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 March 31,June 30, 2008

___ ____ 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   X  NO ____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", " accelerated filer" and smaller reporting company" in Rule 12b-2 of the Exchange Act: Large accelerated filer _______ Accelerated filer   X  Non-accelerated filer (do not check if a smaller reporting company) _______ Smaller reporting company _______

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): 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
MARCH 31,JUNE 30, 2008 AND DECEMBER 31, 2007
(Dollars in thousands, except 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 SIX MONTHS ENDED MARCH 31,JUNE 30, 2008 AND 2007
(Dollars in thousands, except 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 THREESIX MONTHS ENDED MARCH 31,JUNE 30, 2008 AND 2007
(Dollars in thousands, except 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 THREESIX MONTHS ENDED MARCH 31,JUNE 30, 2008 AND 2007
(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 (LOSS)
FOR THE THREE AND SIX MONTHS ENDED MARCH 31,JUNE 30, 2008 AND 2007
(Dollars in thousands)
(unaudited)

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

BAR HARBOR BANKSHARES AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
MARCH 31,JUNE 30, 2008
(Dollars in thousands, except 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 six months ended March 31,June 30, 2008 is not necessarily indicative of the results that may be expected for the year ending December 31, 2008, or any other interim periods.

The consolidated balance sheet at December 31, 2007 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 210). 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, 2007, 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 probable 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.

The allowance for loan losses consists of allowances established for specific loans including impaired loans, a pool of allowances based on historical charge-offs by loan types, and supplemental allowances 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: 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 March 31,June 30, 2008 and December 31, 2007, 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, included in other assets on the consolidated balance sheet, 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 six months ended March 31,June 30, 2008 and 2007:

Note 4: Retirement Benefit Plans

Prior to the first quarter of 2007, the Company sponsored a 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.

In the first quarter of 2007, the Company settled its limited postretirement benefit program. The Company voluntarily paid out $699 to plan participants, representing 64% of the accrued postretirement 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 $442 actuarial gain ($291, net of tax) related to the program. The actuarial gain was previously included in accumulated other comprehensive income, net of tax.

The Company also has non-qualified supplemental executive retirement agreements with certain retired officers. The agreements provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations.

The Company also has supplemental executive retirement agreements with certain current executive officers. These agreements provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, or in the event that the participating executive leaves the Company followingupon a change of control event.control.

The following table summarizes the net periodic benefit costs for the three and six months ended March 31,June 30, 2008 and 2007:

The Company is expected to recognize $379 of expense for the foregoing plans for the year ended December 31, 2008. The Company is expected to contribute $222 to the foregoing plans in 2008. As of March 31,June 30, 2008, the Company had contributed $58.$111.

Note 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 March 31,June 30, 2008 and December 31, 2007:

As of March 31,June 30, 2008 and December 31, 2007, the fair value of the standby letters of credit was not significant to the Company’s consolidated financial statements.

Note 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 repricing 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 March 31,June 30, 2008, the Bank had three outstanding derivative instruments with notional amounts totaling $40,000. These derivative instruments were an interest rate swap agreement and interest rate floor agreements, with notional principal amounts totaling $10,000 and $30,000, respectively. The details are summarized as follows:

Interest Rate Swap Agreement:

During 2003 anthe interest rate swap agreement was purchased to limit the Bank’s exposure to falling interest rates on a pool of loans indexed to the Prime interest rate. 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 an interest rate of 6.25% over the term of the agreement.

The interest rate swap agreement was designated as a cash flow hedge 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."

At March 31,June 30, 2008, the fair value of the interest rate swap agreement was an unrealized gain of $106,$56, compared with an unrealized loss of $34 at December 31, 2007. The fair value of the interest rate swap agreement was included in other assets on the consolidated balance sheets.

During the three and six months ended March 31,June 30, 2008, the total net cash flows received from (paid to) counter-parties amounted to $1,$31 and $32, compared with ($105)103) and ($209) during the same periodperiods in 2007. The net cash flows received from (paid to) counter-parties were recorded in interest income.

At March 31,June 30, 2008, the net unrealized gain on the interest rate swap agreement included in accumulated other comprehensive income, net of tax, amounted to $70$37 compared with an unrealized loss, net of tax, of $22 at December 31, 2007.

Interest Rate Floor 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.

For the three and six months ended March 31,June 30, 2008, total cash flows received from counterparties amounted to $17,$82 and $99, compared with none during the same periodperiods in 2007. The cash flows received from counterparties were recorded in interest income.

At March 31,June 30, 2008, the total fair value of the interest rate floor agreements was $824$407 compared with $299 at December 31, 2007. The fair values of the interest rate floor agreements are included in other assets on the Company’s consolidated balance sheets. Pursuant to SFAS 133, changes in the fair value, representing unrealized gains or losses, are recorded in accumulated other comprehensive income.

The premiums paid on the interest rate floor agreements are being recognized as reductions of interest income over the duration of the agreements using the floorlet method, in accordance with SFAS 133. During the three and six months ended March 31,June 30, 2008, $13$15 and $28 of the premium was recognized as a reduction of interest income. At March 31,June 30, 2008, the remaining unamortized premiums, net of tax, totaled $118,$109, compared with $128 at December 31, 2007. During the next twelve months, $65$69 of the premiums will be recognized as reductions of interest income, decreasing the interest income related to the hedged pool of Prime-based loans.

A summary of the hedging related balances follows:

Note 7: Fair Value Measurements

Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, "Fair Value Measurements," for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position (FSP) No. 157-2, "Effective Date of FASB Statement No. 157," the Company has delayed application of SFAS No. 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

• Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
  
• Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
  
• Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity's own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, among other things, as well as other unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value effective January 1, 2008.

• Securities Available For Sale: Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market pricing spreads, callable features, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the securities’ terms and conditions, among other things.
  
• Derivative Instruments: Derivative instruments are reported at fair value utilizing Level 2 inputs. The Company obtains dealer market price estimates to value its Prime interest rate swaps and floors. The fair values were determined using proprietypricing models from independent third-party sources, taking into account such factors as the size of the transaction, estimated future cash flows, custom tailored features of the transaction, counterparty credit quality and the estimated current replacement cost of the derivative.derivative instrument.

The foregoing valuation methodologies may produce fair value calculations that may not be fully indicative of net realizable value or reflective of future fair values. While Company management believes these valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31,June 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

SFAS No. 157 also requires disclosure of assets and liabilities measured and recorded at fair value on a nonrecurringnon-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

The following table summarizes financial assets and financial liabilities measured at fair value on a non recurringnon-recurring basis for which fair value adjustments were made during the first quarteras of June 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:value.

InSpecific allowances for impaired loans are determined in accordance with the provisions of SFAS No. 114 during"Accounting by Creditors For Impairment of a Loan," as amended by SFAS 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." During the first quartersix months ended June 30, 2008 specific loan loss allowances of 2008 one$130 and $250 were established for two collateral dependent impaired commercial real estate loanloans with a carrying amountprincipal balances of $994 was written down to its estimated fair value of $864, resulting in an impairment charge of $130, which wasand $1,025, respectively. These specific loan loss allowances were included in the Company’s consolidated statement of income. Theprovision for loan losses during the period in which the allowances were established. Company management determined the impairment chargecharges based on the fair valuevalues of collateral. Based on this technique, these impaired loans arewere classified as Level 3 for valuation purposes. In the second quarter of 2008, one of these impaired loans was satisfied with no adjustment necessary to the corresponding loan loss allowance.

Note 8: Recently Adopted Accounting Standards

The Company recently adopted the following accounting standards:

Fair Value Measurements for Financial Assets and Liabilities: Effective January 1, 2008, the Company adopted the provisions of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." SFAS No. 159 permits the Company to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, thus the Company may record identical financial assets and liabilities at fair value or by another measurement basis permitted under generally accepted accounting principals, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. Adoption of SFAS 159 on January 1, 2008 did not have a significant impact on the Company’s financial statements. The fair value option was not elected for any financial instrument as of January 1, 2008.

Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards: In June 2007, the FASB ratified a consensus reached by the Emerging Issues Task Force (the "EITF") on Issue No. 06-11, "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards," which clarifies the accounting for income tax benefits related to the payment of dividends on equity-classified employee share-based payment awards that are charged to retained earnings under SFAS No. 123(R). The EITF concluded that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified non-vested equity shares, non-vested equity share units and outstanding equity share options should be recognized as an increase to additional paid-in capital. EITF Issue No. 06-11 should be applied prospectively to the income tax benefits that result from dividends on equity-classified employee share-based payment awards that are declared in fiscal years beginning after payment awards that are declared in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Retrospective application to previously issued financial statements is prohibited. The Company’s adoption of EITF Issue No. 06-11 did not have an impact on its consolidated financial condition or results of operations.

Written Loan Commitments Recorded at Fair Value Through Earnings: In November 2007, the United States Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin ("SAB") No. 109, "Written Loan Commitments Recorded at Fair Value Through Earnings."  SAB No. 109 provides views on the accounting for written loan commitments recorded at fair value under GAAP. SAB No. 109 supersedes SAB No. 105, "Application of Accounting Principles to Loan Commitments."  Specifically, SAB No. 109 states that the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The provisions of SAB No. 109 are applicable on a prospective basis to written loan commitments recorded at fair value under GAAP that are issued or modified in fiscal quarters beginning after December 15, 2007 (January 1, 2008 for the Company). SAB No. 109 did not have an impact on the Company’s consolidated financial condition or results of operations.

Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards: In June 2007, the FASB ratified a consensus reached by the Emerging Issues Task Force (the "EITF") on Issue No. 06-01, "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards," which clarifies the accounting for income tax benefits related to the payment of dividends on equity-classified employee share-based payment awards that are charged to retained earnings under SFAS No. 123(R). The EITF concluded that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified non-vested equity shares, non-vested equity share units and outstanding equity share options should be recognized as an increase to additional paid-in capital. EITF Issue No. 06-11 should be applied prospectively to the income tax benefits that result from dividends on equity-classified employee share-based payment awards that are declared in fiscal years beginning after payment awards that are declared in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Retrospective application to previously issued financial statements is prohibited. The Company’s adoption of EITF Issue No. 06-11 did not have an impact on its consolidated financial condition or results of operations.

Note 9: Recent Accounting Developments

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

Business Combinations: In December 2007, the Financial Accounting Standards Board ("FASB") issued revised Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," or SFAS No. 141(R). SFAS No. 141(R) retains the fundamental requirements of SFAS 141 that the acquisition method of accounting (formally the purchase method) be used for all business combinations; that an acquirer be identified for each business combination; and that intangible assets be identified and recognized separately from goodwill. SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed and any non-controlling interest in the acquired entity at the acquisition date, measured at their fair values as of that date, with limited exceptions. Additionally, SFAS No. 141(R) changes the requirements for recognizing assets acquired and liabilities assumed arising from contingencies and recognizing and measuring contingent consideration. SFAS No. 141(R) also enhances the disclosure requirements for business combinations. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (January 1, 2009 for the Company) and may not be applied before that date.

Non-controlling interests in Consolidated Financial Statements: In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin ("ARB") No. 51", "Consolidated Financial Statements". SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other things, SFAS No. 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. SFAS No. 160 also amends SFAS No. 128, "Earnings per Share," so that earnings per share calculations in consolidated financial statements will continue to be based on amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2008 (January 1, 2009 for the Company) and is applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented. SFAS No. 160 is not expected to have an impact on the Company’s consolidated financial condition or results of operations.

Disclosures About Derivative Instruments and Hedging Activities: In March 2008, the FASB issued SFAS No. 161, "Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133." SFAS No. 161 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," to amend and expand the disclosure requirements of SFAS No. 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk related features in derivative agreements. SFAS No. 161 must be applied prospectively for interim periods and fiscal years beginning after November 15, 2008 (January 1, 2009 for the Company). SFAS No.161 is not expected to have a significant impact on the Company's consolidated results of operation or financial condition.

The Hierarchy of Generally Accepted Accounting Principals: In May 2008, the FASB issued SFAS No. 162, "TheHierarchy of Generally Accepted Accounting Principles". SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the "GAAP hierarchy"). SFAS No. 162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." SFAS No.162 is not expected to have a significant impact on the Company's consolidated results of operation or financial condition.

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

Management’s discussion and analysis, which follows, focuses on the factors affecting the Company’s consolidated results of operations for the three and six months ended March 31,June 30, 2008 and 2007, and financial condition at March 31,June 30, 2008, and December 31, 2007, and where appropriate, factors that may affect future financial performance. The following discussion and analysis of 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.

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 share data.

Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in firstsecond quarter 2008 and 2007 interest income was $519$467 and $407,$384, respectively, of tax-exempt interest income from certain investment securities and loans. For the six months ended June 30, 2008 and 2007, the amount of tax-exempt income included in interest income was $987 and $790.

An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income totals discussed in certain sections of this Management’s Discussion and Analysis, representing tax equivalent adjustments of $230$211 and $178,$168, in the firstsecond quarter of 2008 and 2007, respectively, and $441 and $346 for the six months ended June 30, 2008 and 2007, respectively, which increased net interest income accordingly. The analysis of net interest income tables included in this report on 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 and results of operations 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, 2007 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 theThe allowance for loan losses (the "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 probable 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 March 31,June 30, 2008 and December 31, 2007, 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: 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 effect on 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.

EXECUTIVE OVERVIEW

Summary Results of Operations

The Company reported consolidated net income of $2.0 million$2,029 or fully diluted earnings per share of $0.64$0.67 for the three months ended March 31,June 30, 2008, compared with $1.4 million$1,843 or fully diluted earnings per share of $0.44$0.59 for the same quarter in 2007, representing increases of $577 thousand$186 and $0.20,$0.08, or 42.0%10.1% and 45.5%13.6%%, respectively. The annualized return on average shareholders’ equity ("ROE") and average assets ("ROA") amounted to 11.66%12.27% and 0.87%0.89%, respectively, compared with 9.02%11.79% and 0.67%0.91% for the same quarter in 2007.

As more fully enumerateddiscussed below, the increase in firstsecond quarter 2008 earnings compared with the firstsecond quarter of 2007 was principally attributed to a $936 or 16.7% increase in net interest income and a $274 or 16.5% increase in non-interest income, offset in part by a $681 or 15.0% increase in non-interest expenses. The Bank also recorded a provision for loan losses of $297 during the second quarter, representing an increase of $264 compared with the same quarter last year.

For the six months ended June 30, 2008, consolidated net income amounted to $3,981 or fully diluted earnings per share of $1.31, compared with $3,218 or fully diluted earnings per share of $1.03 for the same period in 2007. The annualized ROE and ROA amounted to 11.96% and 0.88%, respectively, compared with 10.42% and 0.79% for the same period in 2007.

As more fully discussed below, the increased level of earnings was attributed to a variety of factors including: a $1.0 million$1,946 or 19.1%17.9% increase in net interest income; a $1.3 million$1,417 increase in net securities gains;gains (losses); and a $313 thousand gain representing the proceeds from shares redeemed in connection with the Visa Inc. initial public offering. Partially offsetting the foregoing revenue increases was a $512 thousand$776 increase in the provision for loan losses. In addition,losses and a $1,872 increase in non-interest expenses, which largely reflected the recording of a non-recurring $832 expense reduction recorded in the first quarter of 2007 the Company recorded an $832 thousand reduction in non-interest expense related to the Company’s settlement of its limited postretirement benefit program.

• Net Interest Income: For the quarterthree and six months ended March 31,June 30, 2008, net interest income on a fully tax equivalent basis amounted to $6.5 million,$6,743 and $13,265, representing an increaseincreases of $1.1 million,$979 and $2,041, or 19.5%17.0% and 18.2%, compared with the same quarterperiods in 2007.2007, respectively. The increaseincreases in net interest income waswere principally attributed to a 24 basis point improvement in the fully tax equivalent net interest margin, combined with average earning asset growth of $70.9 million, or 8.9%. Since September of 2007, the Federal Reserve has lowered short termand an improved net interest margin. The 325 basis point decline in short-term interest rates 300 basis points. These actionsover the past nine months favorably impacted the Bank’s net interest margin, as the cost of interest bearing liabilities declined faster and net interest income, reflecting its liability sensitive balance sheet.
  to a greater extent than the decline in earning asset yields.
• Non- interest Income: For the quarter ended March 31,June 30, 2008, total non-interest income amounted to $2.0 million,$1,932, representing an increase of $1.7 million,$274, or 442%16.5%, compared with the same quarter in 2007. The increase in non-interest income was principallylargely attributed to a $1.3 million$120 increase in net securities gains. Financial services fees and credit and debit card fees also posted meaningful increases, up $97 and $66, or 15.1% and 15.0%, respectively, compared with the same quarter in 2007.

For the six months ended June 30, 2008, total non-interest income amounted to $3,981, representing an increase of $1,945, or 95.5%, compared with the same period in 2007. In the first quarterhalf of 2007 the Bank restructured a portion of its securities portfolio, recording net securities losses of $920 thousand,$902, whereas in the first quarterhalf of 2008 the Bank recorded securities gains of $377 thousand.$515. Also included in first quarter 2008 non-interest income was a $313 thousand gain recorded in the first quarter of 2008 representing the proceeds from shares redeemed in connection with the Visa, Inc. initial public offering.


For the six months ended June 30, 2008, credit and debit card fees and financial services fees were up $132 and $95, or 18.6% and 8.0%, respectively, compared with the same period in 2007.

• Non-Interest Expense: For the quarter ended March 31,June 30, 2008, total non-interest expense amounted to $5.0 million,$5,234 representing an increase of $1.2 million,$681 or 31.4%15.0%, compared with the same quarter in 2007. The increase in non-interest expense was principally attributed to higher levels of salaries and employee benefits, due to a variety of factors enumerated below.

For the six months ended June 30, 2008, total non-interest expense amounted to $10,222, representing an increase of $1,872, or 22.4%, compared with the same period in 2007. The increase in non-interest expense was largely attributed to the settlement of the Company’s limited postretirement program in the first quarter of 2007, the financial impact of which reduced that quarter’sreporting period’s non-interest expense by $832 thousand.$832. The increase in first quarter non-interest expense was also attributed to higher levels of salaries and employee benefit expenses,benefits, which were up $312 thousand$842 or 13.3%18.7% compared with the first quartersix months of 2007. The increase in salaries and employee benefits was attributed to a variety of factors includingincluding: strategic additions to staff,staff; normal increases in base salaries, andsalaries; higher levels of accrued incentive compensation.

Summary Financial Condition

Total assets ended the firstsecond quarter at $911 million,$913,346, representing increasesan increase of $21 million and $84 million,$23,874, or 2.4% and 10.1%2.7%, compared with December 31, and March 31, 2007, respectively.2007.

• Loans: Total loans ended the firstsecond quarter of 2008 at $607 million,$613,635, representing increasesan increase of $27 million and $55 million,$33,924, or 4.7% and 9.9%5.9%, compared with December 31, and March 31, 2007, respectively.2007. Business lending activity continued at a healthy pace during the first quarter, leadingled the overall growth in the loan portfolio.
  
• Credit Quality: The Bank’s non-performing loans ended the firstsecond quarter at $2.3 million,low levels, representing $2,704 or 0.38%0.44% of total loans, compared with $2.1 million$2,062, or 0.36% at December 31, 2007. One problemFor the six months ended June 30, 2008 net loan accounted for $864 of non-performing loans at quarter end and $1,144 at December 31, 2007. Net charge-offs amounted to $300 thousand during the quarter,$318, or annualized net charge-offs to average loans outstanding of 0.20%. The aforementioned problem loan was accountable0.11%, compared with $57 or 0.02% for $280 thousand of first quarter charge-offs. The real estate securing this loan was sold during the second quarter ofsame period in 2007. For the three and six months ended June 30, 2008, and no further losses were sustained.

The Bank’s provisionthe Bank recorded provisions for loan losses amounted to $512 thousand in the first quarter of 2008$297 and $809, representing increases of $264 and $776 compared with no provisionthe same periods in the first quarter of last year.2007, respectively. The increaseincreases in the provision principally reflects continuedwere largely attributed to growth in the loan portfolio, generally declining real estate values in much of the Bank’s market area,markets served by the Bank and other qualitative and environmental considerations.

• Securities: Total securities ended the firstsecond quarter at $257 million,$252,104, representing a decline of $8 million$12,513, or 3.0% and an increase of $29 million or 12.9%4.7%, compared with December 31, and March 31, 2007, respectively.2007. The decline in the securities portfolio during the first quarter was principally attributed to called securities, where call options were exercised, paydownspay-downs on mortgage-backed securities and sales of securities, the cash flows from which were not fully reinvested, largely due to prevailing market conditions and strong first quarter loan growth.
  

• Deposits: Total deposits ended the firstsecond quarter at $558 million,$576,378, representing increasesan increase of $19 million and $52 million,$37,262 or 3.6% and 10.2%,6.9% compared with December 31, and March 31, 2007, respectively. Total deposits included brokered certificates of deposit, which declined $5 million and $21 million compared with December 31 and March 31, 2007, respectively.

At March 31, 2008, total retail deposits stood at $460 million, representing increases of $25 million and $73 million, or 5.6% and 18.8%, compared with December 31 and March 31, 2007, respectively.2007. 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. Consequently, during the first quarterReflecting this seasonality, as of June 30, 2008 demand deposits and NOW accounts declined $17 millionwere showing declines of $11,247 and $3 million$2,664 compared with December 31, 2007, or 17.3% and 4.0%, respectively. However, comparing March 31, 2008These declines were more than offset with the same date last year, all categories ofgrowth in retail deposits were showing increases, led by time deposits and savings and savings/money market accounts.

• Borrowings: Total borrowings ended the firstsecond quarter at $281 million,$267,286, representing increasesa decline of $3 million and $29 million,$11,567, or 0.9% and 11.5%4.2%, compared with December 31, and March 31 2007, respectively.2007. The additionaldecline in borrowings were utilized to help supportprincipally reflected the strong retail deposit growth achieved during the six months ended June 30, 2008, which reduced the Bank’s earning asset growth.
  dependence on borrowed funds.

• Capital: The CompanyBank continued to exceed regulatory requirements for well-capitalized institutions, ending"well-capitalized"institutions. At June 30, 2008, the first quarter of 2008 with aBank’s Tier I Leverage, Tier I Risk-based, and Total Risk-based Capital Ratio of 6.90%.
  ratios were 7.14%, 10.64% and 11.90%, respectively.

• Tangible Book Value: At March 31, 2008, the Company’s tangible book valueCash Dividends: The Company paid cash dividends of 25 cents per share of common stock outstanding amounted to $21.08,in the second quarter of 2008, representing an increase of $1.631.5 cents, or 8.4%6.4%, compared with the same date last year.quarter in 2007. In July 2008, Board of Directors declared a third quarter dividend of 26 cents per share, representing an increase of 2.0 cents, or 8.3%, compared with the dividend declared for the same quarter in 2007.

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 March 31,June 30, 2008, net interest income on a fully tax equivalent basis amounted to $6,522,$6,743, compared with $5,460$5,764 in the firstsecond quarter of 2007, representing an increase of $1,062,$979, or 19.5%17.0%. As more fully discussed below, the increase in the Bank’s firstsecond quarter 2008 net interest income compared with the same quarter in 2007 was principally attributed to average earning asset growth of $103,766 or 13.3%, combined with an 11 basis point improvement in the tax equivalent net interest margin.

For the six months ended June 30, 2008, net interest income on a 24fully tax equivalent basis amounted to $13,265, compared with $11,224 for the same period in 2007, representing an increase of $2,041, or 18.2%. As more fully discussed below, the increase in net interest income was principally attributed to earning asset growth of $87,368 or 11.1%, combined with an 18 basis point improvement in the tax equivalent net interest margin, combinedcompared with average earning asset growth of $70,891, or 8.9%.the six months ended June 30, 2007.

Factors contributing to the changes in net interest income and the net interest margin are more fully 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 six months ended March 31,June 30, 2008 and 2007, respectively:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
MARCH 31,JUNE 30, 2008 AND 2007

(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, net interest income and net interest margin are reported on a tax equivalent basis.

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
SIX MONTHS ENDED
JUNE 30, 2008 AND 2007

(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, net interest income and net interest margin are reported on a tax equivalent basis.

Net Interest Margin: The net interest margin, expressed on a Taxtax equivalent basis, represents the difference between interest and dividends earned on interest-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 Taxtax equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average Taxtax 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 six months ended March 31,June 30, 2008 the fully tax equivalent net interest margin amounted to 3.03%3.07% and 3.05%, compared with 2.79%2.96% and 2.87% during the same quarterperiods in 2007, representing an improvementimprovements of 2411 and 18 basis points.points, respectively.

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

NET INTEREST MARGIN ANALYSIS
FOR QUARTER ENDED

Since(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, net interest income and net interest margin are reported on a tax equivalent basis.

During the period of September 2007 through April 2008, the Board of Governors of the Federal Reserve System (the "Federal Reserve") decreased short term interest rates sixseven times for a total of 300325 basis points. These actions have favorably impacted the Bank’s net interest income, given its liability sensitive balance sheet. Specifically, the Bank’s total weighted average cost of funds declined at a faster pace and to a greater extent than the decline in the weighted average yield on its earning asset portfolios.

The weighted average yield on average earning assets amounted to 6.35%6.08% in the firstsecond quarter of 2008, compared with 6.40%6.57% in the firstsecond quarter of 2007, representing a decline of five49 basis points. However, the weighted average cost of interest bearing liabilities amounted to 3.71%3.36% in the firstsecond quarter of 2008, compared with 4.04% in the firstsecond quarter of 2007, representing a decline of 3368 basis points. In short, since the firstsecond quarter of 2007, the decline in the Bank’s weighted average cost of interest bearing liabilities exceeded the decline in the weighted average yield on its earning asset portfolios by 2819 basis points.

ShouldFor the six months ended June 30, 2008, the weighted average yield on average earning assets amounted to 6.22%, compared with 6.48% for the same period in 2007, representing a decline of 26 basis points. However, the weighted average cost of interest bearing liabilities amounted to 3.53% during the six months ended June 30, 2008, compared with 4.04% for the same period in 2007, representing a decline of 51 basis points. In short, termcomparing the first six months of 2008 with the same period in 2007, the decline in the Bank’s weighted average cost of interest bearing liabilities exceeded the decline in the weighted average yield on its earning asset portfolios by 25 basis points.

Should interest rates continue at current levels, or decline further, Company management anticipates the Bank’s improving net interest margin trend will continue into the secondthird and thirdfourth quarters of 2008, generating higher levels of net interest income. Management anticipates the continued improvement in the net interest margin will be driven by a continued downward re-pricing of interest bearing liabilities, as time deposits and borrowed funds maturities are replaced at lower prevailing costs, while the yields on its average earning asset portfolios continue to stabilize. Management also anticipates that the net interest margin and net interest income will be favorably impacted by the current positively sloped U.S. Treasury yield curve, as compared with the yield flat-to-inverted curve environment experienced in 2007.

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 quarterthree and six months ended March 31,June 30, 2008, total interest income, on a fully Taxtax equivalent basis, amounted to $13,660$13,376 and $27,036 compared with $12,538$12,774 and $25,312 during the same quarterperiods in 2007, representing an increaseincreases of $1,122,$602 and $1,724, or 8.9%.4.7% and 6.8%, respectively.

The increaseincreases in interest income waswere principally attributed to average earning asset growth of $70,891,$103,766 and $87,368, or 8.9%13.3% and 11.1%, offset in part by a five49 and 26 basis point declinedeclines in the weighted average earning asset yield,yields, when comparing the first quarter ofthree and six months ended June 30, 2008 with the same quarterperiods in 2007.2007, respectively. The declinedeclines in the weighted average earning asset yield wasyields were principally attributed to the reduction of short termshort-term interest rates by the Federal Reserve, the impact of which moderately reduced the weighted average yield on the Bank’s variable rate loan portfolios from 6.74%portfolios. To a lesser extent, the weighted average loan yields were also impacted by the renegotiation of certain fixed rate loans to 6.52%variable rate loans with lower prevailing interest rates. For the three and six months ended June 30, 2008, the weighted average yield on the Bank’s loan portfolio amounted to 6.19% and 6.35%, or 22representing declines of 69 and 46 basis points. points compared with the same periods in 2007.

For the three and six months ended March 31,June 30, 2008, the weighted average yield on the Bank’s securities portfolio amounted to 6.02%6.00% and 6.01%, representing improvements of 23 and 35 basis points, compared with 5.56% during the same periodperiods in 2007, representing an improvement of 46 basis points.2007. The improved yield on the securities portfolio reflects, in part, the restructuring of a portion of the portfolio in 2007. In addition, because the majority of the securities portfolio consistsis comprised of fixed rate securities, the decline in short-term interest rates has had minimal impact on itsthe portfolio’s weighted average yield.

Comparing the first quarter of 2008 with the same quarter in 2007, interest income from the loan portfolio increased $350 or 3.8%, and interest income from the securities portfolio increased $755, or 24.3%.

As depicted on the rate /volumerate/volume analysis tables below, comparing the three and six months ended June 30, 2008 with the same periods in 2007, the increased volume of total average earning assets on the balance sheet during the first quarter of 2008 contributed $1,265$6,626 and $5,527 to the increaseincreases in first quarter 2008 interest income, compared with the first quarterbut were largely offset by declines of 2007, offset in part by a decrease of $143$6,024 and $3,803 attributed to the decline inimpact of the lower weighted average earning asset yield.yields.

Interest Expense: For the quarterthree and six months ended March 31,June 30, 2008, total interest expense amounted to $7,138,$6,633 and $13,771, compared with $7,078$7,010 and $14,088 during the same quarterperiods in 2007, representing an increasedeclines of $60,$377 and $317, or 0.8%.5.4% and 2.3%, respectively.

The increasedeclines in interest expense waswere principally attributed to an increase68 and 51 basis point declines in the weighted average cost of funds, largely offset by increases in average interest bearing liabilities amountingtotaling $99,467 and $80,884, or 14.3% and 11.5%, when comparing the three and six months ended June 30, 2008 with the same periods in 2007, respectively. The declines in the average cost of interest bearing funds were principally attributed to $62,214 or 8.7%declines in short-term market interest rates between periods and, to a lesser extent, a proportionately lower utilization of wholesale funding.

For the three and six months ended June 30, 2008, the total weighted average cost of funds amounted to 3.36% and 3.53%, almost allcompared with 4.04% and 4.04% during the same periods in 2007, respectively. For the three and six months ended June 30, 2008, the weighted average cost of which was offset by a 33borrowed funds declined 72 and 64 basis pointpoints to 4.21% and 4.30%, while the weighted average cost of interest bearing deposits declined 64 and 41 basis points to 2.92% and 3.12%, compared with the same periods in 2007, respectively. The decline in the weighted average cost of borrowed funds outpaced the decline in the weighted average cost of interest bearing liabilities, when comparingdeposits, reflecting the first quarter of 2008 with the same quarter in 2007. The decline in the weighted average cost of interest bearing liabilities was principally attributed to declines in short term interest rates, which favorably impacted the weighted average costshorter maturities of the Bank’s variable rate funding sourcesborrowing base as well as its short term borrowings. Should short term interest rates continue at current levels, Bank management anticipates further declinesbegan declining, combined with highly competitive market pricing pressures for deposits in the weighted average cost of funds, as maturing time deposits and borrowings continue to re-price at lower costs.markets served by the Bank.

As depicted on the rate/volume analysis tabletables below, comparing the three and six months ended June 30, 2008 with the same periods in 2007, the impact of the lower weighted average rate paid on interest bearing liabilities contributed $4,228 and $3,434 to the declines in interest expense, but were largely offset by increases of $3,851 and $3,117 attributed to the impact of the increased volume of average interest bearing liabilities on the balance sheet during the first quarter of 2008 contributed $607 to the increase in first quarter 2008 interest expense compared with the first quarter of 2007, but was largely offset by a decrease of $547 attributed to the decline in the cost of interest bearing liabilities.

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 MARCH 31,JUNE 30, 2008 VERSUS MARCH 31,JUNE 30, 2007
INCREASES (DECREASES) DUE TO:

(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, net interest income and net interest margin are reported on a tax equivalent basis.

ANALYSIS OF VOLUME AND RATE CHANGES ON NET INTEREST INCOME
SIX MONTHS ENDED JUNE 30, 2008 VERSUS JUNE 30, 2007
INCREASES (DECREASES) DUE TO:

(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, net interest income and net interest margin are reported on a tax equivalent basis.

Provision for Loan Losses

The provision for loan losses reflects the amount necessary to maintain the allowance for loan losses (the "allowance") at a level that, in management’s judgment, is appropriate for the amount of inherent risk of probable loss in the Bank’s current loan portfolio.

The Bank’s non-performing loans remained at relatively low levels at quarter end, representing $2,296$2,704 or 0.38%0.44% of total loans, compared with $2,062 or 0.36% of total loans at December 31, 2007. At March 31, 2008, one problem loan accounted for $864, or 38% of total non-performing loans.

Net charge-offs amounted to $300 in$318 during the first quartersix months of 2008, or annualized net charge-offs to average loans outstanding of 0.20%. The problem loan mentioned above was accountable for $280 of first quarter 2008 charge-offs. The real estate securing this loan was sold during the second quarter of 2008 and no further charge-offs were sustained. In the first quarter of 2007, net loan charge-offs amounted to $26,0.11%, compared with $57 or annualized net charge-offs to average loans outstanding of 0.20%.0.02% for the same period in 2007. One problem loan was accountable for $280, or 88.1%, of the charge-offs during the six months ended June 30, 2008.

The allowance expressed as a percentage of non-performing loans stood at 216%194% at March 31,June 30, 2008, compared with 230% at December 31, 2007.

For the three and six months ended March 31,June 30, 2008, the provision for loan losses (the "provision") amounted to $512$297 and $809 compared with no provision$33 during the same periodperiods in 2007. The increaseincreases in the provision principally reflects continuedwere largely attributed to growth in the loan portfolio, generally declining real estate values in much of the Bank’s market area, increases in net loan charge-offs, and other qualitative and environmental considerations.

Refer below to Item 2 of this Part I, Financial Condition, Loans, Allowance for Loan Losses, in this report on Form 10-Q for further discussion and analysis regarding the allowance.

Non-interest Income

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

For the quarterthree and six months ended March 31,June 30, 2008, total non-interest income amounted to $2,049,$1,932 and $3,981, compared with $378$1,658 and $2,036 during the same quarterperiods in 2006,2007, representing an increaseincreases of $1,671,$274 and $1,945 or 442.1%.16.5%, and 95.5%, respectively.

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

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

For the three and six months ended June 30, 2008, income from trust and other financial services amounted to $739 and $1,278, compared with $642 and $1,183 during the same periods in 2007, representing increases $97 and $95, or 15.1% and 8.0%, respectively. Revenue generated from third party brokerage activities posted meaningful increases, which were principally attributed to staff additions and new client relationships. Revenue from trust and investment management activities was relatively flat compared with the three and six months ended June 30, 2007, principally reflecting declining market values of assets under management and held in custody.

At March 31,June 30, 2008, total assets under management at Bar Harbor Trust Services ("Trust Services"), a Maine chartered non-depository trust company and second tier subsidiary of the Company, stood at $265,482$265,663 compared with $278,227 and $257,799 at December 31 and March 31, 2007, representing a decline of $12,745$12,564 or 4.6% and an increase4.5%. The decline in assets under management was principally reflective of $7,683, or 3.0%, respectively.

For the quarter ended March 31, 2008, income from trust and other financial services amounted to $539, compared with $541broad declines experienced by the equity markets in general during the same quarter in 2007, representing a decline of $2 or 0.4%. Revenue generated from third party brokerage activities posted moderate declines, reflecting lower trading volumes, including sales of mutual funds and annuity products.six months ended June 30, 2008.

Service Charges on Deposits: This income is principally derived from monthly deposit account maintenance and activity fees, overdraft fees, and a variety of other deposit account related fees.

Income generatedFor the three and six months ended June 30, 2008, income from service charges on deposit accounts totaled $362amounted to $405 and $767, compared with $418 and $788 for the quarter ended March 31, 2008, compared with $370 during the same quarterperiods in 2007, representing a declinedeclines of $8,$13 and $21, or 2.2%.3.1% and 2.7%, respectively. The declinedeclines in service charges on deposit accounts waswere principally attributed to arelatively small declinedeclines in deposit account overdraft activity, in the first quarter of 2008 compared with the same quarter inthree and six months ended June 30, 2007, and the fact that the Bank has not increased its deposit account fee amounts charged to customers since early 2007.

Credit and Debit Card Service Charges and Fees: This income is principally derived from the Bank’s merchant credit card processing services, its Visa debit card product and, to a lesser extent, fees associated with its Visa credit card portfolio. Historically, the Bank’s merchant credit card processing activities have been highly seasonal in nature with transaction and fee income volumes peaking in the summer and autumn, while declining in the winter and spring.

For quarterthe three and six months ended March 31,June 30, 2008, credit and debit card service charges and fees amounted to $333,$507 and $840, compared with $267$441 and $708 during the same quarterperiods in 2007, representing an increaseincreases of $66 and $132, or 24.7%.15.0% and 18.6%, respectively.

The first quarter increaseincreases in credit and debit card fees waswere largely attributed to an increaseincreases in debit card fees, principally reflecting the ongoing growth in the Bank’s demand deposits accounts base, combined with the 2007 introduction of a new deposit account product that offers rewards for debit card transactions. Merchant credit card processing fees also posed an increase,posted increases, reflecting higher merchant credit card processing volumes compared with the first quarter ofthree and six months ended June 30, 2007. The increase in credit and debit card processing revenue was largely offset by an increase in credit and debit card processing expense, which is included in non-interest expense in the Company’s consolidated statements of income.

Net Securities Gains (Losses): For the quarterthree months ended March 31,June 30, 2008, nettotal securities gains amounted to $377,$138, compared with $18 for the same quarter in 2007, representing an increase of $120. For the six months ended June 30, 2008, total securities gains amounted to $515, compared with net securities losses of $920$902 during the same period in the first quarter of 2007, representing an increase of $1,297.$1,417. The amount recorded in the first quarterhalf of 2008 represented realized gains on the sale of securities, while the amount recorded in the first quarterhalf of 2007 represented a securities impairment loss partiallyof $1,162, offset in part by realized gains.gains from the sale of securities of $260.

In April 2007, Company’s Board of Directors approved the restructuring of a portion of the Company’s consolidated balance sheet through the sale of $43,337 of its aggregate $227,473 available for sale 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, the Company recorded an adjustment to write down these securities to fair value at March 31, 2007, resulting in an impairment loss of $1,162. In the first quarter of 2007 the Company also recorded $241 in realized gains on sales of securities.

Other Operating Income: For the quarterthree months ended March 31,June 30, 2008, total other operating income amounted to $388,$86, unchanged compared with $68the same quarter in 2007. For the six months ended June 30, 2008, total other operating income amounted to $474, compared with $154 during the same quarterperiod in 2007, representing an increase of $320, or 470.6%207.8%. The increase was attributed to a gain recorded in the first quarter of 2008 representing the proceeds from shares redeemed in connection with the Visa, Inc. initial public offering.

As previously reported, in Part II, Item 7 of the Company’s Annual Report on Form 10-K, and in connection with the Bank’s merchant services and Visa credit card business, prior to September 2007 the Bank was a member of Visa U.S.A. Inc. Card Association. As a part of the Visa Inc. reorganization in 2007, (the "Visa Reorganization"), the Bank received its proportionate number of Class U.S.A. shares of Visa IncInc. common stock, or 20,187 shares.

In connection with the Visa Inc. initial public offering that occurred in March of 2008, the Bank receivedBank’s Class U.S.A. shares were converted to 18,949 shares of Visa Inc. Class B Common Stock, of which 7,326 shares were immediately redeemed. The proceeds from this redemption amounted to $313 and were recorded in other operating income in the Company’s consolidated statement of income. The 11,623 post redemption non-marketable shares owned by the Bank are convertible to Class A Visa Inc. shares three years after the initial public offering, or upon settlement of certain litigation between Visa Inc. and other third parties, whichever is later. As of March 29, 2008, the conversion rate of Class B shares into Class A shares was 0.71429.

Non-interest Expense

For the quarterthree and six months ended March 31,June 30, 2008, total non-interest expense amounted to $4,988,$5,234 and $10,222, representing increases of $681 and $1,872, or 15.0% and 22.4%, compared with $3,797 during the same quarterperiods in 2007, representing an increase of 1,191 or 31.4%. respectively.

Factors contributing to the changes in non-interest expense are enumerated in the following discussion and analysis.

Salaries and Employee Benefit Expenses: For the quarterthree and six months ended March 31,June 30, 2008, salaries and employee benefit expenses amounted to $2,657,$2,684 and $5,341, compared with $2,345$2,154 and $4,499 during the same quarterperiods in 2007, representing an increaseincreases of $312$530 and $842, or 13.3%. 24.6% and 18.7%, respectively.

The increaseincreases in salaries and employee benefits waswere attributed to a variety of factors including strategic additions to staff, normal increases in base salaries, and higher levels of accrued incentive compensation. The increasecompensation, certain employee severance payments, and a non-recurring employee health insurance credit attained in salaries and benefits followed a two-year period where salary and employee benefits declined.the second quarter of 2007 based on favorable claims experience.

Postretirement 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 $699 to plan participants. This payment fully settled all Company obligations related to this program. In connection with the settlement of the postretirement program, the Company recorded a first quarter 2007 reduction in non-interest expense of $832, representing the remaining accrued benefit obligation and the actuarial gain related to the program.

Occupancy Expenses: For the quarterthree and six months ended March 31,June 30, 2008, total occupancy expenses amounted to $385,$352 and $737, compared with $373$320 and $693 during the same quarterperiods in 2007, representing an increaseincreases of $12$32 and $44, or or 3.2%.10.0% and 6.4%, respectively.

The increaseincreases in occupancy expensesexpense were principally reflectedattributed higher fuel and utilities prices in the first quarterhalf of 2008 compared with the same quarterperiods last year. Grounds keeping and snow removal expenses at the Bank’s twelve branch office locations also posted moderate increases in the first half of 2008 compared with the same periods in 2007.

Furniture and Equipment Expenses: For the quarterthree and six months ended March 31,June, 30 2008, furniture and equipment expenses amounted to $490,$373 and $863, compared with $449$439 and $888 during the first quartersame periods in 2007, representing an increasedeclines of $41,$66 and $25, or 9.1%.15.0% and 2.8%, respectively.

The first quarter increasedeclines in furniture and equipment expenses waswere principally attributed to higherlower maintenance fees on certain equipment and a higher level of equipment repairs,decline in depreciation expense, compared with the first quarter ofthree and six months ended June 30, 2007.

Credit and Debit Card Expenses: Credit and debit card expenses principally relate to the Bank’s merchant credit card processing activities, Visa debit card processing expenses and, to a lesser extent, its Visa credit card portfolio. Historically, the Bank’s merchant credit card processing activities have been highly seasonal in nature with transaction volumes peaking in the summer and autumn, while declining in the winter and spring.

For the quarterthree and six months ended March 31, 2008,June 30, 2009, credit and debit card expenses amounted to $255,$326 and $581, compared with $188$270 and $458 during the same quarterperiods in 2007, representing an increaseincreases of $67,$56 and $123, or 35.6%. 20.7% and 26.9%, respectively.

The increaseincreases in credit and debit card expenses waswere principally attributed to an increaseincreases in debit card fees,transactions, reflecting the growth of the Bank’s retail checking account base and the 2007 introduction of a new deposit product that provides customer rewards for debit card activity. Merchant credit card processing expenses were also moderately higher, in the first quarter of 2008, principally reflecting higher merchant credit card transaction processing volumes compared with the same quarter inthree and six months ended June 30, 2007.

First quarter 2008 creditCredit and debit card expenses also included the costs incurred during the first half of 2008 associated with the voluntary reissuancere-issuance of a large number of credit and debit cards that were compromised in the widely publicizedwidely-publicized Hannaford Bros. Supermarket data breach.

The $67 increase in first quarter 2008increased credit and debit card expenses was essentiallyfor the three and six months ended June 30, 2008 compared with the same periods in 2007 were more than offset by a $66 increaseand $132 increases in credit and debit card income, which is included in non-interest income in the Company’s consolidated statements of income.

Other Operating Expenses: For the quarterthree months ended March 31,June 30, 2008, total other operating expenses amounted to $1,201,$1,499, compared with $1,274$1,370 during the same quarter in 2007, representing a declinean increase of $73,$129, or 5.7%.9.4%, respectively.

The declineincrease in other operating expenses in the second quarter of 2008 compared with the same quarter in 2007 was attributed to a variety of factors including increases in professional services, marketing expenses and staff development costs. The increase in professional services, which include legal fees, was largely attributed to Bank’s issuance of subordinated debt securities in the second quarter of 2008.

For the six months ended June 30, 2008, total other operating expenses amounted to $2,700, compared with $2,644 during the same period in 2007, representing an increase of $56, or 2.1%.

The relatively small increase in other operating expenses in the first half of 2008 compared with the same period in 2007 was principally attributed to a $128 reduction in the Company’s liability related to the Visa Reorganization and the Visa Inc. initial public offering.

As previously reported in Part II, Item 7 of the Company’s Annual Report on Form 10-K, as a former member of Visa, the Bank has an obligation to indemnify Visa U.S.A. under its bylaws and Visa Inc. under a retrospective responsibility plan, approved as part of the Visa Reorganization, for contingent losses in connection with covered litigation (the "Visa Indemnification") disclosed in Visa Inc.’s public filings with the SEC, based on its membership proportion. The Bank is not a party to the lawsuits brought against Visa U.S.A. In 2007 the Bank recorded a $243 liability in connection with the Visa Indemnification. In connection with the March 2008 Visa Inc. public offering the Bank reduced this liability by $128. The Company recognizes its portion of the Visa Indemnification at the estimated fair value of such obligation in accordance with FASB Interpretation No. 45, "Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others".

Excluding the $128 reduction in the Visa Inc. liability discussed above, first quarter 2008 other operating expenses in the first half of 2008 increased $55,$184, or 4.3%7.0%, compared with the same quarterperiod in 2007. The increase was principally attributed to moderate increases in a variety of expense categories including marketing, professional services, charitable contributions and professional services.staff development. These increases were partially offset by a $67declines in courier services, and telecommunications costs. The decline in courier services reflectingwas principally attributed to the mid 2007 implementation of remote image item capture technology in all of the Bank’s branch office locations.

Income Taxes

For the quarterthree and six months ended March 31,June 30, 2008, total income taxes amounted to $889,$904 and $1,793, compared with $488 for$825 and $1,313 during the same quarterperiods in 2007, representing an increaseincreases of $401,$79 and $480, or 82.2%.9.6% and 36.6%, respectively.

The Company's effective tax raterates for the quarterthree and six months ended March 31,June 30, 2008 amounted to 31.3%30.8% and 31.1%, compared with 26.2%30.9% and 29.0% for the same quarterperiods in 2007. The income tax provisions for these periods were less than the expense that would result from applying the federal statutory rate of 34% to income before income taxes, principally because of the impact of tax exempt interest income on certain investment securities, loans and bank owned life insurance.

Fluctuations in the Company’s effective tax rate are generally attributed to changes in the relationship between non-taxable income and non-deductible expense, and income before income taxes, during any given reporting period.

FINANCIAL CONDITION

Total Assets

The Company’s assets principally consist of loans and securities, which at March 31,June 30, 2008 represented 66.7%67.2% and 28.2%27.6% of total assets, compared with 65.2% and 29.7% at December 31, 2007, respectively.

At March 31,June 30, 2008, total assets amounted to $910,894,$913,346, compared with $889,472 and $827,266 at December 31, and March 31, 2007, representing increasesan increase of $21,422 and $83,628,$23,874, or 2.4% and 10.1%, respectively.2.7%.

Securities

The securities portfolio is primarily comprised of mortgage-backed securities issued by U.S. government agencies, U.S. government sponsored enterprises, and other corporateprivate label issuers. The portfolio also includes tax-exempt obligations of state and political subdivisions, and obligations of other U.S. government sponsored enterprises. As of June 30, 2008, the securities portfolio did not contain any pools of sub-prime mortgage-backed securities, collateralized debt obligations, or commercial mortgage-backed securities. Additionally, the Bank did not have any corporate debt exposure in its securities portfolio, nor did it own any perpetual preferred stock in FHLMC or FNMA, nor any interests in pooled trust preferred securities.

InDuring the first quarter ofsix months ended June 30, 2008, the securities portfolio represented 29.8%29.4% of the Company’s average earning assets and generated 28.3%28.4% of total tax equivalent interest and dividend income, compared with 28.5%28.1% and 24.6%24.5% during the same period in the first quarter of 2007, respectively.2007.

The overall objectives of the Bank’s strategy for the securities portfolio include maintaining appropriate liquidity reserves, diversifying earning assets, managing interest rate risk, leveraging the Bank’s strong capital position, and generating acceptable levels of net interest income.

Securities available for sale represented 100% of total securities at March 31,June 30, 2008 and December 31, 2007. Securities available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity. Gains and losses on the sale of securities available for sale are determined using the specific-identification method and are shown separately in the consolidated statements of income.

Total Securities: At March 31,June 30, 2008, total securities amounted to $256,698,$252,104, compared with $264,617 and $227,473 at December 31 and March 31, 2007, representing a decline of $7,919$12,513 or 3.0% and an increase of $29,225, or 12.9%, respectively.4.7%. The decline in the securities portfolio from December 31, 2007 was principally attributed to called securities, paydowns on mortgage-backed securities and sales of securities, the cash flows from which were not fully reinvested due to prevailing market conditions and strong first quarter loan growth.

In the second quarter of 2007, the Bank completed the restructuring of a portion of its securities portfolio, selling a total of $46,170 in securities with below market yields while paying down short-term borrowings. During the later part of the second quarter of 2007, market yields climbed to a five-year high, with the benchmark 10-year U.S. Treasury advancing from 4.63% in mid May to 5.30% in mid June. The strong increase in market yields presented opportunities for replacing the securities sold; further increasing the Bank’s earning assets with additional securities, and generating higher levels of net interest income. The $29,225 increase in securities at March 31, 2008 compared with the same date in 2007 was principally attributed to the implementation of the foregoing strategy.

Impaired Securities: The securities portfolio contains certain investments where amortized cost exceeds fair value, which at March 31,June 30, 2008 amounted to unrealized losses of $3,483,$4,779, compared with $723 at December 31, 2007. The increase in unrealized losses from December 31, 2007 levels was principally attributed to changes in prevailing market conditions, interest rates and market yields at quarter end, including historically wide pricing spreads to the U.S. Treasury yield curve (the "yield curve").

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

Management believes the unrealized losses in the securities portfolio at March 31,June 30, 2008 were attributed to prevailing market conditions, interest rates and market yields, combined with historically wide pricing spreads to the yield curve. Because the decline in market value was attributable to changes in prevailing market yields and interest rates, and because the Bank has the ability and intent to hold these investment securities until a recovery of their amortized cost, which may be at maturity, the Company does not consider these investment securities to be other-than-temporarily impaired at March 31,June 30, 2008.

Loans

The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine.

The following table summarizes the components of the Bank's loan portfolio as of the dates indicated.

LOAN PORTFOLIO SUMMARY

Total Loans: At March 31,June 30, 2008, total loans amounted to $607,165,$613,635, compared with $579,711 and $552,643 at December 31, and March 31, 2007, representing increases of $27,454, or 4.7%, and an increase of $54,522,$33,924, or 9.9%, respectively.5.9%. Business lending activity led the overall growth of the loan portfolio during the threesix months ended March 31,June 30, 2008.

Commercial Loans: At March 31,June 30, 2008, total commercial loans amounted to $294,348,$301,850, compared with $264,890 and $236,771 at December 31, and March 31, 2007, representing increasesan increase of $29,458 and 57,577,$36,960, or 11.1% and 24.3%, respectively.14.0%.

Commercial loans represented 105.5%108.8% of total loan growth when comparing March 31,June 30, 2008 with the same date inDecember 31, 2007. Commercial loan growth was almost principally driven by commercial real estate mortgage loans and commercial and industrial loans, which posted increases of $42,255$27,326 and $10,069,$7,032, or 26.3%14.9% and 17.2%10.8%, respectively, when comparing March 31,June 30, 2008 with the same date inDecember 31, 2007. Bank management attributes the overall growth in commercial loans, in part, to an effective business banking team, a variety of new business development initiatives, focused incentive compensation plans, and a relatively stable local economy.

During the later part of the second quarter of 2008, commercial loan origination activity slowed. Based on a variety of factors, Bank management does not currently anticipate the same rate of commercial loan growth in the second half of 2008 as was achieved in the first half of the year.

Consumer Loans: At March 31,June 30, 2008, total consumer loans, which principally consisted of consumer real estate (residential mortgage) loans, amounted to $305,821,$304,935, compared with $307,675 and $308,715 at December 31, and March 31, 2007, representing declinesa decline of $1,854 and $2,894,$2,740, or 0.6% and 0.9%, respectively..

The declinesdecline in consumer loans werewas principally attributed to declinesa $3,194 or 1.3% decline in residential real estate loans, reflecting a continued softening of the real estate markets in the communities served by the Bank. While the Bank originated and closed $6,678$16,610 in residential real estate loans during the first quarterhalf of 2008, this amount was more than offset by $9,572 of$19,804 in cash flows (principal paydowns) from the existing residential real estate loan portfolio. Partially offsetting the decline in residential real estate loans was a $2,288 or 5.0% increase in home equity loans, when comparing June 30, 2008 with December 31, 2007.

Subprime Mortgage Lending: Subprime mortgage lending, which has been the riskiest sector of the residential housing market, is not a market that Bank management has ever actively pursued. In general, the industry does not apply a uniform definition of what actually constitutes "subprime" lending. In referencing subprime lending activities, Bank management relies upon several sources, including Maine’s Predatory Lending Law enacted January 1, 2008, and the "Statement of Subprime Mortgage Lending" issued by the federal bank regulatory agencies (the "Agencies") on June 29, 2007, which further references the Expanded Guidance for Subprime Lending Programs (the "Expanded Guidance"), issued by the Agencies by press release dated January 31, 2001.

In the Expanded Guidance, the Agencies indicated that subprime lending does not refer to individual subprime loans originated and managed, in the ordinary course of business, as exceptions to prime risk selection standards. The Agencies recognize that many Prime loan portfolios will contain such accounts. The Agencies also excluded Prime loans that develop credit problems after origination and community development loans from the subprime arena. According to the Expanded Guidance, subprime loans are other loans to borrowers that display one or more characteristics of reduced payment capacity. Five specific criteria, which are not intended to be exhaustive and are not meant to define specific parameters for all subprime borrowers and may not match all markets’ or institutions’ specific subprime definitions, are set forth, including having a FICO (credit) score of 660 or lower. Based on the definitions and exclusions described above, Bank management considers the Bank as a Prime lender. Within the Bank’s residential mortgage loan portfolio there are loans that, at the time of origination, had FICO scores of 660 or below. However, as a portfolio lender, the Bank reviews all credit underwriting data including all data included in borrower credit reports and does not base its underwriting decisions solely on FICO scores. Bank management believes the aforementioned loans, when made, were amply collateralized and documented, and otherwise conformed to the Bank’s Prime lending standards.

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

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

Non-performing Loans: Non-performing loans include loans on non-accrual status, loans that have been treated as troubled debt restructurings and loans past due 90 days or more and still accruing interest. There were no troubled debt restructurings in the loan portfolio during 2007 and this continued to be the case during the threesix months ended March 31,June 30, 2008. The following table sets forth the details of non-performing loans as of the dates indicated:

TOTAL NON-PERFORMING LOANS

During the quarter ended March 31,As of June 30, 2008, non-performing loans increased by $234,were up $642 or 31.1% compared with year-end 2007, but remained at relatively low levels. The Bank attributes this to mature credit administration processes and disciplined underwriting standards, aided by a relatively stable local economy. The Bank maintains a centralized loan collection and managed asset department, providing timely and effective collection efforts for problem loans.

At March 31,June 30, 2008, total non-performing loans amounted to $2,296,$2,704, compared with $2,062 and $422 at December 31 and March 31, 2007, representing increases of $234 and $1,874, or 11.3%, and 444.1%, respectively.2007. One problemcollateral dependent commercial real estate loan accounted for $864$1,025 or 37.9% of non-performing loans at quarter end and $1,144 at December 31, 2007. This problem loan was accountable for $280 of first quarter charge-offs. The real estate securing this loan was sold duringend. During the second quarter of 2008, a specific loan loss allowance of $250 was established for this problem loan, and no further charge-offthis amount was sustained.included in the overall provision for loan losses. Company management determined the specific loan loss allowance based on the fair value of collateral securing the loan.

While the level of non-performing loans ratios continued to reflect the favorable quality of the loan portfolio at June 30, 2008, Bank management is cognizant of the continued softening of the real estate market and softening economic conditions overall, and believes it is managing credit risk accordingly. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank's customers, including interest rates and debt service levels, declining collateral values, risinghistorically high oil and gas prices, tourism activity, and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.

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

At March 31,June 30, 2008 and December 31, 2007 total OREO amounted to $340, unchanged compared with none as of MarchDecember 31, 2007. One commercial property comprised the March 31,June 30, 2008 and December 31, 2007 balance of OREO.

Allowance for Loan Losses: The allowance for loan losses (the "allowance") is available to absorb probable losses on loans. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated quarterly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration.

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

Specific allowances for impaired loans are determined in accordance with SFAS No. 114 "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $1,650$1,987 as of March 31,June 30, 2008, compared with $1,598 and $294 as of December 31, and March 31, 2007, respectively.2007. The related allowance for loan losses on these impaired loans amounted to $100$420 as of March 31,June 30, 2008, compared with $250 and $100 at$280 as of December 31, and March 31, 2007, respectively.2007.

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

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

The Bank’s loan loss experience increased during threesix months ended March 31,June 30, 2008, with net loan charge-offs amounting to $300,$318, or annualized net charge-offs to average loans outstanding of 0.20%0.11%, compared with $26$57 or annualized net charge-offs to average loans outstanding of 0.02% during the first quartersix months of 2007. One problem loan accounted for $280, or 93.3%88.1%, of first quarter charge-offs.total charge-offs during the six months ended June 30, 2008.

There were no material changes in loan concentrations during the threesix months ended March 31,June 30, 2008.

The following table details changes in the allowance and summarizes loan loss experience by loan type for the three-monthsix-month periods ended March 31,June 30, 2008 and 2007.

ALLOWANCE FOR LOAN LOSSES
THREESIX MONTHS ENDED
MARCH 31,JUNE 30, 2008 AND 2007