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

FORM 10-Q

(Mark One)

X       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006March 31, 2007

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

Commission File 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    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 a shell company (as defined in exchange act ruleExchange Act Rule 12b-2): YES: _____ NO:   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, 2006MARCH 31, 2007 AND DECEMBER 31, 20052006
(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, 2007 AND 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 CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINETHREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2007 AND 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 NINETHREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2007 AND 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 COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2007 AND 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
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 2006MARCH 31, 2007
(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, 2006March 31, 2007 is not necessarily indicative of the results that may be expected for the year ending December 31, 2006,2007, or any other interim periods.

The consolidated balance sheet at December 31, 20052006 has been derived from audited consolidated financial statements at that date. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X (17 CFR Part 218). 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, 2005,2006, 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 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 is available to absorb losses on loans. The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the loan portfolio, given past and present conditions. The allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged-off.

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

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

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

Income Taxes: On January 1, 2007, the Company adopted Financial Accounting Interpretation Number 48 ("FIN 48") to account for uncertain tax positions. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

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

Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of September 30, 2006March 31, 2007 and December 31, 2005,2006, there was no valuation allowance for deferred tax assets. Deferred tax assets are included in other assets on the consolidated balance sheet.

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

The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Goodwill is evaluated for impairment at least annually, or upon a triggering event as defined by Statement of Financial Accounting Standards ("SFAS") No. 142, using certain fair value 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: 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 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, 2006March 31, 2007 and 2005:

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

Note 4: Stock Based Compensation

On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and 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 September 30, 2006, 80,578 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 granted. Vesting terms range from five to seven years. No option shall be granted after October 3, 2010, ten years after the effective date of the ISOP.

Implementation of New Accounting Standards: In December 2004, the Financial Accounting Standards Board ("FASB") issued a revision of Statement of Financial Accounting Standards ("SFAS") No. 123. SFAS No. 123(R), "Share-Based Payment," makes significant changes to accounting for "payments" involving employee compensation and "shares" or securities in the form 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 stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was effective on January 1, 2006 for calendar-year public companies and is applied prospectively to stock 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, but not yet vested as of, January 1, 2006, based on the grant date fair value; and (b) the compensation expense for all 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 recognition and measurement principles of APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations ("intrinsic value method"). Under the provisions of the Company’s ISOP, the exercise price per share of each option granted cannot be less than the fair market value of the underlying common shares on the date of the grant. Accordingly, the Company previously did not recognize any stock-based employee compensation expense in net income prior to January 1, 2006.

Impact of the Adoption of SFAS No. 123(R): As a result of adopting SFAS 123(R), for the three and nine months ended September 30, 2006, the Company recorded expenses of $38 and $109, respectively.

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

The fair value was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for stock option grants during the nine months ended September 30, 2006 and 2005:

The expected market price volatility for the grants during the nine months ended September 30, 2006, was determined by using the Company’s historical stock price volatility on a daily basis during the seven-year period ending September 30, 2006.

Stock Option Activity: The following table summarizes the Company’s stock option activity during the nine months ended September 30, 2006:

The intrinsic value of the options exercised and cash received by the Company for options exercised during the nine months ended September 30, 2006 was approximately $266 and $433, respectively.

As of September 30, 2006, there was approximately $396 of unrecognized compensation cost related to unvested stock option awards net of estimated forfeitures. This is expected to be recognized as expense over the next seven years, with a weighted average recognition period of 1.95 years.

Stock Options Outstanding: The following table summarizes stock options outstanding by exercise price range at September 30, 2006:

Note 5:4: Retirement Benefit Plans

ThePrior to the first quarter of 2007, the Company sponsorssponsored a limited post-retirement benefit program, which fundsfunded medical coverage and life insurance benefits to a closed group of active and retired employees who meetmet minimum age and service requirements. It iswas the Company's policy to record the cost of post-retirement health care and life insurance plans based on actuarial estimates, which arewere dependent on claims and premiums paid. The cost of providing these benefits iswas accrued during the active service period of the employee.

In the first quarter of 2007, the Company settled its limited post-retirement benefit program. The Company voluntarily paid out $700 to plan participants, representing 64% of the accrued post retirement benefit obligation. This payment fully settled all Company obligations related to this program. In connection with the settlement of the postretirement program, the Company recorded a reduction in non-interest expense of $832, representing the elimination of the $390 remaining accrued benefit obligation included in other liabilities on the consolidated balance sheet, and the $291 actuarial gain related to the program, which was included in accumulated other comprehensive income, net of tax effect of $151.

The Company has non-qualified supplemental executive retirement plans for certain retired officers. These 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 table summarizes the net periodic benefit costs for the three and nine months ended September 30, 2006March 31, 2007 and 2005:2006:

The Company is expected to recognize $365$359 of expense for the foregoing plans for the year ended December 31, 2006.2007. The Company is expected to contribute $222 to the foregoing plans in 2007. As of March 31, 2007, the Company had contributed $58.

Note 6:5: 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, 2006March 31, 2007 and December 31, 2005:2006:

As of September 30, 2006,March 31, 2007 and December 31, 2005,2006, the fair value of the standby letters of credit were not significant to the Company’s consolidated financial statements.

Note 7:6: Financial Derivative Instruments

As part of its overall 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. Any ineffective portion is recorded in earnings. 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, 2006March 31, 2007 the Bank had four outstanding derivative instruments with notional principal amounts totaling $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:

The Bank is required to pay to 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.

The interest rate swap agreements were designated as cash flow hedges in accordance with 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".Loans."

At September 30, 2006,March 31, 2007, the fair market value of the interest rate swap agreements was an unrealized loss of $534$364 compared with unrealized losses of $641$473 and $596$745 at December 31, and September 30, 2005,March 31, 2006, respectively. The fair market values of the interest rate swap agreements were included in other liabilities on the consolidated balance sheets.

During the three months ended March 31, 2007, the total net cash flows (paid to) received from counter-parties amounted to ($106), compared with ($53) during the same period in 2006. The net cash flows (paid to) received from counter-parties were recorded in interest income.

At September 30, 2006,March 31, 2007, the net unrealized loss on the interest rate swap agreements included in accumulated other comprehensive loss, net of tax, amounted to $352,$240 compared with $423$313 and $394$492 at December 31 and September 30, 2005,March 31, 2006, respectively. Also included in accumulated other comprehensive loss at September 30, 2006,March 31, 2007, was a net deferred loss, net of tax, of $4 related to the de-designation and re-designation of these interest rate swap agreements as cash flow hedges in 2004.

During the three and nine months ended September 30, 2006, the total net cash flows (paid to) received from counter-parties amounted to ($97) and ($223), compared with ($12) and $33 during the same periods in 2005. The net cash flows (paid to) received from counter-parties were recorded in interest income.

Interest Rate Floor Agreements:Agreements

During 2005, interest rate floor agreements were purchased to limit the Bank’s exposure to falling interest rates on two pools of loans indexed to the Prime interest rate. Under the terms of the agreements, the Bank paid premiums of $186 and $69 for the right to receive cash flow payments if the Prime interest rate falls below the floors of 6.00% and 6.50%, thus effectively ensuring interest income on the pools of prime-based loans at minimum rates of 6.00% and 6.50% for the duration of the agreements. The interest rate floor agreements were designated as cash flow hedges in accordance with SFAS 133.

At September 30, 2006,March 31, 2007, the total fair market value of the interest rate floor agreements was an unrealized gain of $61$38 compared with $131$40 at December 31, 2005.2006. The fair market values of the interest rate floor agreements wereare included in other assets on the Company’s consolidated balance sheets. Pursuant to SFAS 133, changes in the fair market value, representing unrealized gains or losses, are recorded in accumulated other comprehensive loss.

The premiums paid on the interest rate floor agreements are included in accumulated other comprehensive lossincome on the consolidated balance sheetsheets and are being recognized in interest income over the duration of the agreements using the floorlet method, in accordance with SFAS 133. During the three and nine months ended September 30, 2006, $5 and $12March 31, 2007, $8 of the premium was recognized in interest income, respectively.income. At September 30, 2006,March 31, 2007, the remaining unamortized premiums, net of tax, totaled $160,$150, compared with $167$154 at December 31, 2005.2006. During the next twelve months, $36$47 of the premiums will be recognized in interest income, decreasing the interest income related to the hedged pool of Prime-based loans.

At September 30, 2006,March 31, 2007, and December 31, 2005,2006, the unamortized premium net of the unrealized lossgain on the interest rate floor agreement amounted to $119$126 and $80,$129, net of tax, respectively, and was recorded in accumulated other comprehensive lossincome on the consolidated balance sheet.

A summary of the hedging related balances follows:

Note 7: Recently Adopted Accounting Standards

The Company recently adopted the following accounting standards:

Accounting for Uncertainty in Income Taxes:

In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109" ("FIN 48"). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company's financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, and disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

On January 1, 2007 the Company adopted the provisions of FIN 48 and there was no impact on the consolidated financial statements. Upon the adoption of this standard, the Company performed an analysis of its tax positions to determine whether there may be uncertainties that require further analysis under FIN 48 based upon their specific facts and circumstances. The Company did not identify any uncertain tax positions for which tax benefits should not be recognized under FIN 48 upon adoption or as of March 31, 2007. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2004 through 2006. The Company’s state income tax returns are also open to audit under the statute of limitations for the years ended December 31, 2004 through 2006.

Accounting for Servicing of Financial Assets: In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 ("SFAS 156"), "Accounting for Servicing of Financial Assets." This statement amends Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting 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 amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective as of the beginning of a company's first fiscal year after September 15, 2006 (January 1, 2007 for the Company). The Company’s adoption of SFAS 156 did not have an impact on its financial condition or results of operations.

Prior Year Financial Statement Misstatements: In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. There are two widely recognized methods for quantifying the effects of financial statement misstatements: the "roll-over" and "iron curtain" methods. The roll-over method, the method the Company historically used, focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements. Because the focus is on the income statement, the roll-over method can lead to the accumulation of misstatements in the balance sheet that may become material to the balance sheet. The iron curtain method focuses primarily on the effect of correcting the accumulated misstatement as of the balance sheet date, with less emphasis on the reversing effects of prior year errors on the income statements. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements under both the roll-over and iron curtain methods. This framework is referred to as the "dual approach." SAB 108 permits companies to initially apply its provisions either by restating prior financial statements as if the dual approach had always been used or recording the cumulative effect of initially applying the dual approach as adjustments to the balance sheet as of the first day of the fiscal year with an offsetting adjustment recorded to retained earnings.

The Company completed an analysis under the "dual approach" and adopted SAB 108 effective as of January 1, 2006. The Company applied the SAB 108 provisions using the cumulative effect transition method. Upon adoption of SAB 108, the Company reversed $331 of income taxes payable resulting from cumulative over accruals of income tax expense. These misstatements primarily resulted from the incorrect determination of depreciation and deferred loan origination costs for tax purposes and principally occurred prior to 2004, with certain amounts dating back to the 1990’s. After considering all of the quantitative and qualitative factors, the Company determined these misstatements had not previously been material to any of those prior periods when measured using the roll-over method. Given that the effect of correcting these misstatements during 2006 would be material to the Company’s 2006 financial statements, the Company concluded that the cumulative effect adjustment method of initially applying the guidance in SAB 108 was appropriate. In accordance with the transition provisions of SAB 108, the Company recorded this cumulative effect adjustment, resulting in a $331 increase in other assets and a $331 increase in retained earnings as of January 1, 2006.

Note 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.

Employers’ AccountingFair Value Measurements for Defined Benefit PensionFinancial Assets and Other Postretirement Plans: On September 29, 2006,Liabilities: In February 2007, the Financial Accounting Standards Board ("FASB")FASB issued Statement of Financial Accounting Standards No. 158, "Employers' Accounting159 ("SFAS 159"), "The Fair Value Option for Defined Benefit PensionFinancial Assets and Other Postretirement Plans" ("Financial Liabilities, including an amendment of FASB Statement No. 115." This standard provides companies with an option to report selected financial assets and liabilities at fair value. The Standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. Generally accepted accounting principles have required different measurement attributes for different assets and liabilities that can create artificial volatility in earnings. SFAS 158").159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. This statement, which amendsnew standard also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 87, 88, 106 and 132R,159 requires employerscompanies to recognize the over-funded or under-funded status of defined benefit pensionprovide additional information that will help investors and other post-retirement benefit plans as an asset or liability on its balance sheet and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, netusers of tax effects, until they are amortized as a component of net periodic cost. The measurement date, which is the date at which the benefit obligation and plan assets are measured, is required to be the company's fiscal year end. SFAS 158 is effective for publicly held companies for fiscal years ending after December 15, 2006 (January 1, 2007 for the Company), except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008 (January 1, 2009 for the Company). The Company is currently analyzing the effects of SFAS 158 but does not expect its implementation will have a significant impact on the Company's financial condition or results of operations.

Quantifying Financial Statement Misstatements: In September 2006, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 108 expressing the SEC staff's views regarding the process of quantifying financial statement misstatements and addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. The prior year misstatements, while not considered material in the individual years in which the misstatements occurred, may be considered material in a subsequent year if a company were to correct those misstatements through current period earnings. The SAB requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The SAB does not change the staff’s previous guidance in SAB 99 on evaluating the materiality of misstatements. Initial application of SAB 108 allows registrants to elect not to restate prior periods but to reflect the initial application in their annual financial statements coveringto more easily understand the first fiscal year ending after November 15, 2006 (December 31, 2006 for the Company). The cumulative effect of the initial application should be reported incompany’s choice to use fair value on its earnings. It also requires entities to display the carrying amountsfair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet.  The new Statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in FASB Statements No. 157, "Fair Value Measurements," and No. 107, "Disclosures about Fair Value of Financial Instruments."SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 (January 1, 2008 for the Company).   Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also adopts the offsetting adjustment, netprovisions of tax, should be made toSFAS 157 at the opening balance of retained earnings for that year. Registrants will need to disclose the nature and amount of each item, when and how each error being corrected arose, and the fact that the errors were previously considered immaterial.same time. The Company did not adopt SFAS 159 early and is currently evaluating the impact of adopting this SAB will have on its financial statements.statement.

Fair Value Measurements: In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements".Measurements." This statement establishes a single authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair value measurements. The statement is effective for fair value measures already required or permitted by other standards for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within that fiscal year (January 1, 2007 for the Company). The Company is in the process of evaluating the impact of adopting this statement.

Accounting for Uncertainty in Income Taxes: In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes." FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 (January 1, 20072008 for the Company). The Company is currently analyzingevaluating the effectsimpact of FIN 48.

Accounting for Servicing Rights of Financial Assets: In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 ("adopting SFAS 156"), "Accounting for Servicing of Financial Assets." This statement amends Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting 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 amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective as of the beginning of a company's first fiscal year after September 15, 2006 (January 1, 2007 for the Company). The Company157, but does not anticipate that the adoption of SFAS 156this standard will have a material impact on its financial condition or results of 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, and provide supplemental information and analysis.

Amounts in the prior period financial statements are reclassified whenever necessary to conform to 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 presented on a fully taxable equivalent basis. Specifically, included in thirdfirst quarter 20062007 and 20052006 net interest income was $474$407 and $358,$477, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine months ended September 30, 2006 and 2005, the amount of tax-exempt income included in net interest income was $1,426 and $1,178, 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 $176$149 and $149$187 in the thirdfirst quarter of 20062007 and 2005, respectively, and $547 and $502 in tax-equivalent adjustments for the nine months ended September 30, 2006, and 2005, 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. 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, 20052006 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 -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 Item 2 below of this Part I, Allowance for Loan Losses and Provision for Loan Losses in this report on Form 10-Q, for further discussion and analysis concerning the allowance.

Income Taxes – Taxes: On January 1, 2007, the Company adopted Financial Accounting Interpretation Number 48 ("FIN 48") to account for uncertain tax positions. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements.

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, 2006March 31, 2007 and December 31, 2005,2006, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.

Goodwill and Other Intangible Assets -Assets: The valuation techniques 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, may have an adverse affect on the Company's results of operations. Refer above to Note 2

EXECUTIVE OVERVIEW

Summary Results 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 OVERVIEWOperations

The Company reported consolidated net income of $2.0$1.4 million or fully diluted earnings per share of $0.63$0.44 for the three months ended September 30, 2006March 31, 2007, compared with $1.8$1.6 million or fully diluted earnings per share of $0.58$0.50 for the same quarter in 2005,2006, representing increasesdeclines of $142$188 thousand and $0.05,$0.06, or 8%12.0% and 9%12.4%, respectively. The annualized return on average shareholders’ equity ("ROE") and average assets ("ROA") amounted to 13.76%9.02% and 0.97%0.67%, respectively, compared with 12.88%11.16% and 1.04%0.84% for the same quarter in 2005.2006. The decline in first quarter earnings was principally attributed to the Company’s planned restructuring of a portion of its balance sheet, substantially offset by the settlement of its limited postretirement benefit program.

As

• Balance Sheet Restructuring: In April 2007, the Company’s Board of Directors approved the restructuring of a portion of the Company’s balance sheet through the sale of $43.3 million of its aggregate $227.5 million available for sale investment securities portfolio, the proceeds from which were initially used to pay down short-term borrowings. Since the Company no longer had the intent to hold these securities until a recovery of their amortized cost, which may be at maturity, the Company recorded an adjustment to write down these securities to fair value at March 31, 2007, resulting in a pre-tax impairment loss of $1.2 million included in first quarter 2007 earnings as a reduction of non-interest income. The Company’s overall objectives are to improve future period earnings, lower the interest rate risk profile of the Company’s balance sheet, and provide a means to more effectively respond to the current and future yield curve environments.

• Post Retirement Plan Settlement: In the first quarter of 2007, the Company settled its limited postretirement benefit program, which funded medical coverage and life insurance benefits to a closed group of active and retired employees who met minimum age and service requirements. The Company voluntarily paid out $700 thousand to plan participants, representing 64% of the total benefit obligation. This payment fully enumerated below,settled all Company obligations related to this program. In connection with the increasesettlement of the postretirement program, the Company recorded a first quarter reduction in thirdnon-interest expense of $832 thousand, representing the remaining accrued benefit obligation and the actuarial gain related to the program.

• Net Interest Income: For the quarter 2006ended March 31, 2007, net interest income on a tax equivalent basis amounted to $5.4 million, representing a decline of $243 thousand, or 4.3%, compared with the same quarter in 20052006. The decline in net interest income was principally attributed to a $31940 basis point decline in the net interest margin, which in the first quarter of 2007 amounted to 2.77%. As is widely the situation throughout the banking industry, the decline in the net interest margin was largely attributed to the seventeen consecutive increases in short-term interest rates by the Federal Reserve Bank from June 2004 to June 2006 and a flat-to-inverted yield curve over the past fifteen months, the impact of which has caused the Bank’s funding costs to increase at a faster pace than the yield on its earning asset portfolios.

• Non- interest Income: For the quarter ended March 31, 2007, total non-interest income amounted to $378 thousand, increaserepresenting a decline of $1.2 million, or 76.4%, compared with the same quarter in 2006. The decline in non-interest income was principally attributed to a $1.2 million securities impairment loss in connection with the Company’s restructuring of a portion of its balance sheet. Also included in first quarter net securities losses were realized gains on the sale of securities. Net interest income was up $61securities amounting to $241 thousand, representing a decline of $69 thousand, or 1%, while non-interest expenses were up $30 thousand, or less than 1%.

  For the nine months ended September 30, 2006, consolidated net income amounted to $5.2 million or fully diluted earnings per share of $1.66, compared with $4.7 million or fully diluted earnings per share of $1.49 for the same period in 2005, representing increases of $438 thousand and $0.16, or 9% and 11%, respectively. The annualized ROE and ROA amounted to 12.26% and 0.88%, respectively, compared with 11.27% and 0.93% for the same period in 2005.

  As more fully discussed below, the $438 thousand increase in net income for the nine months ended September 30, 2006 compared with the same period in 2005 was principally attributed to a $305 thousand or 6% increase in non-interest income, a $283 thousand or 2% decline in non-interest expense and, to a lesser extent, a $155 thousand or 1% increase in net interest income. Realized gains on the sale of securities included in non-interest income were up $87 thousand, or 15%22.3%, compared with the same periodquarter last year.

For the quarter ended March 31, 2007, fees from financial services, service charges on deposits and credit and debit card fees posted increases of 7.3%, 7.9% and 16.1%, respectively, compared with the same quarter in 2006. First quarter 2007 other operating income amounted to $68 thousand, representing a decline of $96 thousand, or 59%, compared with the same quarter in 2006. The decline in other operating income was attributed to a $150 thousand gain on the sale of a parcel of Bank owned real estate recorded during the first quarter of 2006.

• Non-Interest Expense: For the quarter ended March 31, 2007, total non-interest expense amounted to $3.8 million, representing a decline of $1.1 million, or 22.3%, compared with the same quarter in 2006. The decline in non-interest expense was principally attributed to the settlement of the Company’s limited post retirement program, the financial impact of which reduced first quarter non-interest expense by $832 thousand. The decline in first quarter non-interest expense was also attributed to lower salaries and employee benefits expense and other miscellaneous operating expenses, which posted declines of $99 thousand and $189 thousand, or 4.1% and 12.9%, compared with the first quarter of 2006, respectively.

Summary Financial Condition

The Company’s total assets ended the thirdfirst quarter of 20062007 at $795 million. At quarter-end, total loans stood at $547$827.3 million, representing increases of $33$2.4 million and $54 million compared with December 31 and September 30, 2005, or 6% and 11%, respectively. Commercial loans continued to drive the overall growth of the Bank’s loan portfolio, posting increases of $20 million and $35$45.7 million, or 10%0.3% and 18%5.9%, compared with December 31 and September 30, 2005,March 31, 2006.

• Loans: Total loans ended the first quarter at $552.6 million, representing a decline of $2.5 million or 0.4% compared with December 31, 2006 and an increase of $23.5 million or 4.5% compared with March 31, 2006. The small decline in the loan portfolio compared with December 31, 2006 principally reflected anticipated paydowns on certain seasonal borrowings, combined with softening loan demand and intensifying competition in the markets served by the Bank. The increase in the loan portfolio compared with March 31, 2006 was driven by business lending activity, which accounted for $16.4 million or 69.5% of the total year-over-year loan growth.

• Credit Quality: The Bank’s non-performing loans remained at low levels at quarter-end, representing $422 thousand or 0.08% of total loans, compared with $628 thousand and $896 thousand, or 0.11% and 0.17% of total loans at December 31 and March 31, 2006, respectively.

  At September 30, 2006, retail deposits totaled $428 The Bank’s loan loss experience continued at low levels during the first quarter, with net charge-offs amounting to $26 thousand, or annualized net charge-offs to average loans outstanding of 0.02%, compared with $202 thousand or annualized net charge-offs to average loans outstanding of 0.16% during the first quarter of 2006. In the first quarter of 2007 the Bank did not record a provision for loan losses, compared with $28 thousand in the first quarter of 2006.

• Securities: Total securities ended the first quarter at $227.5 million, representing increases of $43$14.2 million and $44$26.3 million, or 11%6.7% and 13.1%, compared with December 31 and September 30, 2005,March 31, 2006, respectively. Market yields showed meaningful improvement early in the first quarter, with the benchmark 10-year U.S. Treasury note climbing to a five-month high, presenting opportunities for increasing the Bank’s earning assets and generating higher levels of net interest income.

• Deposits: Total deposits ended the first quarter at $506.8 million, representing increases of $10.5 million and $32.1 million, or 2.1% and 6.8% compared with December 31 and March 31, 2006, respectively. Deposit growth was largely attributed to certificates of deposit obtained in the national market, which were principally used to fund the Bank’s earning asset growth and replace the seasonal deposit outflows experienced in the first quarter of 2007.

At March 31, 2007, retail deposits totaled $387.4 million, representing declines of $26.6 million and $5.0 million, or 6.4% and 1.3%, compared with December 31 and March 31, 2006, respectively. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in winter and spring, and higher deposits in summer and autumn. During the first quarter of 2007, the Bank’s net deposit outflows were moderately higher than historical norms.

• Shareholders’ Equity: The Company continued to exceed regulatory requirements for well-capitalized institutions, ending"well-capitalized" institutions. At March 31, 2007, the thirdCompany’s Tier 1Leverage, Tier 1 Risk-based, and Total Risk-based Capital ratios amounted to 7.26%, 11.18% and 12.02%, respectively. Total shareholders’ equity ended the quarter at $62.6 million, representing increases of $1.5 million and $6.4 million, or 2.5% and 11.4%, compared with December 31 and March 31, 2006, with a Tier I Capital Ratio of 7.15%.

  respectively.

• Tangible Book Value: At September 30, 2006March 31, 2007 the Company’s tangible book value per share of common stock outstanding amounted to $18.32,$19.44, compared with $17.34$18.93 and $17.32 at the same date in 2005.

  On October 17, 2006 the Company declared a cash dividend of 23 cents per share of common stock for the quarter ended September 30,December 31 and March 31, 2006, representing an increaseincreases of 2 cents per share or 9.5% compared with the dividend paid for the same quarter in 2005.2.7% and 12.2%, respectively.

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 three months ended September 30, 2006,March 31, 2007, net interest income on a fully tax-equivalent basis amounted to $5,724,$5,431, compared with $5,636$5,674 in the third quarter of 2005, representing an increase of $88, or 1.6%.

The Federal Home Loan Bank of Boston (the "FHLB"), of which the Bank is a member and shareholder, did not declare a dividend on its stock during the second quarter of 2006. Pursuant to its "Dividend Schedule Transition Plan," in the thirdfirst quarter of 2006, the FHLB declaredrepresenting a dividend that was "grossed up" to an equivalent accrual period matching the numberdecline of days in the second and third quarters of 2006. This action favorably impacted the Bank’s third quarter net interest income by $168 and the Bank’s net interest margin by 8 basis points.

$243, or 4.3%. As discussed below, the Bank’s thirdfirst quarter 20062007 net interest income was significantlyadversely impacted by a 4440 basis point decline in the net interest margin compared with the same quarter in 2005.

For the nine months ended September 30, 2006, net interest income on a fully tax-equivalent basis amounted to $16,850, compared with $16,650 during the same period in 2005, representing an increase of $200, or 1.2%. The increase in net interest income was principally attributed to average earning asset growth, as the net interest margin declined 46 basis points to 3.00% compared with the nine months ended September 30, 2005. As is widely the situation throughout the banking industry, the decline in the net interest margin was largely attributed to the increases in short-term interest rates by the Board of Governors of the Federal Reserve System and a flat-to-inverted U.S. Treasury yield curve, the impact of which has caused the Bank’s funding costs to increase at a faster pace than the yield on its earning asset portfolios.2006.

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

Net Interest Income Analysis: The following tables summarize the Company’s 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, 2007 and 2006, and 2005, respectively:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
SEPTEMBER 30,MARCH 31, 2007 AND 2006 AND 2005

(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.

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED
SEPTEMBER 30, 2006 AND 2005

	2006				2005
	Average Balance	Interest	Average Rate		Average Balance	Interest	Average Rate
Interest Earning Assets:
Loans (1,3)	$533,954	$26,204	6.56%		$471,716	$21,528	6.10%
Taxable securities	167,169	6,117	4.89%		129,291	3,987	4.12%
Non-taxable securities (3)	35,195	1,741	6.61%		30,405	1,579	6.94%
Total Securities	202,364	7,858	5.19%		159,696	5,566	4.66%
Investment in Federal Home Loan Bank stock	12,315	501	5.44%		10,683	333	4.17%
Fed funds sold, money market funds, and time      deposits with other banks	2,182	82	5.02%		2,002	47	3.14%
Total Earning Assets	750,815	34,645	6.17%		644,097	27,474	5.70%
Non-Interest Earning Assets:
Cash and due from banks	8,622				9,037
Allowance for loan losses	(4,564)				(4,783)
Other assets (2)	28,025				28,871
Total Assets	$782,898				$677,222
Interest Bearing Liabilities:
Deposits	$423,531	$ 9,271	2.93%		$355,676	$ 4,718	1.77%
Securities sold under repurchase agreements and fed funds purchased	13,878	269	2.59%		13,735	178	1.73%
Borrowings from Federal Home Loan Bank	230,234	8,255	4.79%		194,076	5,928	4.08%
Total Borrowings	244,112	8,524	4.67%		207,811	6,106	3.93%
Total Interest Bearing Liabilities	667,643	17,795	3.56%		563,487	10,824	2.57%
Rate Spread			2.61%				3.13%
Non-Interest Bearing Liabilities:
Demand deposits	52,628				51,658
Other liabilities	6,230				5,904
Total Liabilities	726,501				621,049
Shareholders' equity	56,397				56,173
Total Liabilities and Shareholders' Equity	$782,898				$677,222
Net interest income and net interest margin (3)		16,850	3.00%			16,650	3.46%
Less: Tax Equivalent adjustment		(547)				(502)
Net interest income and net interest margin		$16,303	2.90%			$16,148	3.35%