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

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarter ended: September 30, 2004March 31, 2005 Commission File No. 841105-D

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES: (X) NO: ( )

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).

YES: (X) NO: ( )NO: (X)

Number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date:

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004MARCH 31, 2005 AND DECEMBER 31, 20032004
(Dollars in thousands, except per share data)
(unaudited)

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands, except per share data)
(unaudited)

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands, except per share data)
(unaudited)

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands)
(unaudited)

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMECASH FLOWS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2005 AND 2004 AND 2003
(Dollars in thousands, except per share data)thousands)
(unaudited)

     

EARNINGS PER SHARE:
Basic	$ 0.63	$ 0.39		$ 1.35	$ 1.25
Diluted	$ 0.61	$ 0.38		$ 1.30	$ 1.23

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Dollars in thousands)
(unaudited)

	Three Months Ended September 30,
	2004		2003
Net income	$ 1,943		$ 1,229
Unrealized appreciation (depreciation) on securities available for sale, net of           reclassification adjustment, net of tax of $734 and $509 at September 30, 2004           and 2003, respectively	1,425		(988)
Net unrealized depreciation on interest rate swap agreements           marked to market, net of tax of $1 and $47 at September 30, 2004 and           2003, respectively	(1)		(90)
Accretion of net unrealized appreciation related to interest rate swap           agreements de-designated in 2004, net of tax of $2	(4)		---
Total other comprehensive income (loss)	1,420		(1,078)
Total comprehensive income	$ 3,363		$ 151

	Nine Months Ended September 30,
	2004		2003
Net income	$ 4,182		$ 3,945
Unrealized depreciation on securities available for sale, net of reclassification           adjustment, net of tax of $104 and $815 at September 30, 2004 and 2003, respectively	(203)		(1,582)
Net unrealized (depreciation) appreciation on interest rate swap agreements           marked to market, net of tax of $1 and $39 at September 30, 2004 and 2003, respectively	(1)		76
Accretion of net unrealized appreciation related to interest rate swap agreements           de-designated in 2004, net of tax of $29	(57)		---
Total comprehensive loss	(261)		(1,506)
Total comprehensive income	$ 3,921		$ 2,439

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Dollars in thousands, except per share data)
(unaudited)

	Capital Stock	Surplus	Retained Earnings	Accumulated Other Comprehensive Income	Treasury Stock	Total Shareholders’ Equity
Balance December 31, 2002	$7,287	$4,002	$45,994	$2,347	$(5,794)	$53,836
Net income	---	---	3,945	---	---	3,945
Total other comprehensive loss	---	---	---	(1,506)	---	(1,506)
Cash dividends declared ($0.57 per share)	---	---	(1,795)	---	---	(1,795)
Purchase of treasury stock (60,835 shares)	---	---	---	---	(1,238)	(1,238)
Stock options exercised (9,774 shares)	---	---	(58)	---	213	155
Balance September 30, 2003	$7,287	$4,002	$48,086	$   841	$(6,819)	$53,397

Balance December 31, 2003	$7,287	$4,002	$48,746	$ 514	$(7,434)	$53,115
Net income	---	---	4,182	---	---	4,182
Total other comprehensive loss	---	---	---	(261)	---	(261)
Cash dividends declared ($0.60 per share)	---	---	(1,860)	---	---	(1,860)
Purchase of treasury stock (30,285 shares)	---	---	---	---	(801)	(801)
Stock options exercised (17,817 shares)	---	---	(175)	---	463	288
Balance September 30, 2004	$7,287	$4,002	$50,893	$ 253	$(7,772)	$54,663

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(Dollars in thousands)
(unaudited)

	2004	2003
Cash flows from operating activities:
Net income	$ 4,182	$ 3,945
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	893	827
Amortization of core deposit intangible	39	---
Provision for loan losses	150	420
Net realized gains on sale of securities available for sale	(416)	(868)
Net realized gain on sale of security held to maturity	(16)	---
Net gain on interest rate swap agreements	(29)	---
Net amortization of bond premiums	833	175
Income on bank owned life insurance	(158)	(149)
Net change in other assets	(449)	383
Net change in other liabilities	195	(108)
Net cash provided by operating activities	5,224	4,625
Cash flows from investing activities:
Net payment for branch acquisition	4,528	---
Proceeds from maturity and principal pay downs of securities held to maturity	394	685
Purchases of securities available for sale	(96,544)	(94,664)
Purchases of securities held to maturity	(1,688)	(2,857)
Proceeds from maturities, calls and principal pay downs of securities available for sale	43,066	65,346
Proceeds from sale of securities held to maturity	491	---
Proceeds from sale of securities available for sale	35,763	35,845
Net increase in Federal Home Loan Bank stock	(1,531)	(1,041)
Net loans made to customers	(34,451)	(27,203)
Capital expenditures	(457)	(781)
Net cash used in investing activities	(50,429)	(24,670)
Cash flows from financing activities:
Net increase in deposits	36,995	12,991
Net decrease in securities sold under repurchase agreements	(3,326)	(1,641)
Proceeds from Federal Home Loan Bank advances	25,000	31,800
Repayment of Federal Home Loan Bank advances	(10,559)	(17,477)
Purchases of treasury stock	(801)	(1,238)
Proceeds from exercise of stock options	288	155
Payments of dividends	(1,860)	(1,795)
Net cash provided by financing activities	45,737	22,795
Net increase in cash and cash equivalents	532	2,750
Cash and cash equivalents at beginning of period	14,469	12,867
Cash and cash equivalents at end of period	$ 15,001	$15,617
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$ 8,491	$ 8,406
Income taxes, net of refunds	935	1,458
Non-cash transactions:
Transfer from loans to other real estate owned	$     ---	$     (46)
Acquired other real estateowned	---	335
Unrealized depreciation on securities available for sale, net of tax of $104 and $815 at               September 30, 2004 and 2003, respectively	(203)	(1,582)
Net unrealized (depreciation) appreciation on interest rate swap agreements marked to market,               net of $1 and $39, at September 30, 2004 and 2003, respectively	(1)	76
Accretion of net unrealized appreciation related to interest rate swap agreements de-designated               in 2004, net of tax of $29	(57)	---
Acquired in branch purchase:
Fair value of loans	$ 12,343	$     ---
Fair value of premises and equipment	980	---
Fair value of core deposit intangible	391	---
Fair value of deposits	(21,100)	---
Excess of fair value of assets over liabilities (goodwill)	2,858	---
Net payment	$ (4,528)	$   ---

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
September 30, 2004MARCH 31, 2005
(Dollars in thousands, except per share data)
(unaudited)

Note 1: Basis of Presentation

The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All inter-company transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform withto current period presentation. The net income reported for the three and nine-monthsthree-months ended September 30, 2004March 31, 2005 is not necessarily indicative of the results that may be expected for the year ending December 31, 20042005 or any other interim periods.

The consolidated balance sheet at December 31, 20032004 has been derived from audited consolidated financial statements at that date. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements included in the Registrant'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2003,2004, and notes thereto.

Note 2: Management’s Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, income tax estimates, and interest income recognition on loans, and the valuation of intangible assets.

Management believes theThe allowance for loan losses (the "allowance") at the Company’s wholly owned banking subsidiary Bar Harbor Bank & Trust (the "Bank") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, for loan losses, which is established through a provision for loan loss expense, is basedavailable to absorb losses on loans. The allowance is maintained at a level that, in management’s evaluationjudgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. Arriving at an appropriate level of allowance required in relation toinvolves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated inherent risklosses is evaluated regularly based on review of loss inloans, 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. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the sizeportfolio, business and composition of the portfolio, current economic andconditions, 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 properties to be foreclosed.collateral. The use of different estimates or assumptions could produce different provisions for loan losses, and 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 Company estimates its income taxes for each period for which a statement of operationsincome 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 income tax return and financial reporting 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 past taxes paid and/or 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 September 30, 2004March 31, 2005 and December 31, 2003,2004, there was no valuation allowance for deferred tax assets.  Deferred tax assets which are included in other assets on the consolidated balance sheet.

Interest income on loans is included inaccrued and credited to income as earned based uponon the unpaid principal balanceamount of the loan. The Company’s policy is to discontinue the accrual of interest, and to reverse the uncollected interest recordedloans outstanding. Residential real estate loans are generally placed on loans,non-accrual status when scheduled payments become contractuallythey reach 90 days past due, are in excessprocess of foreclosure, or sooner if judged appropriate by management. All consumer loans are generally placed on non-accrual when they reach 90 days or more past due, or sooner if judged appropriate 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 judgmentprocess of management,collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the ultimate90 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 or interest becomes doubtful.is reasonably assured and the loan has performed for a period of time, generally six months.

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. Core depositGoodwill is evaluated for impairment at least annually, or upon a triggering event as defined by Statement of Financial Accounting Standards ("SFAS") No. 142, using several fair value techniques, such as 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 identifiablefactors. Identifiable intangible assets areconsist of core deposit intangibles amortized to expense over their estimated useful lives andon a straight-line method, which approximates the amount of economic benefits to the 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. The valuation techniques used byFurthermore, the Company to determine the carrying valuedetermination of tangible andwhich intangible assets acquired in acquisitions andhave finite lives is subjective, as is the estimated livesdetermination of identifiablethe amortization period for such 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.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.

Note 3: Goodwill and Other Intangible Assets

A summary of goodwill, by subsidiary, capitalized on the Company’s consolidated balance sheet follows:

During the first quarter of 2004, the Company acquired $2,858$2,816 in goodwill in connection with the acquisition by the Bank of a branch in Rockland, Maine by its wholly owned subsidiary, Bar Harbor Bank & Trust (the "Bank").Maine.

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 the Rockland branch. 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 September 30, 2004 consolidated balance sheet. There was no such intangible asset at December 31, 2003.sheets.

A summary of the core deposit intangible asset follows as of September 30,March 31, 2005 and December 31, 2004:

Amortization expense on the core deposit intangible asset is expected to total $17$50 for the remainder of 2004,2005, and $67 for each year 2005for years 2006 thru 2009.

Note 4: Earnings Per Share

Earnings per share have been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity, such as the Company’s dilutive stock options.

The following is a reconciliation of basic and diluted earnings per share for the threethree-months ended March 31, 2005 and nine-months ended September 30,2004:

BAR HARBOR BANKSHARES AND SUBSIDIARIES
EARNINGS PER SHARE
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(in thousands, except number of shares and 2003:per share data)
(unaudited)

Note 5: Stock 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 thatfor officers and employees, which is described more fully in Notes 1 and 16Note 14 to the Consolidated Financial Statements in the Company’s 20032004 Annual Report on Form 10-K. The Company accounts

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 plan undergrant date based on the recognitionvalue of the award and measurement principlesis 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", and related interpretations. No stock-basedEmployees," whereby compensation costs have been reflected in net income, as all options granted undercost is the plan had an exerciseexcess, if any, of the quoted market price equal to the market value of the underlying common stock onat the grant date.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 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 compensation costs for the plan beenCompany determined cost based on the fair value of the options at the grant dates consistent withdate for its stock options and expense related to the method described inemployee stock option plan under SFAS No. 123, the Company’sits net income and earnings per share data would have been reduced to the pro forma amounts indicated below (in thousands except for per-share data):below:

Note 6: Retirement Benefit Plans

The Company sponsors a post retirementlimited post-retirement benefit plan,program which providesfunds medical coverage and life insurance benefits to eligible employees. a closed group of retired employees who meet minimum age and service requirements. It is the Company's policy to record the cost of postretirement health care and life insurance plans based on actuarial estimates, which are dependent on claims and premiums paid. The cost of providing these benefits was accrued during the active service period of the employee.

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.

The Company also has non-qualified supplemental executive retirement agreementsplans for certain active and retiredexecutive 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.

The following tables provide the net periodic benefit costs for the threethree-months ended March 31, 2005 and nine-months ended September 30, 2004 and 2003:2004:

The Company is expected to contribute $454$371 to the foregoing plans in 2004.2005. As of September 30, 2004,March 31, 2005, the Company had contributed $343$114 to the plans.

Note 7: Commitments and ContingenciesContingent Liabilities

The Company 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.

ExposureCommitments to credit loss in the event of nonperformance by the counter-party to the financial instrument for commitments to makeoriginate 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 standby lettersmay require payment of credit is represented bya fee. Since many of the contractual amount of those instruments.commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. At September 30, 2004 and December 31, 2003, commitments to extend credit and unused lines of credit totaled $115,405 and $98,874, respectively. Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, these amounts do not necessarily represent future cash commitments. Collateral obtained upon funding of the commitment is determinedThe Bank evaluates each customer’s creditworthiness on a case-by-case basis usingbasis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.

The Company 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. Standby letters

The following table summarizes the contractual amounts of credit totaled $1,155 at September 30, 2004commitments and $2,205 atcontingent liabilities as of March 31, 2005 and December 31, 2003. 2004:

As of September 30,March 31, 2005, and December 31, 2004, the fair value of the standby letters of credit waswere not significant to the Company’s consolidated financial statements.

Note 8: Financial Derivative Instruments

As part of its overall asset 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 effect on net income.

At September 30, 2004March 31, 2005 the CompanyBank had two outstanding derivative instruments with notional principal amounts totaling $20 million, both of which were interest rate swap agreements. The details are summarized as follows:

The CompanyBank 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 agreement.

Financial instruments are reviewed as part of the asset/liability management process and are factored into the Company’s overall interest rate risk position. The Company regularly reviews the credit quality of the counter-party from which the interest rate swap agreements have been purchased. The notional amounts of the agreements do not represent exposure to credit loss. The Company 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.

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 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 agreements 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, changes in their fair value are being 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 September 30, 2004, DecemberMarch 31, 2003 and September 30, 2003,2005 the fair value ofunrealized gain (loss) on the interest rate swap agreements were $28, $86was ($590), compared with ($225) and $388, respectively,$328 at December 31 and March 31, 2004, respectively. Unrealized gains and losses are included in other assets on the consolidated balance sheet.sheets.

At September 30, 2004March 31, 2005 the net unrealized loss on these interest rate swap agreements included in accumulated other comprehensive income,loss, net of tax, amounted to $1. At December$389, compared with none at March 31, 20032004 when hedge accounting was not applied. Also included in accumulated other comprehensive loss at March 31, 2005, was a net deferred loss, net of tax, of $14 related to the de-designation and September 30, 2003re-designation of these swaps as cash flow hedges in 2004.

The change in the net unrealized gainsloss on these interest rate swap agreements included in accumulated other comprehensive income, net of tax, amounted to $57 and $256, respectively.

During the quarter ended September 30, 2004, the Company recorded in non-interest income unrealized appreciation of $428 representing a mark-to-market adjustmenttaxes, for interest rate swap agreements prior to their designation as cash flow hedges, compared with an unrealized loss of $728 recorded in the quarter ended June 30, 2004, and an unrealized gain of $328 recorded in the quarter ended March 31, 2004. 2005 is summarized below:

For the nine-monthsthree-months ended September 30,March 31, 2004, a period during which hedge accounting was not applied, the net unrealized gain on interest rate swap agreements recorded in non-interest income amounted to $29. No such amounts$328. During the year ended December 31, 2004 the total net unrealized gains on interest rate swap agreements recorded in non-interest income amounted to $29, during the periods in which hedge accounting was not applied. A summary of the total unrealized gains (losses) that were recorded in non-interest income during 2003.periods in which hedge accounting was not applied follows:

For the three and nine-monthsthree-months ended September 30, 2004,March 31, 2005, the total net cash flows received from counter-partiescounterparties amounted to $89 and $386, respectively,$22, compared with $128 and $324$167 during the same periodsperiod in 2003. Of the $89 in2004. The net cash flows received from counter-partiescounterparties during the first quarter of 2005 were recorded in interest income (hedge accounting), whereas during the first quarter of 2004 the net cash flows were recorded in non-interest income (non-hedge accounting).

The Bank performs quarterly assessments of hedge effectiveness and measures any ineffective portion of its hedges as required by SFAS No. 133. The Bank did not recognize any amounts in earnings related to ineffectiveness of cash flow hedges during the three-months ended September 30, 2004, $79 was recorded in non-interest income and $10 in interest income. Of the $386 in net cash flows received from counter-parties during the nine-months ended September 30, 2004, $376 was recorded in non-interest income and $10 in interest income. The $324 in net cash flows received during the nine-months ended September 30, 2003 was recorded in interest income.March 31, 2005.

Note 9: Business Segments

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 has determined that its operations are solely 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 reporting for that segment. As more fully described in Part I, Item 1 of the Company’s Annual Report on Form 10-K, and Part I, Item 2, Other Events of the Company’s March 31, 2004 Form 10-Q, 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 the first quarter of 2004 the principal elements of the plan were completed, with the results of all operations now viewed as a single strategic unit by the chief operating decision maker. For the year ended December 31, 2003 revenue from Financial Services represented only 5.8% of the Company’s total revenue. In these circumstances, Accordingly, disaggregated segment information is not required with respectpresented in the notes to investment management, trust and third party brokerage services provided by the Company.financial statements.

Note 10: Recently Issued Accounting Pronouncements

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-basedThe following information addresses new 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.   Entitiesproposed accounting pronouncements that choose to use the first-payments-received technique are still required by SFAS 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 it 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 consolidated financial statements or results of operations for the periods ended September 30, 2004, however, prospectively the adoption of the guidance could have a significantan impact on the Company’s consolidated financial position.condition, results of operations, earnings per share, or cash flows.

Accounting For Share-Based Payments: In MarchDecember 2004, FASB issued SFAS No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R") which requires companies to recognize in the FASB Emerging Issues Task Force ("EITF") reached a consensus on Issue 03-1, "The Meaningincome statement the grant-date fair value of Other Than Temporary Impairment (Issue 03-1)". The Task Force reached a consensus on an other-than-temporary impairment model for debtstock options and equity securities accounted forother equity-based compensation issued to employees, including employee stock purchase plans. Current disclosure provisions 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 scope123 continue to apply prior to adoption 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 presumedSFAS 123R. In addition 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 investments cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and cannot be adjusted for subsequent recoveries in fair value, unless required by other authoritative literature.

On September 30, 2004, the FASB issued FSP EITF Issue 03-01-1, which delayedstock option awards granted after 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 after the effective date.

SFAS No. 123R is effective in the first fiscal year beginning after June 15, 2005 (January 1, 2006 for the measurement and recognition guidanceCompany). The adoption of an impairment loss thatSFAS No. 123R is other-than-temporary (i.e. steps 2 and 3expected to decrease earnings per share by approximately $0.04 in 2006, based upon the current level of the impairment model) contained in paragraphs 10-20 of EITF 03-1. Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue 03-1a. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The 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 portfolio held at September 30, 2004, EITF 03-1unvested options. SFAS No. 123R is not expected to have a material effect on the Company's financial position or results of operations.

Statement of Financial Accounting Standards ("SFAS") No. 133 Implementation Issue C13, "When a Loan Commitment Is Included in the Scope of Statement 133", requires commitments to originate mortgage loans that will be held for sale upon origination to be accounted for as derivatives, but does not provide guidance on how the fair value of those commitments should be measured. In a December 2003 speech, the SEC staff indicated it believes loan commitments are written options and therefore should never result in the recognition of an asset under SFAS No. 133. Rather, the staff indicated lenders should initially recognize a liability for loan commitments, with the offsetting debit recognized as a derivative loss to the extent a premium is not received from the potential borrower. The staff indicated it would not object to a registrants recognizing loan commitments as assets provided such registrant discontinues that practice for commitments entered into in the first reporting period beginning after March 15, 2004 and provided assets recorded on loan commitments entered into prior to that date are reversed when the related loan closes or the commitment expires. The guidance did not have a significant impact on the Company’s consolidated financial statementscondition or results of operations.

In January 2003, the Financial Accounting Standards Board issued FASB 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 dates 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 financial position or results of operations.cash flows.

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of the financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this report on Form 10-Q. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries.

Certain amounts in the 2004 interim consolidated financial statements have been reclassified to conform to the presentation used in 2005.

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

Use of Non-GAAP Financial Measures: Certain information is discussed on a fully taxable equivalent basis. Specifically, included in thirdfirst quarter 20042005 and 20032004 net interest income was $437$435 and $416,$363, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine-months ended September 30, 2004 and 2003, the amount of tax-exempt income included in net interest income was $1,219 and $1,218, respectively. 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 $193$202 and $179$154 in the thirdfirst quarter of 20042005 and 2003 respectively, and $531 and $522 in tax-equivalent adjustments for the nine-months ended September 30, 2004, and 2003, respectively. The analysis of net interest income tables included in this Form 10-Q 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. NetOther financial institutions commonly present net interest income is commonly presented by other financial institutions 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 is generally used by institutions to provide a better basis of comparison from institution to institution. The Company follows these practices.

FORWARD LOOKING STATEMENTS DISCLAIMER

The following discussion,Certain statements, as well as certain other statementsdiscussions contained in this report on Form 10-Q, 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 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 lookingforward-looking statements contained herein represent the Company's judgment as of the date of this report on Form 10-Q, 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 report on Form 10-Q, except to the extent required by federal securities laws.

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 its December 31, 20032004 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:

Allowance for Loan 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. 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 a greater amount of provisionsprovision for loan losses is necessary the result is lower net income. Refer to Part I, Item 2, Allowance for Loan Losses and Provision in this Reportreport on Form 10-Q, for further discussion and analysis concerning the allowance.

Income 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 September 30, 2004March 31, 2005 and December 31, 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 - 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 Note 2 of the consolidated financial statements in Part I, Item 1 of this report on Form 10-Q for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.

SUMMARY OVERVIEW

The Company reported consolidated net income of $1,943 or fully diluted earnings per share of $0.61 for the three-months ended September 30, 2004, compared with $1,229$1,213 or fully diluted earnings per share of $0.38 for the three-months ended March 31, 2005 compared with $1,436 or fully diluted earnings per share of $0.45 for the same quarter in 2003,2004, representing increasesdecreases of $714$223 and $0.23,$0.07, or 58.1%15.5% and 60.5%14.6%, respectively. The annualized return on average assets ("ROA") and average shareholders’ equity ("ROE") amounted to 1.15%0.74% and 13.71%8.77%, respectively, compared with 0.87%0.97% and 9.29%10.88% for the same quarter in 2003.2004.

As more fully enumerated below, several factors contributed favorably to the Company’s thirddecline in first quarter performance2005 earnings compared with the samefirst quarter of 2004 was principally attributed to a decline in 2003, the more significant of which included: a $551 increase in net interest income; the recording of $428 a mark-to-market adjustment for unrealized appreciationincome on interest rate swap agreements;agreements related to a $136 increasemark-to-market adjustment of $328 recorded in the first quarter of 2004, and a $172 decline in net gains on the sale of investment securities;securities. In addition, during the first quarter of 2005 the Company recorded an employee severance payment of $238, made in connection with the Company’s previously announced resignation of Dean S. Read as President of the Bank. The foregoing items were offset in part by a $496 increase in net interest income and a $90 decline in the provision for loan losses.

For the nine-months ended September 30, 2004, consolidated net income amounted to $4,182 or fully diluted earnings per share of $1.30, compared with $3,945 or fully diluted earnings per share of $1.23 for the same period in 2003, representing increases of $237 and $0.07, or 6.0% and 5.7%, respectively. The ROA and ROE amounted to 0.87% and 9.52% respectively, compared with 0.95% and 9.85% for the first nine-months of 2003.

As more fully enumerated below, the more significant factors unfavorably impacting the Company’s year-to-date results of operationslosses compared with the same period in 2003 included: a declinefirst quarter of $436 in net gains on the sale of investment securities; a $317 increase in marketing and public relations costs principally related to the Company’s previously announced corporate re-branding and market research initiatives; other-than-temporary impairment write-downs of certain non-marketable equity investments amounting to $189 compared with none during 2003; and the recording of a $160 loss associated with certain trust activities. The foregoing items were offset in part by a $465 increase in net interest income and a $270 decline in the provision for loan losses.2004.

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 incurredpaid 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.

For the quarter ended September 30, 2004,March 31, 2005, net interest income on a fully tax equivalent basis amounted to $5,505,$5,513, compared with $4,940$4,969 during the thirdfirst quarter of 2003,2004, representing an increase of $565,$544, or 11.4%10.9%. The increase in net interest income was principally attributed to the $97,418 or 18.1%an increase in average earning assets of $62,466 or 11.0% and, to a lesser extent, a three basis point improvement in the net interest margin, when comparing the three-months ended September 30, 2004March 31, 2005 with the same period in 2003, as the net interest margin declined 20 basis points between periods.

For the nine-months ended September 30, 2004, net interest income on a fully tax-equivalent basis amounted to $15,482, compared with $15,008 during the same period in 2003, representing an increase of $474, or 3.2%. The increase in net interest income during the nine-months ended September 30, 2004 compared with the same period in 2003 was principally attributed to an $81,304 or 15.5% increase in average earning assets, as the net interest margin declined 41 basis points between these two periods.2004.

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 set forth an analysistable summarizes the Company’s average balance sheets and components of net interest income, by each major categoryincluding a reconciliation of interest earning assets and interest bearing liabilitiestax equivalent adjustments, for the threethree-months ended March 31, 2005 and nine-months ended September 30, 2004, and 2003, respectively:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30,MARCH 31, 2005 AND 2004 AND 2003

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

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003

(1)  For purposes of these computations, non-accrual loans are included in average loans.
(2)  For purposes of these computations, investment securities and available for sale securities are at amortized cost and net unrealized gains
(losses) on available-for-sale securities are recorded in other assets.
(3)  For purposes of these computations, 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-bearing 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.

During the three and nine-months ended September 30, 2004, the Bank continued to experience considerable margin erosion in the low interest rate environment compared with the same periods in 2003. The net interest margin amounted to 3.45% during the thirdfirst quarter of 2004 compared with 3.65% during the same quarter in 2003, representing a decline of 20 basis points. For the nine-months ended September 30, 20042005 the net interest margin amounted to 3.41%3.54% compared with 3.82% during3.51% in the same periodfirst quarter of 2004. Comparing the first quarter of 2005 with 2004, average earning asset yields increased 18 basis points while the average cost of funds increased 12 basis points.

The following table summarizes the net interest margin components, on a quarterly basis, over the past two years. Factors contributing to the changes in 2003, representingthe net interest margin are enumerated in the following discussion and analysis.

NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED

(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, reported on a decline of 41 basis points.tax equivalent basis.

The prolonged, historically low interest rate environment hasduring 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. ComparingThe interest rate environment over the nine-months ended September 30, 2004 withpast few years caused considerable margin erosion given the same periodBank’s asset sensitive balance sheet; specifically, the decline in 2003,yields on earning assets occurred at a faster pace than the decline in the average yield oncost of interest bearing funds.

The Bank has been deliberate in its efforts to mitigate the interest rate risk associated with the addition of long term, fixed rate earning assets exceededto the decline in the rate paid onbalance sheet during a period of historically low interest bearing liabilities by 32 basis points. During the twelve months ended September 30, 2004, the Bank’s earning asset base continued to cycle into the current rate environment while most of the funding base had already reset to current interest rate levels or reached their assumed floors.

rates. Management believes the Bank’sits strategy of maintaining an asset sensitive balance sheet has contributed to the net interest margin declinedeclines experienced over the past year.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 anticipates isanticipated 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 current strategy of maintaining an asset sensitive balance sheet is important to the Company’s long-term success and such posture better positions it for rising interest rates and an improving economy.

In late June of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") began increasing short-term interest rates. As management anticipated,Over the three recentpast nine-months, the Fed funds targeted rate was increased seven times, ending the first quarter of 2005 at 2.75%. These rate increases in the Federal Funds rate totaling 75 basis points favorably impacted the Bank’s net interest margin during this period of time, with the three-months ended September 30, 2004. Foryield on average earning assets increasing 47 basis points to 5.61%, and the quarter ended September 30, 2004cost of interest bearing funds increasing only 27 basis points to 2.37%. Consequently, the Bank’s net interest margin was 3.45%increased to 3.54% in first quarter of 2005, compared with the two-year low of 3.28% experienced during the quarter ended June 30, 2004, representing an improvement of 1726 basis points.

The Bank’s interest rate sensitivity position is more fully described in Part I, Item 3 of this report on Form 10-Q, Quantitative and Qualitative Disclosures About Market Risk.

Interest Income: For the quarter ended September 30, 2004,March 31, 2005, total interest income, on a fully tax equivalent basis, amounted to $8,448$8,743 compared with $7,668$7,677 for the same quarter in 2003,2004, representing an increase of $780,$1,066, or 10.2%13.9%. For the nine-months ended September 30, 2004 total

The increase in interest income on a fully tax equivalentwas attributed to earning asset growth of $62,466 combined with an 18 basis amounted to $23,973 comparedpoint increase in average earning asset yields, when comparing the three-month period ended March 31, 2005 with $23,414 during the same period in 2003, representing an increase of $559, or 2.4%.

The increases in interest income were principally attributed to the growth in average earning assets between reporting periods, as earning asset yields posted declines of 37 and 68 basis when comparing the three and nine-month periods ended September 30, 2004 with the same periods in 2003.2004. Principally reflecting the Federal Reserve’s recent increases in short-term interest rates, the yield on average earning assets amounted to 5.28%5.61% during the current quarter ended September 30, 2004,March 31, 2005, compared with 5.14%5.43% during the same quarter ended June 30,in 2004.

As discussed above, the three and nine-month declines in total interest income attributed to lower yields were largely offset by growth in average earning assets. As depicted on the following rate / volume analysis tables, the volume of interest earning assets added to the balance sheet since the third quarter of 2003 contributed $2,824 to third quarter 2004 interest income, offset by a decline of $2,044 attributed to the impact of lower yields and interest rates. For the nine-months ended September 30, 2004, the volume of interest earning assets contributed $4,202 to interest income, offset by a decline of $3,643 attributed to the impact of lower yields and interest rates.

Interest Expense -Expense: Total interest expense for the quarter ended September 30, 2004March 31, 2005 amounted to $2,943$3,230 compared with $2,728$2,708 during the same quarter in 2003,2004, representing an increase of $215,$522, or 7.9%. For the nine-months ended September 30, 2004, total interest expense amounted to $8,491 compared with $8,406 during the same period in 2003, representing an increase of $85, or 1.0%19.3%.

The increase in interest expense during the three and nine-months ended September 30, 2004 was principally attributed to the increases$68,690 increase in average interest bearing liabilities amounting to $95,216 or 20.9%, and $81,349 or 18.1%, comparedcombined with the same periods in 2003, respectively. These increases were substantially offset by declinesa 12 basis point increase in the average cost of funds, which duringwhen comparing the three and nine-month periodsthree-month period ended September 30, 2004 amounted to 2.12% and 2.14%, comparedMarch 31, 2005 with 2.37% and 2.50% during the same periodsperiod in 2003, representing declines of 25 and 36 basis points, respectively.

2004. The declinesincrease 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. During the three and nine-months ended September 30, 2004, the total average cost of interest bearing deposits amounted to 1.34% and 1.33%, compared with 1.49% and 1.64% during the same periodsincreases in 2003, representing declines of 15 and 31 basis points, respectively.

During the three and nine-months ended September 30, 2004, the average cost of borrowings amounted to 3.33% and 3.38%, compared with 3.74% and 3.85% during the same periods in 2003, representing declines of 41 and 47 basis points, respectively. These declines were principally attributed to the replacement of maturing borrowed funds at prevailing low interest rates. The disproportionate rate of decline in the current quarter compared with the nine-months ended September 30, 2004, reflects the impact of recent interest rate increases by the Federal Reserve on the Bank’s short-term borrowing base.

Consistent with the Bank’s asset and liability management strategies, a portion of the Bank’s borrowings have longer maturities than the funding provided by traditional deposits in order to preserve the sensitivity of net interest income in a rising interest rate environment. While the use of longer maturity borrowings to fund earning assets naturally results in less net interest income, they more closely match the maturities of fixed rate earning assets being added to the balance sheet, and lessen the degree of exposure to interest rate risk.

As discussed above, the three and nine-month declines in total interest expense resulting from lower interest rates were largely offset by increases in interest bearing liabilities. As depicted on the rate / volume analysis tables below, the volume of interest bearing liabilities added to the balance sheet since the third quarter of 2003 contributed $1,820 to third quarter 2004 interest expense, offset by a reduction of $1,605 due to lower interest rates. For the nine-months ended September 30, 2004, the impact of lower interest rates reduced interest expense by $1,850, offset by an increase of $1,935 attributed to the volume of interest bearing liabilities.between periods.

Rate / Volume Analysis: The following tables settable sets 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
THREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2005 VERSUS MARCH 31, 2004 VERSUS SEPTEMBER 30, 2003
INCREASES (DECREASES) DUE TO:

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

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30,Provision for Loan Losses

For the three-months ended March 31, 2005, the Bank did not record a provision for loan losses, compared with $90 during the first quarter of 2004.

The provision for loan losses reflects the amount necessary to maintain the Allowance for Loan Losses ("allowance") at a level that, in management’s judgment, is appropriate for the amount of inherent risk of loss in the current loan portfolio. In prior reporting periods the allowance for loan losses incorporated loss estimates relating to borrowers in the Maine wild blueberry industry that were involved in extensive legal matters, which warranted recognition of increased credit risk. During the first quarter of 2005, these 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 the current quarter. Non-performing loans at March 31, 2005 amounted to $527, representing a decline of $196 or 27.1% compared with December 31, 2004, VERSUS SEPTEMBER 30, 2003
INCREASES (DECREASES) DUE TO:

(1) For purposesand a decline of these computations, non-accrual$1,185 or 69.2% compared with the same date in 2004. The allowance for loan losses expressed as a percentage of non-performing loans are includedstrengthened to 911% at March 31, 2005, compared with 668% and 301% at December 31 and March 31, 2004, respectively.

The Bank's loan loss experience showed an improvement during the first three-months of 2005 compared with the same period in 2004. Net charge-offs amounted to $30, or annualized net charge offs to average loans.
(2) Reportedloans outstanding of 0.03%, compared with net charge-offs of $209, or annualized net charge offs to average loans outstanding of 0.21% during the three-months ended March 31, 2004.

Although somewhat offset by the continued increases in the loan portfolio, as well as a variety of other risk related attributes, the improved credit risk related to borrowers in the Maine wild blueberry industry was the principal reason underlying the zero provision for the quarter ended March 31, 2005.

Refer to Part I, Item 2, Allowance for Loan Losses, in this report on form 10-Q for further discussion and analysis regarding the provision and allowance for loan losses.

Based upon the continued performance of the loan portfolio, combined with certain improvements with respect to specific credit relationships, the Bank did not record a tax-equivalent basis.provision for loan losses during the first quarter of 2005. Refer to Part I, Item 2, Allowance for Loan Losses, in this report on Form 10-Qfor further discussion and analysis regarding the provision and allowance 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 quarter ended September 30, 2004,March 31, 2005, total non-interest income amounted to $2,498$1,103 compared with $1,919$1,841 for the same quarter in 2003,2004, representing an increasea decrease of $579,$738, or 30.2%40.1%.