
Total short-term borrowings	$131,338			$89,851

Securities Sold Under Agreements to Repurchase: Securities sold under agreements to repurchase generally mature within one to four days from the transaction date. Information concerning securities sold under agreements to repurchase for 2005, 2004, 2003, and 20022003 is summarized as follows:

	2004	2003
Average daily balance during the year	$13,427	$13,086
Average interest rate during the year	1.12%	1.32%
Maximum month-end balance during the year	$17,745	$17,083
Amount outstanding at end of year	$15,077	$15,925

	2005	2004	2003
Average daily balance during the year	$14,588	$13,427	$13,086
Average interest rate during the year	1.86%	1.12%	1.32%
Maximum month-end balance during the year	$17,705	$17,745	$17,083
Amount outstanding at end of year	$16,438	$15,077	$15,925

Securities collateralizing repurchase agreements, which are held in safekeeping by nonaffiliated financial institutions and under the Bank's control, were as follows at December 31:

	2004	2003
Amortized cost	$22,257	$20,069
Carrying value	$22,317	$20,256

	2005	2004	2003
Carrying value	$20,987	$22,317	$20,069
Estimated fair value	$20,987	$22,317	$20,256

Note 12:11: Long-term Debt

A summary of long-term debt, all of which represent advances from the Federal Home Loan Bank, is as follows:

December 31, 2005
Maturity	Total Principal	Weighted Average Rate	Range of Interest Rates
2007	$ 19,170	4.20%	2.44% to 5.01%
2008	28,900	4.06%	2.78% to 5.68%
2009	14,330	4.13%	2.69% to 5.30%
2010	13,000	5.42%	4.80% to 5.95%
2011	30,227	4.70%	3.86% to 5.09%
2012 and thereafter	2,731	4.87%	4.71% to 5.07%
Total long-term debt	$108,358

 

December 31, 2004	December 31, 2004			December 31, 2004
				Total	Weighted Average	Range of
Maturity	Total Principal	Weighted Average Rate	Range of Interest Rates	Principal	Rate	Interest Rates
2006	$     6,400	4.80%	3.57% to 5.66%	$      6,400	4.80%	3.57% to 5.66%
2007	19,987	4.19%	2.44% to 5.01%	19,987	4.19%	2.44% to 5.01%
2008	28,900	4.06%	2.78% to 5.68%	28,900	4.06%	2.78% to 5.68%
2009	15,002	4.14%	2.69% to 5.30%	15,002	4.14%	2.69% to 5.30%
2010	13,000	5.42%	4.80% to 5.95%	13,000	5.42%	4.80% to 5.95%
2011 and thereafter	33,783	4.70%	3.86% to 5.09%	33,783	4.70%	3.86% to 5.09%
Total long-term borrowings	$117,072
Total long-term debt				$117,072

All FHLB advances are fixed-rate instruments. Advances are payable at their call dates or final maturity. Advances are stated at their contractual final maturity dates and do not reflect call features.dates. At December 31, 2004,2005, the Bank had  $60$50 million in callable advances with a weighted average interest rate of 4.80% and maturity dates ranging from 2005 to 2011.as follows: 2007, $3,500; 2008, $5,000; 2009, $4,000; 2010, $12,000; 2011, $25,500; 2012 and thereafter, $0.

Pursuant to an agreement with the FHLB, advances are collateralized by stock in the FHLB and a blanket lien on qualifyingqualified collateral, consisting primarily of loans with first mortgage loans, loans guaranteedmortgages secured by the U. S. Government,one to four family properties, certain multi-family loans, U.S. Government Agency debentures, U.S. Government mortgage-backedunencumbered investment securities, and other non-Government mortgage backed securities.qualified assets.

Note 13: Shareholders'12: Shareholders’ Equity

Dividend Limitations: Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to its shareholders. The Bank is subject to certain requirements imposed by federal banking laws and regulations. These requirements, among other things, establish minimum levels of capital and restrict the amount of dividends that may be distributed by the Bank to the Company. At December 31, 2004,2005, the Bank had $19,662$8,354 available for dividends that could be paid without prior regulatory approval.

Regulatory Capital Requirements: The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and average assets. Management believes, as of December 31, 2004,2005, that the Company and Bank exceed all capital adequacy requirements to which they are subject. As of December 31, 2004,2005, the most recent notification from the federal regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The following table sets forth the Company’s and the Bank’s regulatory capital at December 31, 2004,2005, under the rules applicable at that date.

			For Capital Adequacy Purposes		To be well Capitalized under Prompt Corrective Action Provisions		Consolidated		For Capital Adequacy Purposes		To be well Capitalized under Prompt corrective Action provisions
	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio
As of December 31, 2004
As of December 31, 2005
Total Capital
(To Risk-Weighted Assets)
Consolidated	$56,260	13.01%	$34,588	8.0%	N/A		$56,556	11.30%	$40,028	8.0%	N/A
Bank	$55,077	12.76%	$34,523	8.0%	$43,154	10.0%	$58,313	11.67%	$39,967	8.0%	$49,959	10.0%
Tier 1 Capital
(To Risk-Weighted Assets)
Consolidated	$51,431	11.90%	$17,294	4.0%	N/A		$54,416	10.88%	$20,014	4.0%	N/A
Bank	$52,505	12.17%	$17,262	4.0%	$25,893	6.0%	$56,173	11.24%	$19,984	4.0%	$29,975	6.0%
Tier 1Capital
Tier 1 Capital
(To Average Assets)
Consolidated	$51,431	7.75%	$26,547	4.0%	N/A		$54,416	7.55%	$28,847	4.0%	N/A
Bank	$52,505	7.99%	$26,274	4.0%	$32,843	5.0%	$56,173	7.80%	$28,823	4.0%	$36,029	5.0%

The following table sets forth the Company’s and the Bank’s regulatory capital at December 31, 2003,2004, under the rules applicable at that date.

			For Capital Adequacy Purposes		To be well Capitalized under Prompt Corrective Action Provisions				For Capital Adequacy Purposes		To be well Capitalized under Prompt Corrective Action Provisions
	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio	Actual Amount	Ratio
As of December 31, 2003
As of December 31, 2004
Total Capital
(To Risk-Weighted Assets)
Consolidated	$56,403	14.70%	$30,694	8.00%	N/A		$56,260	13.01%	$34,588	8.0%	N/A
Bank	$50,139	13.07%	$30,208	8.00%	$37,761	10.0%	$55,077	12.76%	$34,523	8.0%	$43,154	10.0%
Tier 1 Capital
(To Risk-Weighted Assets)
Consolidated	$51,601	13.45%	$15,347	4.00%	N/A		$51,431	11.90%	$17,294	4.0%	N/A
Bank	$45,412	12.03%	$15,104	4.00%	$22,656	6.0%	$52,505	12.17%	$17,262	4.0%	$25,893	6.0%
Tier 1Capital
Tier 1 Capital
(To Average Assets)
Consolidated	$51,601	8.93%	$23,111	4.00%	N/A		$51,431	7.75%	$26,547	4.0%	N/A
Bank	$45,412	7.86%	$22,904	4.00%	$28,630	5.0%	$52,505	7.99%	$26,274	4.0%	$32,843	5.0%

Stock Repurchase Plans:Plan: In November 1999,March 2004, the Company announced a second stock repurchase plan, which was subsequently continued through December 31, 2003, at which time it terminated. Under that plan the Company was authorized to makeauthorizing open market and privately negotiated purchases of up to 10% of its outstanding shares of common stock, or 344,000 shares. As of 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 recorded the repurchased shares as treasury stock.

In March 2004, the Company announced a second stock repurchase plan which allows the Company to make open market and privately negotiated purchases of up to 10% of itsCompany’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and willwere to continue through December 31, 2005. In December 2005, the Company announced the continuance of this plan through December 31, 2006. 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. As of December 31, 2004,2005, the Company had repurchased 49,920103,732 shares of stock under thisthe plan, at a total cost of $1,349 and an average price of $27.03$27.21 per share. The Company records repurchased shares as treasury stock.

 

Note 14:13: Stock Based Compensation Plan:Compensation:

The Bar Harbor Bankshares and its Subsidiaries Incentive Stock Option Plan (ISO)("ISO") for officers and employees was established October 3, 2000, providing for the issuance of up to 450 thousand shares of common stock. The purchase price of the stock covered by each option shall be its fair market value, which must be equal to at least 100% of the fair market value on the date such option is granted. Initial grants were made in 2001 totaling 228 thousand shares. Vesting terms range from five to seven years. No option shall be granted after October 3, 2010, ten years after the effective date of the ISO.

The following table provides information as of December 31, 2004 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights, net of forfeits and exercised shares	Weighted Average exercise price of outstanding options, warrants and rights	Number of securities remaining available for future issuance under equity compensation [(excluding securities referenced in column (a)]
	(a)	(b)	(c)
Equity compensation plans approved      by security holders	318,350	$17.93	131,650
Equity compensation plans not approved      by security holders	--	N/A	--
Total	318,350	$17.93	131,650

A summary of the status of the planISO as of December 31, 2005, 2004 2003 and 2002,2003, and changes during the years then ended is presented below.

	2004			2003			2002
	Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
Outstanding at the beginning of the year	332,071	$16.90		328,457	$16.30		228,160	$15.43
Granted during the year	41,500	27.15		44,500	21.43		162,602	17.18
Exercised during the year	(26,683)	16.33		(11,255)	15.91		(5,241)	15.41
Forfeited during the year	(28,538)	20.78		(29,631)	17.45		(57,064)	15.41
Outstanding at the end of the year	318,350	$17.93		332,071	$16.90		328,457	$16.30
Exercisable at year end	88,392			66,161			29,672
Weighted average fair value of options       granted during the year		$  2.69			$  1.80			$  1.71

	2005			2004			2003
	Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
Outstanding at the beginning of the year	321,607	$18.09		332,071	$16.90		328,457	$16.30
Granted during the year	29,500	27.31		47,500	27.11		44,500	21.43
Exercised during the year	(34,122)	16.16		(26,683)	16.33		(11,255)	15.91
Forfeited during the year	(23,696)	15.65		(31,281)	20.68		(29,631)	17.45
Outstanding at the end of the year	293,289	$19.43		321,607	$18.09		332,071	$16.90
Exercisable at year end	101,434			88,392			66,161

The following information applies to options outstanding at December 31, 2004:2005:

		OPTIONS OUTSTANDING			OPTIONS EXERCISABLE
Range of Exercise Prices		Number of Shares	Average Remaining Contractual Life	Weighted Average Exercise Price	Number of Shares	Exercise Price
$15.40		114,821	6.47	$15.40	42,124	$15.40
$15.80		4,130	6.81	$15.80	1,286	$15.80
$16.05		90,000	7.15	$16.05	30,000	$16.05
$17.75 to $22.70		63,973	7.72	$18.89	14,396	$18.86
$23.20 to $29.10		45,426	9.51	$26.91	586	$24.72
$15.40 to $29.10
		318,350	7.35	$17.93	88,392	$16.25

	OPTIONS OUTSTANDING			OPTIONS EXERCISABLE
Range of Exercise Prices	Number of Shares	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price	Number of Shares	Weighted Average Exercise Price
$15.40	63,591	5.47	$15.40	26,937	$15.40
$15.80	4,130	5.81	$15.80	1,997	$15.80
$16.05	90,000	6.15	$16.05	45,000	$16.05
$17.75 - $25.45	59,012	6.78	$19.12	20,684	$19.07
$25.80 - $29.10	76,556	8.86	$27.20	6,816	$27.10
	293,289	6.83	$19.43	101,434	$17.23

The following information applies to options outstanding at December 31, 2003:

		OPTIONS OUTSTANDING			OPTIONS EXERCISABLE
Range of Exercise Prices		Number of Shares	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number of Shares	Exercise Price
$15.40		135,868	7.47	$15.40	39,818	$15.40
$15.80		4,130	7.82	$15.80	1,445	$15.80
$16.05		90,000	8.15	$16.05	15,000	$16.05
$17.75 to $26.20		101,203	8.93	$19.72	9,898	$18.55
$15.40 to $26.20		331,201	8.10	$16.90	66,161	$16.03

The per share weighted average fair value of all stock options granted by the Company during 2004, 2003, and 2002 was $2.69, $1.80, and $1.71 on the date of the grants usingassumptions were used in the Black Scholes option-pricing model with the following weighted average assumptions:model:

	2004	2003	2002
Expected dividend yield	2.94%	2.81%	3.93%
Risk free interest rate	2.79%	2.63%	2.23%
Volatility	11.99%	17.20%	11.00%
Expected life (years)	3.5	3.5	3.5
Weighted average fair value	$2.69	$1.80	$1.71

During the years ended December 31, 2004, 2003, and 2002, the total anti-dilutive stock options amounted to 13, 6, and 29 thousand shares, respectively

	2005	2004	2003
Expected dividend yield	3.19%	2.94%	2.81%
Risk free interest rate	4.32%	2.79%	2.63%
Volatility	16.76%	11.99%	17.20%
Expected life (years)	3.5	3.5	3.5
Weighted average fair value	$3.27	$2.76	$1.80

Note 15:14: Retirement Benefit Plans

Medical and Life Insurance Benefits: The Company sponsors a limited post-retirement benefit program which funds medical coverage and life insurance benefits to a closed group of active and retired employees who meet minimum age and service requirements. It is the Company's policy to record the cost of postretirementpost-retirement health care and life insurance plans based on actuarial estimates, which are dependent on claims and premiums paid. The cost of providing these benefits is accrued during the active service period of the employee. NetThe net periodic postretirement benefit cost includes the following components:

	2004	2003	2002
Interest cost on accumulated postretirement benefit obligation	$ 73	$ 80	$ 84
Amortization of actuarial gain	(16)	(23)	(23)
Net periodic postretirement benefit cost	$ 57	$ 57	$ 61

	2005	2004	2003
Interest cost on accumulated      post-retirement benefit obligation	$ 71	$ 73	$ 80
Amortization	(15)	(16)	(23)
Net periodic post-retirement benefit cost	$ 56	$57	$ 57

The following table sets forth the change in benefit obligations for the years ended December 31:

	2004	2003	2002
Benefit obligation at beginning of year	$1,262	$1,235	$1,247
Interest cost on accumulated postretirement benefit obligation	73	80	84
Amortization	(13)	17	(17)
Benefits paid	(77)	(70)	(79)
Benefit obligation at end of year	$1,245	$1,262	$1,235
Unrecognized gain at end of year	$    303	$    305	$    346
Accrued benefit cost included in other liabilities	$1,548	$1,567	$1,581

	2005	2004
Change in benefit obligations:
Benefit obligation at beginning of year	$1,245	$1,262
Interest cost on accumulated post-retirement      benefit obligation	71	73
Actuarial loss (gain)	48	(13)
Effect of amendments	(27)	---
Benefits paid	(65)	(77)
Benefit obligation at end of year	$1,272	$1,245
Unrecognized prior service cost	27	---
Unrecognized gain at end of year	240	303
Accrued benefit cost included in other liabilities	$1,539	$1,548

The accumulated postretirement benefit obligation (APBO) in 20042005 and 20032004 was determined using a 6.0%5.75% and 6% respectively, weighted average discount rate. The net periodic benefit cost in 2004, 2003,2005 and 20022004 was determined using a 6.00%, 6.75%, and 7.00%, respectively, weighted average discount rate.

The health care cost trend rate was 12%rates were 11.5% in 2004,2005, gradually declining to 6% after 12 years and remaining at that level thereafter. An increase in the health care trend of 1% would increase the APBO by approximately $98$110 and the net periodic benefit cost by $6. A decrease in the health care trend of 1% would decrease the APBO by approximately $87$97 and the net periodic benefit cost by $5.

The Company expects to contribute the following amounts to fund benefit payments for the postretirmenetpost-retirement medical and life insurance benefit plan for the years ending December 31:

2005	$     91
2006	96	$ 82
2007	98	87
2008	101	91
2009	104	95
2010 and thereafter	516
2010		100
2011 and thereafter		500
Total	$1,006	$955

401(k) Plan:  The Company has a 401(k) Plan available to full-time employees and officers. The Company matches employee contributions based on a predetermined formula and may make additional discretionary contributions. The total expense for this plan in 2005, 2004 and 2003 was $424, $391, and 2002 was $391, $393, and $325, respectively.

Supplemental Executive Retirement Plans: The Company has non-qualified supplemental executive retirement agreements for certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations. In 2005, 2004, 2003, and 2002,2003, the expense of these supplemental retirement agreements was $118,$129, $ 122,118, and $128,$122, respectively.

The Company also has Supplemental Executive Retirement Planssupplemental executive retirement plans for certain executive officers. These plans provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the executive leaves the Company following a change of control event. In 2005, 2004 2003 and 2002,2003, the expense of these supplemental retirement agreements was $336,$219, $334 and $253, and $316, respectively. As of December 31, 2004,2005, the Company had accrued a total of $905$1,114 to provide for these future payment obligations.

The following table provides the net periodic benefit costs for the supplemental executive retirement plans for the years ended December 31, 20042005 and 2003:2004:

	2004	2003
Service Cost	$298	$239
Interest Cost	156	136
Net Periodic Benefit Cost	$454	$375

	2005	2004
Service Cost	$179	$298
Interest Cost	171	153
Net Periodic Benefit Cost	$350	$451

The Company expectsfollowing benefit payments, which reflect expected future service as appropriate, are expected to contibutebe paid under the following amounts to the Supplemental Executive Retirement PlansCompany’s supplemental executive retirement plans for the years ending December 31:

2005	$    213
2006	222
2007	222
2008	222
2009	222
2010 and thereafter	7,035
Total	$8,136

2006	$    222
2007	222
2008	222
2009	222
2010	243
2011 and thereafter	6,526
Total	$7,657

Note 16:15: Financial Derivative Instruments

As part of its overall asset liability/management strategy, the CompanyBank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Company’sBank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant effect on net income.

At December 31, 20042005, the CompanyBank had twofour outstanding derivative instruments with notional principal amounts totaling $20 million, both of which$50,000. These derivative instruments were interest rate swap agreements.agreements and interest rate floor agreements, with notional principal amounts totaling $20,000 and $30,000, respectively. The details are summarized as follows:

Description	Maturity	Notional Amount (in thousands)	Fixed Interest Rate	Variable Interest Rate
Receive fixed rate, pay variable rate	09/01/07	$10,000	6.04%	Prime (5.25%)
Receive fixed rate, pay variable rate	01/24/09	$10,000	6.25%	Prime (5.25%)

Interest Rate Swap Agreements:

Description	Maturity	Notional Amount (in thousands)	Fixed Interest Rate	Variable Interest Rate
Receive fixed rate, pay variable rate	09/01/07	$10,000	6.04%	Prime (7.25%)
Receive fixed rate, pay variable rate	01/24/09	$10,000	6.25%	Prime (7.25%)

The CompanyBank is required to pay a counter-party monthly variable rate payments indexed to prime,Prime, while receiving monthly fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively, over the term of each agreement.

These interest rate swap agreements were designated as cash flow hedges at December 31, 2003 and had total unrealized gains of $86. The fair value of these instruments, net of tax, was recorded as a component of accumulated other comprehensive income on the consolidated balance sheet. Changes in fair value were recorded as a component of accumulated other comprehensive income. Current period net cash flows representing net amounts received from or paid to counter-parties were recorded as interest income.

During the first quarter of 2004, these interest rate swap agreements were de-designated as cash flow hedges and, from the time of de-designation, changes in their fair value and current period net cash flows representing net amounts received from or paid to counterparties agreementscounter-parties were recorded in the consolidated statement of income and included as part of non-interest income. The unrealized gain on these interest rate swap agreements at December 31, 2003 of $86 remained in accumulated other comprehensive income, net of tax, to beand is being accreted into interest income over the remaining terms of the respective swap agreements.

In July 2004, the Financial Accounting Standards Board ("FASB") issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:  Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interest-bearing loans, provided all other conditions for a cash flow hedge have been met. During the third quarter of 2004, the CompanyBank designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, unrealized gains or losses arising from changes in their fair value are recorded in accumulated other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties are recorded as interest income.

At December 31, 2004 and2005, the fair market value of the interest rate swap agreements was ($641), compared with ($225) at December 31, 2003,2004.

At December 31, 2005, the net unrealized (loss) gainloss on the interest rate swap agreements was ($225) and $86, respectively, and included in other assets on the consolidated balance sheets.

At December 31, 2004 the unrealized loss on these interest rate swap agreements included inaccumulated other comprehensive income, net of tax, amounted to $149,$275, compared with an unrealized gain of $57$205 at December 31, 2003.2004. Also included in accumulated other comprehensive income for the year endedat December 31, 2004,2005, was a net deferred loss, net of tax, of $15$10 related to the de-designation and re-designation of these swapsinterest rate swap agreements as cash flow hedges in 2004. There were no deferred gains or losses recorded in other comprehensive income in 2003.

During 2004, the net unrealized gains on interest rate swap agreements recorded in non-interest income amounted to $29, during the period in which hedge accounting was not applied.

During 2004,2005, the total net cash flows received from counterpartiescounter-parties amounted to $455,$3, compared with $498 and $117$455 in 2003 and 2002, respectively.2004. The net cash flows received from counter-parties during 2005 were recorded in interest income (hedge accounting). Of the $455 in net cash flows received from counterpartiescounter-parties during 2004, $375 was recorded in non-interest income (non-hedge accounting period) and $80 in interest income (hedge accounting period).

Interest Rate Floor Agreements:

Notional Amount	Termination Date	Prime Strike Rate	Premium Paid
$20,000	08/01/10	6.00%	$186
$10,000	11/01/10	6.50%	$ 69

During 2005, interest rate floor agreements were purchased to limit the Bank’s exposure to falling rates on a pool of loans indexed to the Prime interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69 for the right to receive cash flow payments if the Prime interest rate falls below the floors of 6.00% and 6.50%, thus effectively ensuring interest income on a pool of Prime-based loans at a minimum of 6.00% and 6.50% on the $20,000 and $10,000 notional amounts for the duration of the agreements, respectively. The netinterest rate floor agreements were designated as a cash flows received from counterparties during 2003flow hedges in accordance with SFAS 133.

At December 31, 2005, the total fair market value of the floor agreements was $131 and 2002 werewas included in other assets on the Company’s consolidated balance sheet. Pursuant to SFAS 133, changes in the fair market value, representing unrealized gains or losses, are recorded in accumulated other comprehensive income or loss.

The premiums paid on the interest rate floor agreements are included in accumulated other comprehensive (loss) income on the consolidated balance sheet and are being recognized in interest income over the duration of the agreements using the floorlet method, in accordance with SFAS 133. During 2005, $2 of the premium was recognized in interest income. At December 31, 2005, the remaining unamortized premiums, net of tax, totaled $167. During the next twelve months, $19 of the premium will be recognized in interest income, decreasing the interest income related to the hedged pool of Prime-based loans.

At December 31, 2005, the unamortized premium net of the unrealized loss on the interest rate floor agreement amounted to $80, net of tax, and was recorded in accumulated other comprehensive loss on the consolidated balance sheet.

Note 17:16: Commitments and Contingent Liabilities

The CompanyBank is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.

Commitments to originate loans, including unused lines of credit, are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The CompanyBank uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the CompanyBank upon extension of credit, is based on management’s credit evaluation of the borrower.

The CompanyBank guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are primarily issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Exposure to credit loss in the event of nonperformance by the counter-party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. Typically, these standby letters of credit have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.

The following table summarizes the contractual amounts of commitments and contingent liabilities as of December 31, 2004, 20032005 and 2002.2004.

	2004	2003	2002	December 31, 2005	December 31, 2004
Commitments to originate loans	$14,435	$32,575	$14,581	$  40,779	$14,435
Unused lines of credit	$75,732	$62,616	$52,611	73,190	75,732
Un-advanced portions of construction loans	$ 7,336	$ 3,683	$ 3,950	6,110	7,336
Total				$120,079	$97,503
Standby letters of credit	$ 1,155	$ 2,205	$ 2,800	$      115	$ 1,155

As of December 31, 2004,2005 and 2003,2004, the fair values of the standby letters of credit were not significant to the Company’s consolidated financial statements.

Operating Lease Obligations

The Company leases certain properties used in operations under terms of operating leases, which include renewal options. The following table sets forth the approximate future lease payments over the remaining terms of the non-cancelable leases as of December 31, 2005.

2006	$   73
2007	63
2008	66
2009	70
2010	73
2011 and thereafter	38
Total	$383

Note 18:17: Fair Value of Financial Instruments

The Company discloses fair value information about financial instruments for which it is practicable to estimate fair value. Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Where available, quoted market prices are used. In other cases, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience and other factors. Changes in assumptions could significantly affect these estimates. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in certain cases, could not be realized in an immediate sale of the instrument.

Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amounts presented do not purport to represent the underlying market value of the Company. For certain assets and liabilities, the information required under SFAS No. 107 is supplemented with additional information relevant to an understanding of the fair value.

The following describes the methods and assumptions used by the Company in estimating the fair values of significant financial instruments:

Cash and cash equivalents: For cash and cash equivalents, including cash and due from banks and other short-term investments with maturities of 90 days or less, the carrying amounts reported on the consolidated balance sheet approximate fair values.

Securities available-for-sale and held-to-maturity: available-for-sale: Fair values are based on quoted bid market prices, where available. Where quoted market prices for an instrument are not available, fair values are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instrument being valued. The carrying value of securities available-for-sale reported on the consolidated balance sheet represent estimated fair value, whereas securities held-to-maturity are carried at cost, adjusted for premium amortization or discount accretion.value.

Loans: For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of other loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits: The fair value of deposits with no stated maturity is equal to the carrying amount. The fair value of time deposits is based on the discounted value of contractual cash flows, applying interest rates currently being offered on wholesale funding products of similar maturities. The fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of alternative forms of funding ("deposit base intangibles").

Borrowings: For borrowings that mature or re-price in 90 days or less, carrying value approximates fair value. The fair value of the Company’s remaining borrowings is estimated by using discounted cash flows based on current rates available for similar types of borrowing arrangements taking into account any optionality.

Accrued interest receivable and payable: The carrying amounts of accrued interest receivable and payable approximate their fair values.

Off-balance sheet financial instruments: The fair values of the interest rate swap agreements are based on quoted market prices. The Company’s other off-balance sheet instruments consist of loan commitments and standby letters of credit. Fair values for standby letters of credit and loan commitments were insignificant.

A summary of the carrying values and estimated fair values of the Company’s significant financial instruments at December 31, 2005 and 2004 and 2003 follows:

	December 31, 2004		December 31, 2003
	Carrying	Fair	Carrying	Fair
	Value	Value	Value	Value
Financial assets:
Cash and cash equivalents	$    9,571	$    9,571	$ 14,469	$ 14,469
Securities available for sale	176,337	176,337	124,422	124,422
Securities held to maturity	---	---	33,965	35,093
Loans, net	443,649	446,661	378,130	385,543
Interest receivable	2,790	2,790	2,536	2,536
Financial liabilities:
Deposits (with no stated maturity)	257,293	257,293	219,476	219,476
Time deposits	140,979	140,568	119,604	121,045
Securities sold under repurchase agreements	15,077	15,077	15,925	15,925
Borrowings from the FHLB	191,846	194,701	170,506	176,534
Interest payable	916	916	758	758
Financial derivative instruments
Interest rate swap agreements	(225)	(225)	86	86

	December 31, 2005		December 31, 2004
	Carrying Value	Fair Value	Carrying Value	Fair Value
Financial assets:
Cash and cash equivalents	$ 14,000	$ 14,000	$    9,571	$    9,571
Securities available for sale	183,300	183,300	176,337	176,337
Loans, net	510,219	505,389	443,649	446,661
Interest receivable	3,572	3,572	2,790	2,790
Financial liabilities:
Deposits (with no stated maturity)	255,529	255,529	257,293	257,293
Time deposits	190,202	188,331	140,979	140,568
Securities sold under repurchase          agreements	16,438	16,423	15,077	15,077
Borrowings from the FHLB	223,258	222,926	191,846	194,701
Interest payable	1,411	1,411	916	916
Financial derivative instruments
Interest rate swaps	(641)	(641)	(225)	(225)
Interest rate floors	131	131	---	---

Note 19:18: Legal Contingencies

The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of the Company'sCompany’s business, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.

Note 20:19: Condensed Financial Information – Parent Company Only

The condensed financial statements of Bar Harbor Bankshares as of December 31, 20042005 and 2003,2004, and for each of the three-years in the period ended December 31, 2004,2005, are presented below:

BALANCE SHEETS
December 31

	2004	2003	2005	2004
Cash	$     561	$     376	$     730	$     561
Investment in subsidiaries	54,859	51,849	55,354	54,859
Premises	745	746	742	745
Other assets	414	459	21	414
Total Assets	$56,579	$53,430	$56,847	$56,579
Liabilities
Total Liabilities	$    537	$    315	$     743	$     537
Total Shareholders’ equity	56,042	53,115
Shareholders’ equity
Common stock			7,287	7,287
Surplus			4,002	4,002
Retained earnings			55,181	51,733
Accumulated other comprehensive (loss) income			(1,738)	1,118
Treasury stock			(8, 628)	(8,098)
Total equity			56,104	56,042
Liabilities & Shareholders’ Equity	$56,579	$53,430
Liabilities and Shareholders’ Equity			$56,847	$56,579

STATEMENTS OF INCOME
Years Ended December 31

	2004	2003	2002	2005	2004	2003
Dividend income from subsidiaries	$2,409	$5,075	$5,369	$3,873	$2,409	$5,075
Equity in undistributed earnings of subsidiaries (1)	3,652	714	(387)	2,992	3,652	714
Bankshares expenses, net of tax benefit	(329)	(582)	(417)
Bankshares expenses				(669)	(498)	(881)
Tax benefit				228	169	299
Net income	$5,732	$5,207	$4,565	$6,424	$5,732	$5,207

(1) Amount in parentheses represents the excess of dividends over net income of subsidiaries.

 

STATEMENTS OF CASH FLOWS
Years Ended December 31

	2004	2003	2002
Cash flow from operating activities:
Net income	$ 5,732	$ 5,207	$ 4,565
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation	10	8	7
Net decrease (increase) in other assets	627	(6)	(77)
Equity in undistributed earnings of subsidiaries	(3,652)	(714)	387
Net cash used by operating activities	2,717	4,495	4,882
Cash flows from investing activities:
Additional investments in subsidiaries	888	(350)	(854)
Capital expenditures	(11)	(8)	(6)
Net cash used in investing activities	877	(358)	(860)
Cash flows from financing activities:
Purchase of treasury stock	(1,369)	(1,888)	(1,563)
Proceeds from stock issuance	438	179	101
Dividend paid	(2,478)	(2,386)	(2,445)
Net cash used in financing activities	(3,409)	(4,095)	(3,907)
Net increase (decrease) in cash	185	42	115
Cash and cash equivalents, beginning of year	376	334	219
Cash and cash equivalents, end of year	$   561	$   376	$   334

	2005	2004	2003
Cash flows from operating activities:
Net income	$ 6,424	$ 5,732	$ 5,207
Adjustments to reconcile net income to cash      provided by operating activities:
Depreciation	11	10	8
Net decrease (increase) in other assets	240	627	(6)
Equity in undistributed earnings of subsidiaries	(2,992)	(2,764)	(714)
Net cash provided by operating activities	3,683	3,605	4,495
Cash flows from investing activities:
Additional investment in subsidiaries	---	---	(350)
Capital expenditures	(8)	(11)	(8)
Net cash (used in) provided by investing activities	(8)	(11)	(358)
Cash flows from financing activities:
Purchases of treasury stock	(1,473)	(1,369)	(1,888)
Proceeds from stock option exercises	551	438	179
Dividends paid	(2,584)	(2,478)	(2,386)
Net cash used in financing activities	(3,506)	(3,409)	(4,095)
Net increase in cash and cash equivalents	169	185	42
Cash and cash equivalents, beginning of year	561	376	334
Cash and cash equivalents, end of year	$     730	$     561	$     376

Note 21:20: Selected Quarterly Financial Data (Unaudited)

Year 2004	1st Quarter	2nd Quarter	3rd Quarter	4th Quarter	Year
						Quarter
Year 2005						1	2	3	4	Year
Interest and dividend income	$7,523	$7,664	$8,255	$8,480	$31,922	$8,541	$8,945	$9,486	$10,223	$37,195
Interest expense	2,708	2,840	2,943	3,054	11,545	3,230	3,595	3,999	4,512	15,336
Net interest income	4,815	4,824	5,312	5,426	20,377	5,311	5,350	5,487	5,711	21,859
Provision for loan losses	90	30	30	30	180	---	��     25	25	(50)	---
Noninterest income	1,841	811	2,498	1,422	6,572
Noninterest expense	4,597	4,620	5,032	4,665	18,914
Non-interest income						1,103	1,953	1,967	1,392	6,415
Non-interest expense						4,783	4,865	4,827	4,793	19,268
Income before income taxes	1,969	985	2,748	2,153	7,855	1,631	2,413	2,602	2,360	9,006
Income taxes	533	182	805	603	2,123	418	713	780	671	2,582
Net income	$1,436	$  803	$1,943	$1,550	$5,732	$1,213	$1,700	$1,822	$ 1,689	$ 6,424
Earnings per share:
Basic	$0.46	$0.26	$0.63	$0.50	$1.85	$  0.39	$ 0.55	$ 0.59	$  0.55	$   2.09
Diluted	$0.45	$0.25	$0.61	$0.48	$1.79	$  0.38	$ 0.54	$ 0.58	$  0.54	$   2.03
Year 2003	1st Quarter	2nd Quarter	3rd Quarter	4th Quarter	Year
						Quarter
Year 2004						1	2	3	4	Year
Interest and dividend income	$7,707	$7,696	$7,489	$7,601	$30,493	$7,523	$7,664	$8,255	$ 8,480	$31,922
Interest expense	2,841	2,837	2,728	2,669	11,075	2,708	2,840	2,943	3,054	11,545
Net interest income	4,866	4,859	4,761	4,932	19,418	4,815	4,824	5,312	5,426	20,377
Provision for loan losses	150	150	120		540	90	30	30	30	180
Noninterest income	1,735	1,703	1,919	1,717	7,074
Noninterest expense	4,652	4,448	4,920	4,833	18,853
Non-interest income						1,841	811	2,498	1,422	6,572
Non-interest expense						4,597	4,620	5,032	4,665	18,914
Income before income taxes	1,799	1,964	1,640	1,696	7,099	1,969	985	2,748	2,153	7,855
Income taxes	495	552	411	434	1,892	533	182	805	603	2,123
Net income	$1,304	$1,412	$1,229	$1,262	$ 5,207	$1,436	$  803	$1,943	$ 1,550	$ 5,732
Earnings per share:
Basic	$0.41	$0.44	$0.39	$0.41	$1.67	$ 0.46	$ 0.26	$ 0.63	$  0.50	$  1.85
Diluted	$0.41	$0.43	$0.38	$0.40	$1.63	$ 0.45	$ 0.25	$ 0.61	$  0.48	$  1.79

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures: Procedures: The Company carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are operating in an effective manner.

Management Report on Internal Control over Financial Reporting: Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

• Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
• Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
• Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004.2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework.

Based on our assessment, management believes that as of December 31, 2004,2005, the Company’s internal control over financial reporting is effective, based on the criteria set forth by COSO in  Internal Control --– Integrated Framework.

The Company’s independent registered public accounting firm has issued an audit report on our assessment of, and the effective operation of, the Company’s internal control over financial reporting. This report appears within Item 9A of this report on Form 10-K.

Changes in Internal Control Over Financial Reporting-Reporting:  No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Bar Harbor Bankshares:

We have audited management's assessment, included in the accompanying Management'sManagement Report on Internal Control Over Financial Reporting, that Bar Harbor Bankshares (the Company) maintained effective internal control over financial reporting as of December 31, 2004,2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).    The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.  Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in a reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Bar Harbor Bankshares maintained effective internal control over financial reporting as of December 31, 2004,2005, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004,2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Bar Harbor Bankshares and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, and comprehensive income, changes in shareholders’ equity, comprehensive income, and cash flows for the yearyears then ended, December 31, 2004, and our report dated March 14, 20056, 2006 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Albany, New York
March 14, 20056, 2006

ITEM 9B. OTHER INFORMATION

None.On December 20, 2005, the Company Board of Directors approved the adoption of a new code of ethics, which replaced the Company's prior Code of Ethics. A copy of the Code of Ethics approved by the Board of

Directors is attached to this Annual Report as an Exhibit and is available on our Company website at www.BHBT.com. The Company did not file a Form 8-K Current Report, Item 5.05, in connection with its adoption of the Company's new Code of Ethics.

 

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors and Executive Officers: Information required by this item is incorporated by reference from the sections entitled "Management of the Company", and "Executive Officers", in the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Shareholders, which will bewas filed with the Commission on or before April 30, 2005March 15, 2006 (the "Proxy").

Compliance with Section 16(a) of the Securities Exchange Act of 1934: The information required under this item is incorporated herein by reference from the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company’s definitive Proxy.

Audit Committee Financial Expert: The information required under this item is incorporated herein by reference from "Appendix A" Report of the Audit Committee, contained in the Company’s definitive Proxy.

Code of Ethics: The information required under this item is incorporated herein by reference from the section entitled "Other Matters,"Matters" "Code of Ethics" contained in the Company’s definitive Proxy.

ITEM 11. EXECUTIVE COMPENSATION

Information required by this item is incorporated by reference from the section entitled "Compensation of Directors and Executive Officers" in the Company’s definitive Proxy.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required by this item is incorporated by reference from the sections entitled "Voting Securities and Principal Holders thereof" and "Equity Compensation Plan Information" in the definitive Proxy.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by this item is incorporated by reference from the section entitled "Transactions with Directors, Officers, and Principal Shareholders" in the definitive Proxy.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required by this item is incorporated by reference to the section entitled "Selection of Auditors" in the Company’s definitive ProxyProxy.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)        1. All Financial Statements Filed herewith at Item 8

            2. Financial Statement Schedules Filed herewith at Item 8

            3. Exhibits:

The following exhibits are included as part of this Form 10-K.

EXHIBIT NUMBER
2.1	Plan of Acquisition, Reorganization Agreement, Liquidation, or Succession	Incorporated by reference to Form S-14 filed with the Commission March 26, 1984 (Commission Number 2-90171).
2.2	BTI Restructuring Plan	Incorporated by Reference to Form 10-K, Item 15(a)(3)((2)(b), filed with the Commission on March 29, 2004 (Commission Number 001-13349)
3.1	Articles of Incorporation.	Articles as amended July 11, 1995, are incorporated by reference to Form S-14 filed with the Commission March 26, 1984 (Commission Number 2-90171).
3.2	Bylaws	Bylaws as amended to date are incorporated by reference to Form 10-K, Item 14(a)(3) filed with the Commission March 28, 2002. (Commission Number 001-13349)
10	Material Contracts
10.1	Deferred Compensation Plans	Incorporated by reference to Form 10-K filed with the Commission March 31, 1987 (Commission Number 0-13666).
10.2	Supplemental ExeuctiveExecutive Retirement Plan adoptedAdopted by the Board of Directors on September 16, 2003, and effective as of January 1, 2003, providing Joseph M. Murphy, President and CEO of the Company, Gerald Shencavitz, the Company's Company’s Chief Financial Officer, and Dean S. Read, former President of the Bank, with certain defined retirement benefits.	Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.3	Joseph M. Murphy Employment Contract	Incorporated by reference to Form 10-K Item 15(a)(10.2), filed with the Commission May 27, 2003 (Commission File Number 001-13349).
10.4	Incentive Stock Option Plan 2000	Incorporated by reference to Form 10-K, Item 14(a)(3) filled with the Commission March 28, 2002 (Commission File Number 001-13349).
10.5	Amendment to Employment Agreement, Change in Control, Confidentiality and Non-competition Agreement between the Company and Joseph M. Murphy.	Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.6	Change in Control, Confidentiality, and Non-competition Agreement between the Company and Gerald Shencavitz.	Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.7	Change in Control, Confidentiality, and Non-competition Agreement between the Company and former Bank President Dean S. Read.	Incorporated by reference to Form 10-Q, Part II, Item 6, filed with the Commission November 13, 2003 (Commission File Number 001-13349).
10.8	Change in Control, Confidentiality, and Non-competition Agreement between the Company and Daniel A. Hurley III, President of Bar Harbor Trust Services.	Incorporated by reference to Form 8-K, Exhibit 99.1, "Form of Change in Control, Confidentiality and Non-competition Agreement," filed with the Commission on June 30, 2005 (Commission File Number 001-13349).
10.9	Purchase and Assumption Agreement between Bar Harbor Banking and Trust Company and Androscoggin Savings Bank, dated October 24, 2003.	Incorporated by reference to Form 10-Q, Part II, Item 6 filled with the Commission November 13, 2003 (Commission File Number 001-13349).
10.910.10	Description of the 2005 Two-tiered Executive Compensation Arrangements not pursuant to a written plan or agreement.	Filed herewith
10.1010.11	Infinex AggeementAgreement	Filed herewith Incorporated by reference to Form 10-K, Part III, Item 15(a)(10.10), filed with the Commission on March 14, 2005 (Commission File Number 001-13349).
10.1110.12	Dean S. Read Resignation Agreement and Release	Incorporated by reference to Form 10-K, Part III, Item 15(a)(10.11), filed with the Commission on March 14, 2005 (Commission File Number 001-13349).
10.13	Somesville Bank Branch Lease dated October 27, 2005.	Filed herewith
13	Annual Report to Shareholders	Filed herewith
14	Code of Ethics	Incorporated by reference to Form 10-K Item 15(a)(3)(14), filed with the Commission March 14, 2004 (Commission File Number 001-13349)Filed herewith
21	Subsidiaries of the Registrant	Filed herewith
23	Consent letters	Filed herewith
31.1	Certification of Chief Executive Officer under Rule 13a-14/15d-14(a)	Filed herewith.
31.2	Certification of Chief Financial Officer under Rule 13a-14/15d-14(a)	Filed herewith.
31.2	Certification of Chief Financial Officer under Rule 13a-14/15d-14(a)	Filed herewith.
32.1	Certification of Chief Executive Officer under 18 U.S.C. Sec. 1350.	Filed herewith.
32.2	Certification of Chief Financial Officer under 18 U.S.C. Sec. 1350.	Filed herewith.

The Company’s management contracts and compensatory plans or arrangements consist of Exhibits 10.1 through 10.4 and 10.6.

(c) There are no other financial statements and financial statement schedules, which were excluded from this report, which are required to be included herein.

 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

March 16, 20052006              BAR HARBOR BANKSHARES
                                       (Registrant)

                                        /s/ Joseph M. Murphy

                                        Joseph M. Murphy
                                        President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons have signed this report in the capacities indicated on behalf of the Registrant.

/s/ Thomas A. Colwell Thomas A. Colwell Chairman, Board of Directors	/s/ Joseph M. Murphy Joseph M. Murphy, Director President and Chief Executive Officer
/s/ Robert C. Carter Robert C. Carter, Director	/s/ Robert M. Phillips Robert M. Phillips, Director
/s/ Peter Dodge Peter Dodge, Director	/s/ Gerald Shencavitz Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer
/s/ Martha Tod Dudman Martha Tod Dudman, Director	/s/ Kenneth E. Smith Kenneth E. Smith, Director
/s/ Dwight L. Eaton Dwight L. Eaton, Director	/s/ Constance C. Shea Constance C. Shea, Director
/s/ Cooper F. FriendLauri E. Fernald Cooper F. Friend,Lauri E. Fernald, Director	/s/ Scott G. Toothaker Scott G. Toothaker, Director
/s/ John P. McCurdyClyde H. Lewis John P. McCurdy,Clyde H. Lewis, Director	/s/ David B. Woodside David B. Woodside, Director
/s/ John P. McCurdy John P. McCurdy, Director