Financial Information About Industry Segments

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

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

The Company maintains a website on the Internet at www.BHBT.com. The Company makes available, free of charge, on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. Information contained on the Company’s website does not constitute a part of this report.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

These factors include but are not limited to:

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

None.

ITEM 2. PROPERTIES

The thirteen parcels of real estate owned and utilized by the Company for its operations are described below:

1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building, which houses its banking facilities and administrative offices. The building was renovated in 1998.

2. An office is located at 111 Main Street, Northeast Harbor, Maine. This property consists of a building constructed in 1974 that underwent interior renovations in 1998 to better meet the Bank’s needs at that location.

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

4. An office is located at 25 Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the Bank’s needs at that location.

6. An office is located at 2 Bridge Street, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994 to house an ATM that helps to better meet the needs at that location.

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

8. An office is located 137 High Street, Ellsworth, Maine. This property consists of a building constructed in 1982. The Bank is currently evaluating expansion of the Ellsworth office.

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

11. An office is located at 245 Camden Street (Route 1), Rockland, Maine. The property consists of a building that was purchased from Androscoggin Savings Bank in February 2004. The branch facility was built in 1977 and is considered adequate for the Bank’s needs at that location.

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

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

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

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

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 6 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of the Company’s security holders in the fourth quarter of 2005.

PART II

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

The common stock of the Company is traded on the American Stock Exchange ("AMEX") under the trading symbol BHB. Quarterly stock prices, and dividends paid during the last two years are summarized below. High and low stock prices are based on quotations provided by the American Stock Exchange.

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

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

As of March 7, 2006, the Company had 1,042 registered shareholders of record. The Company declared and distributed dividends totaling $2.58 million or $0.84 per share during 2005, representing an earnings payout ratio of 40.2%. In the first quarter of 2006 the Company increased its quarterly dividend by 4.8% to $0.22 per common share. The dividend will be paid March 15, 2006 to shareholders of record as of the close of business on February 17, 2006.

The Company has a history of paying quarterly dividends on its common stock. However, the Company’s ability to pay such dividends depends on a number of factors, including the Company’s financial condition, earnings, its needs for funds and restrictions on the Company’s ability to pay dividends under federal laws and regulations. Therefore, there can be no assurance that dividends on the Company’s common stock will be paid in the future.

As more fully enumerated under Part II Item 7 of this report on Form 10-K, in November 1999 the Company announced a stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. As of the date of termination of this plan on December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The Company recorded repurchased shares as treasury stock.

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

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

The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the years ended December 31, 2005, 2004 and 2003 should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on Form 10-K. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years, and provide supplemental information and analysis.

Certain amounts in the 2004 and prior years’ financial statements have been reclassified to conform to the presentation used in 2005.

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

An amount equal to the tax benefit derived from this tax exempt income has been added back to the interest income and net interest income totals discussed in this Management’s Discussion and Analysis, resulting in tax equivalent adjustments of $682, $721 and $684 in 2005, 2004 and 2003, respectively. The analysis of net interest income tables included in this Annual Report on Form 10-K provide a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.

Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations. Other financial institutions commonly present net interest income on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use tax-equivalent net interest income to provide a better basis of comparison from institution to institution. The Company follows these practices.

Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2005, the Company had consolidated assets of $748 million and was one of the larger independent community banking institutions in Maine.

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

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

The Company’s key strategic focus is vigorous financial stewardship, deploying investor capital safely yet efficiently for the highest possible returns. The Company strives to provide unmatched service to its customers, while maintaining strong asset quality and a focus toward improving operating efficiencies. In managing its earning asset portfolios, the Company seeks to utilize funding and capital resources within well defined credit, investment, interest-rate and liquidity guidelines. In managing its balance sheet the Company seeks to preserve the sensitivity of net interest income to changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity under prevailing and expected conditions, and strives to maintain a balanced and appropriate mix of loans, investment securities, core deposits, brokered deposits and borrowed funds.

In its normal course of business, the Company faces many risks inherent with providing banking and financial services. Among the more significant risks managed by the Company are losses arising from loans not being repaid, commonly referred to as "credit risk," and losses of income arising from movements in interest rates, commonly referred to as "interest rate and market risk". The Company is also exposed to national and local economic conditions, downturns in the economy, or adverse changes in real estate markets, which could negatively impact its business, financial condition, results of operations or liquidity.

Management has numerous policies and control processes in place that provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions which, if were changed or altered, could impact the Company’s business, financial condition, results of operations or liquidity. The foregoing matters are more fully discussed in Part I, Item 1, "Risk Factors," and throughout this Annual Report on Form 10-K.

Summary Results of Operations

Net income for the year ended December 31, 2005 amounted to $6.4 million, or fully diluted earnings per share of $2.03, compared with $5.7 million or fully diluted earnings per share of $1.79 for the year ended December 31, 2004, representing increases of 12.1% and 13.6%, respectively.

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

• Non-interest Expense: Non-interest expense for the year ended December 31, 2005 amounted to $19.3 million, representing an increase of $354 thousand or 1.9% compared with 2004. The increase in 2005 non-interest expense was principally attributed to a $460 thousand or 4.9% increase in salaries and employee benefits, reflecting overall increases in the level of employee compensation including incentive compensation, as well as the impact and timing of certain staffing changes during 2005 and 2004. Bank credit card program expenses increased $148 thousand or 11.9% during 2005, but were offset by a $189 thousand increase in revenue from these programs. All other categories of non-interest expense posted year-over-year declines during 2005.

• Income Tax Expense: The effective income tax rate for 2005 was 28.7%, compared with 27.0% in 2004. The higher effective tax rate in 2005 was principally attributed to lower levels of non-taxable income generated from the Bank’s securities and loan portfolios.

Outlook

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

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

Reflecting trends in the national and regional economies, the Company’s market area generally witnessed mild economic growth during 2005. Heading into 2006, the economies and real estate markets in the Company’s primary market areas will continue to be significant determinants of the quality of the Company’s assets in future periods and, thus, its results of operations, liquidity, and financial condition. The Company believes future economic activity will in part depend on stronger employment, consumer confidence, personal consumption expenditures, business expenditures for new capital equipment, and a variety of geo-political considerations.

Other factors, which could affect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this Annual Report on Form 10-K and the Company’s discussion of certain "Risk Factors" set forth in Part I, Item 1A of this Report.

Management’s discussion and analysis of the Company’s financial condition are based on the Consolidated Financial Statements, which are prepared in accordance with U.S. generally accepted accounting principles. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates, including those related to the allowance for loan losses, on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements:

Allowance for Loan Losses: Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s Consolidated Financial Statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when a greater amount of provision for loan losses is necessary, the result is lower net income. Refer to Part II, Item 7, Allowance for Loan Losses and Provision, in this Annual Report on Form 10-K, for further discussion and analysis concerning the allowance.

Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2005 and 2004, 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 technique used by the Company to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors.  Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company's results of operations. Refer to Notes 1 and 8 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.

FINANCIAL CONDITION

Asset / Liability Management

In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets represented 95.2% and 94.7% of total average assets during 2005 and 2004, respectively.

The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit products offered within the markets served, as well as through the prudent use of borrowed and brokered funds.

Total tax-equivalent interest and dividend income during 2005 amounted to $37,877 compared with $32,643 in 2004, representing an increase of $5,234, or 16.0%. The 2005 increase in interest and dividend income was principally attributed to earning asset growth, combined with higher earning asset yields.

At December 31, 2005 the Company’s total assets stood at $747,945, representing an increase of $81,134, or 12.2%, compared with December 31, 2004. The increase in total assets was principally attributed to loan growth of $66,388 or 14.8%, followed by an increase in investment securities amounting to $6,963, or 4.0%.

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

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

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

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

Securities Held to Maturity: Securities held to maturity are debt securities for which the Bank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts. During the years ended December 31, 2005 and 2004, the Bank did not own any securities held to maturity.

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

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

Securities Maturity Distribution: The following table summarizes the maturity distribution of the amortized cost of the Bank’s investment securities and weighted average yields of such securities on a fully tax-equivalent basis as of December 31, 2005, based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers in most cases have the right to prepay.

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

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

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

At December 31, 2005 and 2004, management determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.

The following table summarizes temporarily impaired investment securities and their approximate fair values at December 31, 2005. All securities referenced are debt securities. At December 31, 2005, the Bank did not hold any common stock or equity securities in its investment securities portfolio.

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

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

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

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

Total Loans: At December 31, 2005, total loans amounted to $514,866, compared with $448,478 at December 31, 2004, representing an increase of $66,388, or 14.8%. Commercial loans contributed 74.7% to 2005 loan growth, consumer loans contributed 24.1%, followed by an increase of 1.2% in tax-exempt loans to municipalities. In general, loan origination activity has benefited from a still-favorable market interest rate environment, a relatively stable local economy, and initiatives designed to expand the Bank’s product offerings and attract new customers while continuing to leverage its existing customer base.

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

At December 31, 2005, total commercial loans amounted to $213,204, representing an increase of $49,612 or 30.3% compared with December 31, 2004. The 2005 growth in commercial loans represented an all time high. Bank management attributed this growth, in part, to a mature commercial lending team, a variety of new business development initiatives, and a relatively stable local economy.

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

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

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

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

All Other Loans: All other loans represented 0.9% of the loan portfolio at December 31, 2005, compared with 0.5% at December 31, 2004. The balance of all other loans at December 31, 2005 totaled $4,459 compared with $2,153 at December 31, 2004, representing an increase of $2,306, or 107.1%.

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

Loan Concentrations: Loan concentrations continued to reflect the Bank’s business region. At December 31, 2005, approximately $29,857 or 5.8% of the loan portfolio was represented by loans to the lodging industry, compared with $30,535 or $6.8% at December 31, 2004.

Mortgage Loan Servicing : The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2005, the unpaid balance of mortgage loans serviced for others totaled $7,907 compared with $9,935 at December 31, 2004, representing a decline of $2,028, or 20.4%. The decline in 2005 balances was attributed to serviced mortgage loan principal payments, as well as prepayments resulting from loan refinancing activity.

Pursuant to the Bank’s asset and liability management strategy, its need for interest earning assets, and its strong capital position, loans originated during 2005 were held in the Bank’s loan portfolio.

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

The Bank's loan loss experience showed an improvement during 2005 compared with 2004 experience. Net charge-offs during 2005 amounted to $182, representing a decline of $447 or 71.1%, compared with 2004. Expressed as a percentage of total average loans outstanding, 2005 net charge-offs amounted to 0.04%, compared with 0.15% in 2004.

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

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, the Company considers the allowance for loan losses at December 31, 2005 to be appropriate for the risks inherent in the loan portfolio, and resident in the local and national economy as of that date.

The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of retail deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member, and certificates of deposit obtained from the national market.

Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing lines from the FHLB and cash flows from the investment securities portfolio.

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

The 2005 increase in total deposits was principally attributed to certificates of deposit obtained from the national market ("brokered deposits"), which accounted for $36,686 or 77.3% of total 2005 deposit growth.

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

The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include  Small BusinessPlus, BusinessPlus, and Free Small Business , each designed to help business owners manage the varying financial aspects of their business. The Bank also offers its business customers a variety of cash management products including a Cash Management Sweep Account . Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Business demand deposits are also generated by way of the Bank’s Merchant Credit Card Processing Program .

During 2005, the Bank’s most successful NOW account product continued to be Gold Wave Checking , a relationship product designed for its age 50 and above customers.

In pricing time deposits, particularly non-relationship time deposits, the Bank will consider other sources of funding which may be offered at more attractive terms and prices, including borrowed funds and time deposits available in the national market.

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