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

FORM 10-Q

Quarterly Report Pursuant to Section(Mark One)

    XQUARTERLY REPORT PURSUANT TO SECTION 13 orOR 15(d) of the Securities Exchange Act ofOF THE SECURITES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2005                  ended March 31, 2006

____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. Number: 841105-D

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

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

Inapplicable
(Former name, former address and former fiscal year, if changed since last report)

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 ____  NO     X

YES: (X) NO: ( )Indicate by check mark whether the registrant 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 an accelerated filer (as defined in Rule12b-2 of the Exchange Act).

YES: (X) NO: ( )

Indicate by check mark whether the Registrantregistrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

exchange act rule 12b-2): YES: ( )_____  NO:  NO (X)    X

Indicate the 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, 2005MARCH 31, 2006 AND DECEMBER 31, 20042005
(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 AND NINE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2006 AND 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, 2006 AND 2005
(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 CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(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 CHANGES IN SHAREHOLDERS' EQUITYCOMPREHENSIVE INCOME (LOSS)
FOR THE NINETHREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2006 AND 2005 AND 2004
(Dollars in thousands, except per share data)thousands)
(unaudited)

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, 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 COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 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
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 2005MARCH 31, 2006
(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 to current period presentation. The net income reported for the three and nine months ended September 30, 2005March 31, 2006 is not necessarily indicative of the results that may be expected for the year ending December 31, 2005,2006, or any other interim periods.

The consolidated balance sheet at December 31, 20042005 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 principlesUnited States generally accepted in the United States of Americaaccounting principles 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2004,2005, 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, interest income recognition on loans, and the valuation of intangible assets.

Allowance For Loan Losses: The 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 which is established through a provision for loan loss expense, 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 by management.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, non-performingnonperforming loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral. The use

Reserves are established for specific loans including impaired loans, a pool of different estimates or assumptions could produce different provisions forreserves based on historical charge-offs by loan losses,types, and the amountsupplemental reserves that adjust historical loss experience to reflect current economic conditions, industry specific risks, and timing of realized losses and future allowance allocations could vary from current estimates. other observable data.

While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the Bank’s 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.

Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimatingThe Company uses the Company’s actual current taxasset and liability as well as assessing temporary differences resulting from differing timingmethod of recognition of expenses, income and tax credits,accounting for income tax return and financial reporting purposes. These differences result intaxes. Under this method, deferred tax assets and liabilities which are included inrecognized for the Company’s consolidated balance sheets. The Company must also assessfuture tax consequences attributable to differences between the likelihoodfinancial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information indicates that anyit is more likely than not that deferred tax assets will not be recovered from past taxes paid and/or future taxable income and, to the extent that the recovery is not likely,realized, a valuation allowance mustis 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 established. 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.

Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of September 30, 2005March 31, 2006 and December 31, 2004,2005, there was no valuation allowance for deferred tax assets. Deferred tax assets are included in other assets on the consolidated balance sheet.

Interest on loans is accruedGoodwill and credited to income based on the principal amount of loans outstanding. Residential real estate loans are generally placed on non-accrual status when they reach 90 days past due, are in process of foreclosure, or sooner if judged appropriate by management. 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 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.

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 Statement of Financial Accounting Standards ("SFAS")SFAS No. 142, using severalcertain 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 factors. techniques.

Identifiable intangible assets consist of core deposit intangibles amortized over their estimated useful lives on 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 management believes 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.

Note 3: Goodwill and Other Intangible Assets

A summary of goodwill follows:

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

The Company also has 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, and is included in other assets on the consolidated balance sheets.

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

Amortization expense on finite-lived intangible assets is expected to total $17 for the remainder of 2005, and $67 for each of the years 2006 through 2009.

Note 4:3: 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,Company, such as the Company’s dilutive stock options.

The following is a reconciliation of basic and diluted earnings per share for the three and nine months ended September 30, 2005March 31, 2006 and 2004:2005:

(in thousands, except number of shares and per share data)

For the three and nine months ended September 30,March 31, 2006, and 2005, and 2004, the total number of anti-dilutive shares were 18,628options excluded from the earnings per share calculation was 81,513 and 19,375 compared with 16,658 and 13,186,12,627, respectively.

Note 5:4: 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 ("ISOP") for its officers and employees, which provides for the issuance of up to 450,000 shares of common stock. At March 31, 2006, 81,966 shares are still available for future stock option grants. 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 described more fully in Note 14granted. Vesting terms range from five to seven years. No option shall be granted after October 3, 2010, ten years after the Consolidatedeffective date of the ISOP.

Implementation of New Accounting Standards: In December 2004, the Financial StatementsAccounting Standards Board ("FASB") issued a revision of Statement of Financial Accounting Standards ("SFAS") No. 123. SFAS No. 123(R), "Share-Based Payment", which makes significant changes to accounting for "payments" involving employee compensation and "shares" or securities, in the Company’s 2004 Annual Report on Form 10-K.

SFAS No. 123, "Accounting for Stock-Based Compensation" encouragesform of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all entities to adopt astock options be measured at estimated 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 recognizedrecorded as compensation expense over the requisite service period which isassociated with the option, usually the vesting period. However, it also allows an entityThe revised standard was effective on January 1, 2006 for calendar-year public companies and is applied prospectively to continuestock options granted after the effective date and any unvested stock options at that date. The primary effect of the revised standard’s implementation on the Company is recognition of compensation expense associated with stock options.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R), using the modified-prospective-transition method. Under that transition method, compensation expense that the Company recognizes beginning in 2006 includes: (a) the compensation expense for all stock-based payments granted prior to, measurebut not yet vested as of, January 1, 2006, based on the grant date fair value; and (b) the compensation costexpense for those plansall share-based payments granted on or after January 1, 2006, based on the grant date fair value. Because the Company elected to use the modified prospective transition method, results for prior periods have not been restated. Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value based methodrecognition and measurement principles of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees," whereby compensation cost isEmployees", and related interpretations ("intrinsic value method"). Under the excess, if any,provisions of the quotedCompany’s ISOP, the exercise price per share of each option granted cannot be less than the fair market pricevalue of the underlying stock atcommon shares on the grant date (or other measurement date) over the amount an employee must pay to acquire the stock upon exercise of the stock option.

Thegrant. Accordingly, the Company has electedpreviously did not recognize any stock-based employee compensation expense in net income prior to continue withJanuary 1, 2006.

Impact of the accounting methodology in OpinionAdoption of SFAS No. 25 and, as123(R): As a result must make pro forma disclosures of adopting SFAS 123(R), the Company recorded an expense of $35 in the quarter ended March 31, 2006.

Comparable Disclosures: The following table illustrates the effect on the Company’s net income and earnings per share as ifhad the Company applied fair value based methodrecognition provisions of accounting had been applied. SFAS No. 123(R) to its stock-based employee compensation in 2005:

The pro forma disclosures includefair value was estimated at the effectsdate of all awards granted. Hadgrant using the Black-Scholes option-pricing model with the following weighted-average assumptions for stock option grants in the quarter ended March 31, 2006 and 2005:

Expected market price volatility for the grants in the quarter ended March 31, 2006, was determined by using the Company’s historical stock price volatility on a daily basis during the seven-year period ending March 31, 2006.

Stock Option Activity: The following table summarizes the Company’s stock option activity during the three months ended March 31, 2006:

The intrinsic value of the options exercised and cash received by the Company determined cost based onfor options exercised for the fair value at the grant date for itsperiod ended March 31, 2006 was approximately $54 and $64, respectively.

Stock Options Outstanding: The following table summarizes stock options and 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 below:outstanding by exercise price range at March 31, 2006:

Note 6:5: Retirement Benefit Plans

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 post-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 wasis accrued during the active service period of the employee.

The Company has non-qualified supplemental executive retirement agreementsplans for certain retired officers. The agreementsThese plans 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 plans for certain executive officers. These plans provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, death, or in the event that the executive leaves the Company following a change of control event.

The following tables providetable summarizes the net periodic benefit costs for the three and nine months ended September 30, 2005March 31, 2006 and 2004:2005:

The Company is expected to contribute $371$342 to the foregoing plans in 2005.2006. As of September 30, 2005,March 31, 2006, the Company had contributed $271$112 to the plans.

Note 7:6: Commitments and Contingent Liabilities

The Bank 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 Bank 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 Bank upon extension of credit, is based on management’s credit evaluation of the borrower.

The Bank 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 non-performance 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 September 30, 2005March 31, 2006 and December 31, 2004:2005:

As of September 30, 2005,March 31, 2006, and December 31, 2004,2005, the fair value of the standby letters of credit were not significant to the Company’s consolidated financial statements.

Note 8:7: Financial Derivative Instruments

As part of its overall asset/asset 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 effect on net income.

The Company recognizes all of its derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Bank designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Bank formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Bank 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 or loss. For fair value hedges that are highly effective, the gain or loss on the hedge and the loss or gain on the hedged item attributable to the hedged risk are both recognized in earnings, with the differences (if any) representing hedge ineffectiveness. The Bank discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

At September 30, 2005March 31, 2006 the Bank had threefour outstanding derivative instruments with notional principal amounts totaling $40 million.$50,000. These derivative instruments were interest rate swap agreements and interest rate floor agreements, with notional principal amounts totaling $20,000 and $30,000, respectively. The details are summarized as follows:

INTEREST RATE SWAP AGREEMENTS
(Dollars in thousands)Interest Rate Swap Agreements:

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 agreement.

TheseThe 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 counter-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, and 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 regardingaccordance with SFAS No. 133No.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 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 September 30, 2005,March 31, 2006, the fair market value of the interest rate swap agreements was ($596),745) compared with ($225)641) and $28($590) at December 31, and September 30, 2004,March 31, 2005, respectively. The fair market valuevalues of the interest rate swap agreements iswere included in other assetsliabilities on the consolidated balance sheets.

At September 30, 2005,March 31, 2006, the net unrealized gain (loss)loss on the interest rate swap agreements included in accumulated other comprehensive income (loss),loss, net of tax, amounted to ($394),$492, compared with ($149)$423 and $1$389 at December 31 and September 30, 2004.March 31, 2005, respectively. Also included in accumulated other comprehensive lossincome (loss) at September 30, 2005,March 31, 2006, was a net deferred loss, net of tax, of $11$9 related to the de-designation and re-designation of these swapsinterest rate swap agreements as cash flow hedges in 2004.

During the three and nine months ended September 30, 2004, the net unrealized gain on interest rate swap agreements recorded in non-interest income amounted to $428 and $29, respectively. A summary of the total unrealized gains (losses) that were recorded in non-interest income during periods in which hedge accounting was not applied follows:

Three months ended:

(Dollars in thousands)

During the three and nine months ended September 30, 2005,March 31, 2006, the total net cash flows received from (paid to) counter-parties amounted to ($12) and $33,52), compared with $89 and $386$22 during the same periodsperiod in 2004.2005. The net cash flows received from (paid to) counter-parties during the three and nine months ended September 30, 2005 were recorded in interest income (hedge accounting), whereas during the period from January 1, 2004 to September 16, 2004, the net cash flows were recorded in non-interest income (non-hedge accounting).income.

INTEREST RATE FLOOR AGREEMENT
(Dollars in thousands)Interest Rate Floor Agreements:

During September 2005, an interest rate floor agreement wasagreements were purchased to limit the Bank’s exposure to falling interest rates on a pool of loans indexed to the Prime interest rate. Under the terms of the agreement,agreements, the Bank paid a premiumpremiums of $176$186 and $69 for the right to receive cash flow payments if the Prime interest rate falls below the floorfloors of 6.00% and 6.50%, thus effectively lockingensuring interest income on a pool of prime-based loans at a minimum of 6.00% and 6.50% on the $20 million$20,000 and $10,000 notional amountamounts for the duration of the agreement.agreements, respectively. The interest rate floor agreement wasagreements were designated as a cash flow hedgehedges in accordance with SFAS 133.

At September 30, 2005,March 31, 2006, the total fair market value of the interest rate floor agreementagreements was $89 and was$46 compared with $131 at December 31, 2005. The fair market values of the interest rate floor agreements were included in other assets on the Company’s consolidated balance sheet.sheets. 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 premiumpremiums paid on the interest rate floor agreement isagreements are included in accumulated other comprehensive income (loss) income on the consolidated balance sheet and isare being recognized in interest income over the duration of the agreementagreements using the floorlet method, in accordance with SFAS 133. During the three months ended March 31, 2006, $2 of the premium was recognized in interest income. At September 30, 2005,March 31, 2006, the remaining unamortized premium,premiums, net of tax, was $116.totaled $165, compared with $167 at December 31, 2005. During the next twelve months, $11$25 of the premium will be recognized in interest income, decreasing the interest income related to the hedged pool of Prime basedPrime-based loans.

At September 30, 2005,March 31, 2006, the unamortized premium net of the unrealized loss on the interest rate floor agreement amounted to $58,$136, net of tax, and was recorded in accumulated other comprehensive loss on the consolidated balance sheet.

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 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. Accordingly, disaggregated segment information is not presented in the notes to the financial statements.

Note 10:8: Recently Issued Accounting Pronouncements

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

MeaningAccounting for Servicing Rights of Other-Than-Temporary Impairment and Its Application to Certain Investments: On November 3, 2005, FASBFinancial Assets: In March 2006, 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 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 ("SFAS") No. 115156, "Accounting for Servicing of Financial Assets". This statement amends Financial Accounting Standards No. 140, "Accounting for Transfers and SEC Staff Accounting Bulletin 59). Under the FSP, impairment losses must be recognized in earnings equalServicing of Financial Assets and Extinguishments of Liabilities", with respect to the entire difference betweenaccounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires companies to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. The statement permits a company to choose either the security’samortized cost and itsmethod or fair value at the financialmeasurement method for each class of separately recognized servicing assets. This 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 valueis effective as of the security to fully recover prior tobeginning of a company's first fiscal year after September 15, 2006 (January 1, 2007 for the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005.Company). The Company does not expectanticipate that the applicationadoption of the FSPSFAS 156 will have a material impact on its financial condition or results of operations or financial statement disclosures.

Accounting For Share-Based Payments: In December 2004, 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 continue to apply prior to adoption of SFAS No. 123R. In addition to stock 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 Company). The adoption of SFAS No. 123R is expected to decrease earnings per share by approximately $0.03 in 2006, based upon the current level of unvested options. SFAS No. 123R is not expected to have a material effect on the Company's consolidated financial condition or cash flows.

operations.

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.subsidiaries, and provide supplemental information and analysis.

Whenever necessary, certain amountsAmounts in the 2004 interim consolidatedprior period financial statements are reclassified whenever necessary to conform to the presentation used in 2005.current period presentation.

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

Use of Non-GAAP Financial Measures: Certain information discussed below is discussedpresented on a fully taxable equivalent basis. Specifically, included in thirdfirst quarter 20052006 and 20042005 net interest income was $358$477 and $437,$435, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine months ended September 30, 2005 and 2004, the amount of tax-exempt income included in net interest income was $1,178 and $1,219 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 $149$187 and $193$202 in the thirdfirst quarter of 20052006 and 2004 respectively, and $502 and $531 in tax-equivalent adjustments for the nine months ended September 30, 2005, and 2004, respectively. The analysis of net interest income tablestable included in this Form 10-Q provideprovides 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.

FORWARD LOOKING STATEMENTS DISCLAIMER

Certain statements, as well as certain other discussions 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-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, 20042005 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 provision for loan losses is necessary the result is lower net income. Refer to Part I, Item 2 below, Allowance for Loan Losses and Provision in this report 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, 2005March 31, 2006 and December 31, 2004,2005, 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 techniquetechniques 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 $1,822$1,563 or fully diluted earnings per share of $0.58$0.50 for the three months ended September 30, 2005March 31, 2006 compared with $1,943$1,213 or fully diluted earnings per share of $0.61$0.38 for the same quarter in 2004,2005, representing declinesincreases of $121$350 and $0.03,$0.12, or 6.2%28.8% and 4.8%31.2%, respectively. The annualized return on average assets ("ROA") and average shareholders’ equity ("ROE") amounted to 1.04%0.84% and 12.88%11.16%, respectively, compared with 1.15%0.74% and 14.39%8.77% for the same quarter in 2004.

As more fully enumerated below, the decline in third quarter 2005 net income compared with the same quarter in 2004 was principally attributed to a mark-to-market adjustment of $428 recorded in the third quarter of 2004 representing unrealized gains on interest rate swap agreements. Also in the third quarter of 2004, these interest rate swap agreements were designated as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are recorded in accumulated other comprehensive income (loss) and are not reflected in current period earnings.

Also contributing to the decline in third quarter 2005 earnings compared with the same quarter last year was a $201 decline in net gains on the sale of securities.

For the nine months ended September 30, 2005, consolidated net income amounted to $4,735 or fully diluted earnings per share of $1.49, compared with $4,182 or fully diluted earnings per share of $1.30 for the same period in 2004, representing increases of $553 and $0.19, or 13.2% and 14.7%, respectively. The ROA and ROE amounted to 0.93% and 11.27%, respectively, compared with 0.87% and 9.52% during the first nine months of 2004.2005.

As more fully enumerated below, the increase in first quarter 2006 net income during the nine months ended September 30, 2005 compared with the same periodquarter in 20042005 was principally attributed to increasesto:

• A $289 increase in net interest income andrealized gains on the sale of investment securities amounting to $1,197 and $148,
• A $176 or 8.0% and 34.3%, respectively. Also contributing to the earnings3.3% increase was a $100in net interest income
• A $170 or 6.5% decline in salaries and employee benefits expense
• A $145 gain on the sale of Bank owned real estate
• A $54 or 18.7% increase in service charges on deposit accounts

Total loans ended the quarter at $529,119, representing an increase of $14,427 or 2.8% compared with December 31, 2005, and an increase of $71,353 or 15.6% compared with the same date last year. Commercial loans continued to drive the overall growth of the Bank’s loan portfolio.

The Bank’s non-performing loans remained at low levels during the quarter, representing $896, or 0.17% of total loans at March 31, 2006. Reflecting the continued stable performance of the loan portfolio, during the first quarter of 2006 the Bank recorded a provision for loan losses. Comparinglosses of $28 thousand, compared with none during the first nine monthsquarter of 2005.

Investment securities totaled $201,129 at March 31, 2006, representing an increase of $17,829 or 9.7% compared with December 31, 2005, and an increase of $37,700 or 23.1% compared with the same period in 2004, total non-interest expenses posteddate last year.

At March 31, 2006, retail deposits totaled $392,380, representing an increase of $226,$7,035 or less than 2%.1.8% compared with December 31, 2005, and an increase of $33,568 or 9.4% compared with the same date last year.

Driven by strong loan growth, total assets surpassed $700 million during the quarter ended September 30, 2005, increasing $36 millionTotal borrowings amounted to $243,703 at March 31, 2006, representing increases of $4,007 and $48 million,$24,640, or 5.4%1.7% and 7.3%11.3%, compared with December 31, and September 30, 2004,March 31, 2005, respectively.

The Company continued to exceed regulatory requirements for well-capitalized institutions, ending the quarter with a Tier I Capital Ratio of 7.29%.

At September 30, 2005March 31, 2006 the Company’s tangible book value per share of common stock outstanding amounted to $17.34,$17.30, compared with $16.66$16.83 at the same date in 2004, representing an increase of $0.68, or 4.1%.2005.

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.

For the quarter ended September 30, 2005,March 31, 2006, net interest income on a fully tax-equivalent basis amounted to $5,636,$5,674, compared with $5,505$5,513 during the thirdfirst quarter of 2004,2005, representing an increase of $131,$161, or 2.4%2.9%. The increase in net interest income was principally attributed to an increase in average earning assets of $26,226$94,457 or 4.1%15.0%, offset in part by a six basis point decline inas the first quarter 2006 net interest margin when comparing the three months ended September 30, 2005 withwas 37 basis points lower than the same quarter in 2004.

For the nine months ended September 30, 2005, net interest income on a fully tax-equivalent basis amounted to $16,650, compared with $15,482 during the same period in 2004, representing an increase of $1,168 or 7.5%. The increase in net interest income was principally attributed to an increase in average earning assets of $37,900 or 6.3%, aided by a five basis point improvement in the net interest margin, when comparing the nine months ended September 30, 2005 with the same period in 2004.2005.

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 table summarizes the Company’s average balance sheets and components of net interest income, including a reconciliation of tax equivalent adjustments, for the three and nine months ended September 30,March 31, 2006 and 2005, and 2004, respectively:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30,MARCH 31, 2006 AND 2005 AND 2004

1.                                                     (1)   For purposes of these computations, non-accrual loans are included in average loans.

2. 
                                                       (2) For purposes of these computations, unrealized gains (losses) on available-for-sale securities are recorded in other assets.
3. 
                                                       (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, 2005 AND 2004

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 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.

For the three and nine months ended September 30, 2005March 31, 2006 the net interest margin amounted to 3.39% and 3.46%3.17%, representing a decline of six basis points and an increase of five37 basis points compared with the same periodsperiod in 2004, respectively.2005.

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

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

Over the past few years, 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 to the balance sheet during periods of historically low interest rates. 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 interest rate environment, a scenario management anticipated as being more likely to occur. Management believes that its strategy of maintaining an asset sensitive balance sheet was important to the Company’s long-term success and better positioned it for rising interest rates and an improving economy.

In June of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") began increasing short-term interest rates. OverThrough March 31, 2006, the past fifteen months, the Fed fundsFederal Funds targeted rate was increased elevenfifteen times, ending the third quarter of 2005 at 3.75%4.75%. However, during this same period of time, the benchmark 10-year U.S. Treasury note declined 552 basis points, causing a dramatic 330377 basis point flattening of the U.S. Treasury yield curve.

The short-term rate increases since June 2004 and flatteningIn the first quarter of the U.S. Treasury yield curve have not had a significant impact on the Bank’s net interest margin, as the Bank’s earning asset base has been re-pricing at a pace similar to the increases in its funding costs, due in part to a large floating rate loan base and the Bank’s asset sensitive balance sheet.

During the nine months ended September 30, 2005 the net interest margin showed a five basis point increase compared withbegan to decline and this decline has continued through the same period in 2004. However, during the three-month period ended September 30, 2005 thefirst quarter of 2006. The declining net interest margin showed a moderate amount of erosion, declining six basis points compared with the same period in 2004. This decline was principally attributed to the increases in the Bank’s cost of funds outpacing the increaseincreases in yields on its interest earning assets, by 15 basis points, 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 on the Bank’s deposit basewith respect to loans and deposits, a proportionately higher utilization of wholesale funding, particularly brokered deposits obtainedand the inherent net interest margin challenges widely associated with a flat U.S. Treasury yield curve.

Comparing the first quarter of 2006 with the same quarter in 2005, the increase in the national market.cost of the Bank’s interest bearing liabilities exceeded the increase in yields on earning assets by 45 basis points.

Bank management anticipates continued pressure on the net interest margin during 2006, and believes that continued balance sheet growth will be needed to meaningfully increase net interest income should short term interest rates increase or remain at current levels and the U.S. Treasury curve remain flat or become inverted.

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

Interest Income: For the three and nine-month periodsmonths ended September 30, 2005,March 31, 2006, total interest income, on a fully tax-equivalent basis, amounted to $9,635 and $27,474$10,881 compared with $8,448 and $23,973$8,743 during the same periodsperiod in 2004,2005, representing increasesan increase of $1,187 and $3,501,$2,138, or 14.1% and 14.6%, respectively.24.4%.

The increasesincrease in interest income werewas attributed to average earning asset growth of $26,226 and $37,900$94,457 or 15.0%, combined with 49 and 42a 47 basis point increasesincrease in the weighted average earning asset yields, when comparing the three and nine-month periodsmonth period ended September 30, 2005March 31, 2006 with the same periodsperiod in 2004.2005. Principally reflecting the Federal Reserve’s increases in short-term interest rates and its favorable impact on the Bank’s variable rate loan portfolio, the weighted average yield on average earning assets amounted to 5.79% and 5.70%6.08% during the three and nine-month periods ended September 30, 2005,first quarter of 2006, compared with 5.30% and 5.28%5.61% during the same periodsquarter in 2004, respectively.2005.

Comparing the three and nine months ended September 30, 2005first quarter of 2006 with the same periodsquarter in 2004,2005, the weighted average yield on the Bank’s loan portfolio increased 47 and 3748 basis points to 6.22% and 6.10% respectively,6.45%, while the weighted average yield on the investment securities portfolio increased 6 and 1738 basis points to 4.57% and 4.66%, respectively.5.16%.

Interest Expense: For the three and nine-month periodsmonths ended September 30, 2005,March 31, 2006, total interest expense amounted to $3,999 and $10,824$5,207, compared with $2,943 and $8,491$3,230 during the same periodsperiod in 2004,2005, representing increasesan increase of $1,056 and $2,333,$1,977, or 35.9% and 27.5%, respectively.61.2%.

The increasesincrease in interest expense werewas attributed to increases in average interest bearing liabilities amounting to $22,465 and $33,146,$89,296 or 16.1%, combined with 64 and 43a 92 basis point increasesincrease in the weighted average cost of funds, when comparing the three and nine-month periodsmonth period ended September 30, 2005March 31, 2006 with the same periodsperiod in 2004.2005. The increase in the average cost of interest bearing funds was principally attributed to the increases in short-term market interest rates between periods.periods, combined with a proportionately higher utilization of wholesale funding.

Comparing the three and nine-month periods ended September 30, 2005first quarter of 2006 with the same periodsquarter in 2004,2005, the weighted average cost of deposits increased 68 and 44110 basis points to 2.02% and 1.77% respectively,2.62%, while the weighted average cost of borrowed funds increased 77 and 5567 basis points to 4.10% and 3.93%, respectively.4.42%. The increase in borrowing costs outpaced the weighted average cost of deposits outpaced the weighted average cost of borrowed funds, reflecting the shorterlonger maturities in the Bank’s borrowing base that were morenot as susceptible to movements in short-term market interest rates. Therates, combined with a higher utilization of brokered time deposits. In addition, given highly competitive pricing pressures and the need to strengthen customer relationships, during the first quarter of 2006 the Bank has also laggedmore closely followed the market with respect to the re-pricing of maturity and non-maturity deposits, a trend that may not continue in the future, asgiven competitive market pressures continue to accelerate.pressures.

Rate / Volume Analysis: The following table 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, 2006 VERSUS MARCH 31, 2005 VERSUS SEPTEMBER 30, 2004
INCREASES (DECREASES) DUE TO:

	Average Volume	Average Rate	Net Interest Income
Loans (1,2)	$1,084	$ 554	$1,638
Taxable investment securities	234	224	458
Non-taxable investment securities (2)	136	(145)	(9)
Investment in Federal Home Loan Bank stock	14	31	45
Fed funds sold, money market funds, and time      deposits with other banks	2	4	6
TOTAL EARNING ASSETS	$1,470	$ 668	$2,138
Int bearing deposits	258	1,060	1,318
Securities sold under repurchase agreements and fed funds purchased	4	36	40
Borrowings from Federal Home Loan Bank	290	329	619
TOTAL INTEREST BEARING LIABILITIES	$   552	$1,425	$1,977
NET CHANGE IN NET INTEREST INCOME	$   918	$ (757)	$    161

(1) For purposes of these computations, non-accrual loans are included in average loans.
(2) For 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, 2005 VERSUS SEPTEMBER 30, 2004
INCREASES (DECREASES) DUE TO: