FORM 10-K

            Maine                                                                                                                                 01-0393663
(State or other jurisdiction of                                                                                                          (I.R.S. Employer
incorporation or organization)                                                                                                          Identification No.)

PO Box 400
82 Main Street, Bar Harbor, ME                                                                                              04609-0400
(Address of principal executive offices)                                                                                          (Zip Code)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. ( )

Based on the closing price of the common stock of the registrant, the aggregate market value of the voting stock held by non-affiliates of the registrant, as of March 25, 2003 is:

Common Stock, $2.00 par value -- $59,734,451

The number of voting shares outstanding of each of the registrant’s classes of common stock, as of March 25, 2003 is:

Documents incorporated by Reference:
Proxy Statement for 2003 annual meeting pursuant to Regulation 14A of the General Rules and Regulations of the Commission and filed with the Commission on March 27, 2003, is incorporated by reference into Part III of this report.

INDEX

ITEM 1. BUSINESS

ORGANIZATION

Bar Harbor Bankshares ("the Company") was incorporated January 19, 1984. As of March 25, 2003, the Company’s securities consisted of one class of common stock ("the Common Stock"), par value of $2.00 per share, of which there were 3,163,901 shares outstanding held of record by approximately 1,056 shareholders. The Company has two primary, wholly-owned operating subsidiaries: Bar Harbor Banking and Trust Company ("the Bank"), a community bank which offers a wide range of deposit, loan, and related banking products; and BTI Financial Group ("BTI"), a financial services holding company offering brokerage, trust, private banking, financial planning and investment management services to individuals, businesses, not-for-profit organizations and municipalities.

The Company is a bank holding company ("BHC") registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent (the "Superintendent") of the Maine Bureau of Financial Institutions ("BFI").

BANK

The Bank has ten offices in coastal Maine, including its principal office located at 82 Main Street, Bar Harbor, as well as offices in Hancock County and adjacent Washington County, which represent the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Northeast Harbor, Southwest Harbor, Blue Hill, Deer Isle, Ellsworth, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Bank delivers its operations and technology services from its operations center located on Avery Lane in Ellsworth, Maine.

The Bank is a retail bank serving individual and corporate customers, retail establishments, seasonal lodging, campgrounds and restaurants. As a coastal bank, it serves the lobstering and fishing industries. It also serves Maine’s wild blueberry industry through its Washington County offices. It operates in a competitive market that includes other community banks, savings institutions, and credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area. The Bank continues to be one of the larger independent commercial banks in the state of Maine.

The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materially adverse effect on its business. The banking business in the Bank’s market area historically 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. Approximately 86% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on certificates of deposit, Individual Retirement Accounts (IRAS), NOW and money market accounts and does not anticipate any material loss of these deposits.

The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses for whom the Bank offers a wide variety of products and services. The Bank provides all of the traditional banking services offered by a commercial bank, including checking accounts, NOW accounts, savings accounts, money market accounts, time deposit accounts, individual retirement accounts, safe deposit boxes, bank by mail services, night depository services, and a variety of cash management services. The Bank also offers TeleDirect, an interactive voice response system through which customers can get product information, check balances and activity on their accounts as well as perform transfers between their accounts. The Bank continues to offer free, on-line real-time Internet banking services through its dedicated website at www.bhbt.com. Automated Teller Machines (ATMs) are located at each of the ten branch locations, in addition to three machines in non-Bank locations. These ATMs access major networks for use of the Bank’s cards throughout the United States, including the Plus and NYCE systems as well as the major credit card networks. Drive-up facilities are available at all banking offices.

The Bank offers a comprehensive array of lending services, including consumer credit in the form of installment loans, overdraft protection (stand-by-credit), VISA credit card accounts, student loans, residential mortgage loans, and home equity loans. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate purchases, working capital, and a broad range of other business purposes. Business loans are provided primarily to organizations and individuals in the tourist, hospitality, health care, blueberry, shipbuilding and fishing industries as well as to other small and mid-size businesses associated with small coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with correspondent banks, whereby the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances. The Bank’s policy for lending limits is up to 20% of its equity to any borrower provided that the loans are secured, and approved by the Directors’ Loan Committee. This committee is chaired by a member of the Bank’s Board of Directors, and includes non-voting members of the Bank’s management and Board of Directors.

BTI

BTI Financial Group is a wholly owned subsidiary of the Company. It was incorporated on August 16, 1999, as the holding company for three operating subsidiaries: Bar Harbor Trust Services ("Trust"), a Maine chartered trust company; Block Capital Management ("Block"), an SEC registered investment advisor; and Dirigo Investments, Inc. ("Dirigo"), a National Association of Securities Dealers (NASD) registered broker-dealer. BTI is able to provide a comprehensive array of private banking, financial planning, investment management and trust services to individuals, businesses, not-for-profit organizations, and municipalities of varying assets size, and to provide the highest level of customized personal service. The staff includes credentialed investment and trust professionals with extensive experience.

Trust offers revocable, irrevocable, charitable remainder and testamentary trust management, and estate planning and management services such as probate, estate settlement, and tax return preparation. At December 31, 2002, Trust had 837 accounts with assets totaling $202 million.

Block provides discretionary and non-discretionary investment advisory services for corporate and individual investment portfolios, personal trusts, individual and corporate retirement funds, and endowments for not-for-profit organizations. At December 31, 2002, Block had $181 million in assets under management, primarily for clients of Trust.

Dirigo principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. A third party processor provides Dirigo’s support and clearing services.

BTI’s central offices are located in a 22,000-square-foot office facility shared with the Bank, located at 135 High Street, Ellsworth, Maine. Dirigo, Trust, and Block maintain their principal offices at the Ellsworth facility and maintain additional offices at One Cumberland Place, Bangor, Maine. BTI also maintains offices in the headquarters building of the Bank in Bar Harbor, Maine.

The Company competes principally in Down East coastal Maine, which can generally be characterized as a rural area. The Company considers its primary market areas to be in Hancock and Washington counties, each in the state of Maine. The combined population of these two counties is approximately 86,000 people, and their economies are based primarily on tourism, health care, aquaculture, agriculture and small local businesses, but are also supported by a large contingent of retirees. Major competitors in these market areas include local independent banks, local branches of large regional bank affiliates, thrift institutions and credit unions. Other competitors in the Company’s primary market area include insurance companies and financing affiliates of consumer durable goods manufacturers.

The Bank has been able to compete effectively with other financial institutions by emphasizing quality customer service, making decisions at the local level, maintaining long-term customer relationships, building customer loyalty, and providing products and services designed to address the specific needs of customers. However, no assurance can be given that the Bank will continue to be able to compete effectively with other financial institutions in the future.

The financial services landscape has changed considerably over the past five years in the Company’s primary market area. The subsidiaries of BTI each separately face significant competition for their services from local banks, which now or in the future may offer a similar range of services, as well as from a number of brokerage firms and investment advisors with offices in the Company’s market area. In addition, many of these services are widely available to customers by telephone and over the Internet through firms located outside of the Company’s market area.

MANAGEMENT AND EMPLOYEES

The Company has four officers: Joseph M. Murphy, President and Chief Executive Officer; Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer; Dennis K. Miller, Senior Vice President, Audit and Risk Management; and Judith W. Fuller, Corporate Secretary. Marsha C. Sawyer serves as the Clerk of the Company.

Joseph M. Murphy also serves as President and Chief Executive Officer of BTI. Dean S. Read serves as President and Chief Executive Officer of the Bank. Gerald Shencavitz serves as Chief Financial Officer of each of the Company’s subsidiaries, as well as Chief Operating Officer and Treasurer of the Bank. Other senior operating positions in the Company include Presidents of the BTI subsidiaries, and Senior Vice Presidents in charge of retail banking, lending, credit administration and human resources.

The Company maintains comprehensive employee benefit programs, which provide health, dental, long-term and short-term disability and life insurance. All Company employees are eligible for participation in the Bar Harbor Bankshares 401(k) plan and Profit Sharing Plan. Certain officers and employees of the Company may also participate in the Company’s 2000 stock option plan and/or have Supplemental Executive Retirement Agreements with the Company or the Bank.

The Company’s management believes that employee relations are good, and there are no known disputes between management and employees.

SUPERVISION AND REGULATION

The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation, and examination by various federal and state bank regulatory agencies, including the FRB, the FDIC, and the Superintendent, as well as other governmental agencies in the states in which the Company and its subsidiaries operate. The supervision, regulation, and examination to which the Company and its subsidiaries are subject are intended primarily to protect depositors and other customers, or are aimed at carrying out broad public policy goals, and are not necessarily for the protection of the shareholders.

Some of the more significant statutory and regulatory provisions applicable to banks and BHCs, to which the Company and its subsidiaries are subject, are described more fully below, together with certain statutory and regulatory matters concerning the Company and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on the Company’s business and operations, as well as those of its subsidiaries. The Company’s shareholders generally are not subject to these statutory and regulatory provisions.

Bank Holding Company Act - As a registered BHC and a Maine financial institution holding company, the Company is subject to regulation under the BHC Act and Maine law and to examination and supervision by the FRB and the Superintendent, and is required to file reports with, and provide additional information requested by, the FRB and the Superintendent. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals that violate the BHC Act or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary of a BHC.

The BHC Act prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior FRB approval. Unless a BHC becomes a "financial holding company" (an "FHC") under the Gramm-Leach-Bliley Act ("GLBA"), as discussed below, the BHC Act also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or BHC and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. In addition, Maine law requires approval by the Superintendent prior to acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company that controls a Maine financial institution. The Superintendent also must approve acquisition by a Maine financial institution holding company of more than 5% of a financial institution or financial institution holding company domiciled outside of the State of Maine.

Federal Reserve Act - Various other laws and regulations, including Sections 23A and 23B of the Federal Reserve Act, as amended (the "FRA"), generally limit borrowings, extensions of credit, and certain other transactions between the Company and its non-bank subsidiaries and its affiliate insured depository institutions. Section 23A of the FRA also generally requires that an insured depository institution’s loans to non-bank affiliates be secured in appropriate amounts, and Section 23B of the FRA generally requires that transactions between an insured depository institution and its non-bank affiliates be on market terms. These laws and regulations also limit BHCs and their subsidiaries from engaging in certain tying arrangements in connection with any extension of credit, sale or lease of property, or furnishing of services.

Financial Services Modernization - The Gramm-Leach-Bliley Act ("GLBA"), which significantly altered banking laws in the United States, was signed into law in 1999. GLBA enabled combinations among banks, securities firms and insurance companies beginning in 2000. As a result of GLBA, many of the depression-era laws that restricted these affiliations and other activities that may be engaged in by banks and bank holding companies, were repealed. Under GLBA, bank holding companies are permitted to offer their customers virtually any type of service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking.

The Gramm-Leach-Bliley Act established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit BHCs that qualify and elect to be treated as financial holding companies to engage in a range of financial activities broader than would be permissible for traditional BHCs that have not elected to be treated as FHCs, such as the Company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

In order to elect to become an FHC, a BHC must meet certain tests and file an election form with the FRB. To qualify, all of a BHC’s subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the BHC’s banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act evaluation.

A BHC that elects to be treated as an FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. The Company has not elected to become an FHC.

Further, the GLBA permits state banks, to the extent permitted under state law, to engage in certain new activities that are permissible for subsidiaries of an FHC. The GLBA expressly preserves the ability of state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a state bank must be well-capitalized, and such banks would be subject to certain capital deduction, risk management, and affiliate transaction rules. Also, the FDIC’s final rules governing the establishment of financial subsidiaries adopt the position that a state nonmember bank may only conduct through a financial subsidiary activities that a national bank could only engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC’s standard activities rules. Moreover, to mirror the FRB’s actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 - - The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally authorizes BHCs to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers, and to a lesser extent, interstate banking.

Declaration of Dividends - According to its Policy Statement on Cash Dividends Not Fully Covered by Earnings (the "FRB Dividend Policy"), the FRB considers adequate capital to be critical to the health of individual banking organizations and to the safety and stability of the banking system. Of course, one of the major components of the capital adequacy of a bank or a BHC is the strength of its earnings and the extent to which its earnings are retained and added to capital, or paid to shareholders in the form of cash dividends. Accordingly, the FRB Dividend Policy suggests that banks and BHCs generally should not maintain their existing rate of cash dividends on common stock, unless the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The FRB Dividend Policy reiterates the FRB’s belief that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC’s ability to serve as a source of strength.

Under current Maine corporation law, a corporation’s board of directors may declare, and the corporation may pay, dividends on its outstanding shares in cash or other property, generally out of the corporation’s unreserved and unrestricted earned surplus, or out of the unreserved and unrestricted net earnings of the current fiscal year and the next proceeding fiscal year taken as a single period, except under certain circumstances, including when the corporation is insolvent, or when the payment of the dividend would render the corporation insolvent, or when the declaration would be contrary to the corporation’s charter. These same limitations generally apply to investor-owned, Maine financial institutions. Current Maine corporation law will be repealed and replaced effective July 1, 2003, with the new Maine Business Corporation Act (the "New Maine Act"). The New Maine Act adopts a simplified test for when the directors of a corporation may make distributions to its shareholders (subject to restriction by the articles of incorporation), namely, (1) the corporation’s assets must exceed its liabilities (plus any amounts payable to preferred classes of stock), and (2) the corporation must be able to pay its debts as they become due in the usual course of business (i.e., it must not be insolvent).

Federal bank regulatory agencies also have authority to prohibit banking institutions from paying dividends if those agencies determine that, based on the financial condition of the bank, such payment would constitute an unsafe or unsound practice.

Capital Adequacy Guidelines - The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a BHC and in analyzing applications to it under the BHC Act. The FRB’s capital adequacy guidelines apply on a consolidated basis to BHCs with consolidated assets of $150 million or more; thus, these guidelines apply to the Company.

The FRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items, with at least one-half of that amount consisting of Tier 1 or core capital and the remaining amount consisting of Tier 2 or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital), less goodwill and other non-qualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments; perpetual preferred stock, which is not eligible to be included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital (defined by reference to the risk-based capital guidelines) to total assets of 3.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0% leverage ratio requirement is the minimum for the strong BHCs without any supervisory, financial or operational weaknesses or deficiencies, or those that are not experiencing or anticipating significant growth. All other BHCs are required to maintain a minimum leverage ratio of at least 4.0%. BHCs with supervisory, financial, operational, or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels.

At December 31, 2002, and at the time of this report, the Company’s risk-based capital ratio and leverage ratio were well in excess of regulatory requirements, and its management expects these ratios to remain in excess of regulatory requirements. Separate, but substantially similar, capital requirements under FDIC regulations apply to the Company’s bank subsidiary, and these also exceed regulatory requirements at December 31, 2002.

Failure to meet capital guidelines could subject the Company or the Bank to a variety of FDIC corrective actions, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution’s assets, and (v) requiring prior approval of certain expansion proposals.

Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from Part II, Item 7, section entitled "Capital Resources" and from Part II, Item 8, Notes to Consolidated Financial Statements, Note 13, "Shareholders’ Equity," each in this annual report on Form 10-K for the year ended December 31, 2002.

Activities and Investments of Insured State-Chartered Banks - FDIC insured, state-chartered banks, such as the Bank, are also subject to similar restrictions on their business and activities. Section 24 of the Federal Deposit Insurance Act ("FDIA"), generally limits the activities as principal and equity investments of FDIC insured, state-chartered banks to those activities that are permissible to national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.

FDICIA also contains a variety of other provisions that may affect the Company’s and the Bank’s operations, including reporting requirements, regulatory guidelines for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch.

Community Reinvestment – Pursuant to the Community Reinvestment Act ("CRA") and similar provisions of Maine law, regulatory authorities review the performance of the Company and the Bank in meeting the credit needs of the communities served by the Bank. The applicable regulatory authorities consider compliance with this law in connection with the applications for, among other things, approval for branches, branch relocations, and acquisitions of banks and bank holding companies. The Bank received a "satisfactory" rating at its most recent CRA examination May 28, 2002.

Customer Information Security - The FDIC and other bank regulatory agencies have published final guidelines establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to, or use of such information that could result in substantial harm or inconvenience to any customer.

Privacy. The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.

USA Patriot Act. The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, broker-dealers, and other businesses involved in the transfer of money. The Patriot Act requires financial institutions to implement additional policies and procedures with respect to money laundering, suspicious activities, currency transaction reporting, and due diligence on customers. Implementation of the Patriot Act’s requirements will occur in stages, as rules regarding its provisions are finalized by government agencies.

Deposit Insurance. The FDIA does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. A resumption of assessments of deposit insurance premiums charged to well-capitalized institutions, such as the Company’s subsidiary bank, could have an effect on the Company’s net earnings. The Company cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.

Securities Regulation. The common stock of the Company is registered with the U. S. Securities and Exchange Commission ("SEC") under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Act"). Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Act. On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002 (the "S-O Act"), which generally establishes a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies and strengthen the independence of auditors. The following are some, but not all, of the S-O Act’s significant reforms:

• The creation of a strong and independent accounting oversight board to oversee the conduct of auditors of public companies and a strengthening of auditor independence requirements from corporate management by limiting the scope of non-audit services that auditors can provide to their clients;
• Requires steps to enhance the direct responsibility of senior corporate management for financial reporting and for the quality of financial disclosures made by public companies, including certification by the Chief Executive Officer and Chief Financial Officer of the reporting company of certain periodic reports filed with the SEC;
• Public company audit committees are responsible for the appointment, compensation, and oversight of the work of their auditors. The independence of the audit committee is enhanced by barring committee members from accepting consulting fees or being affiliated persons of the company other than in their capacities as board members;
• Requires prompt disclosures of insider transactions in company stock, which generally now must be reported by the second day following the transaction; and
• Imposes a range of new criminal penalties for fraud and other wrongful acts, as well as extending the period during which certain types of lawsuits can be brought against the Company or its insiders.

In addition, Dirigo and Block are subject to certain Broker Dealer and Investment Adviser Regulations promulgated by the NASD and SEC.

Other Proposals. Other legislative and regulatory proposals regarding changes in banking, and the regulation of banks and other financial institutions, are regularly considered by the executive branch of the federal government, Congress and various state governments, including Maine and state and federal regulatory authorities. It cannot be predicted what additional legislative and/or regulatory proposals, if any, will be considered in the future, whether any such proposals will be adopted or, if adopted, how any such proposals would affect the Company or the Bank.

STOCK DIVIDEND

On December 8, 1998, the Board of Directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data information included in the Form 10-K has been restated to reflect the 100% stock dividend.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The information set forth under this item is incorporated by cross-reference to the Company financial statements set forth below in Part II, Item 8 of this report.

AVAILABILITY OF INFORMATION

The Company makes available on its web site, which is located at http://www.bhbt.com, our annual report on Form 10-K on the date on which we electronically file the report with the Securities and Exchange Commission. Investors are encouraged to access this report and other information about our business and operations on our web site.

ITEM 2. PROPERTIES

The twelve 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 housing banking facilities and administrative offices and an adjacent 35-car customer parking lot. The building was renovated in 1998.

2. An office is located on 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 on Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975 that was added to, and renovated in 1989, to better meet the needs at that location.

4. An office is located on 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 needs at that location.

5. An office is located on Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that underwent renovations in 1989 to better meet the needs at that location.

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

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

10. An office is located on Main Street, Machias, Maine. This property consists of a building that was purchased from Key Bank of Maine in May 1990, and was renovated in 1995 to better meet the Bank’s needs at that location.

11. An Operations Center is located on Avery Lane, Ellsworth, Maine, that houses the Bank’s operations departments and data center. The building was constructed in 1996, with occupancy by the Bank taking place in January of 1997.

12. BTI owns and occupies a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. Trust, Block, Dirigo, and the Bank occupy portions of this facility. This facility was renovated in 2001.

A parcel of land adjacent to the Blue Hill branch was purchased in 1981 but has not been developed. The Company also leases office space for Dirigo, Block, and Trust at One Cumberland Place in Bangor, Maine, under terms and conditions considered by management to be favorable to the Company. Other real estates include two out parcels, one improved, contiguous to the BTI Ellsworth location.

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is set forth in Note 7 of the financial statements contained in this report and incorporated herein by reference.

The Bank also has twelve Automated Teller Machines (ATMs) located at ten of its branch offices, plus three off-site ATMs located on Mount Desert Island, the primary market area it serves.

ITEM 3. LEGAL PROCEEDINGS

The Company previously reported that Paul G. Ahern, a former director of the Company and executive officer and employee of BTI, resigned all of his positions in January 2002 and made monetary demands for severance benefits under his employment agreement. The disputes between the Company and Mr. Ahern regarding his demands under his employment agreement were submitted to a binding arbitration proceeding in order to determine the rights of the parties. On November 4, 2002, the Company received a written "Arbitration Award" in which the independent arbitrator in this matter found in favor of the Company and BTI with regard to all of Mr. Ahern’s claims under his employment agreement. This decision of the arbitrator with regard to Mr. Ahern’s employment agreement claims is binding and final.

The Company previously reported that Bonnie R. McFee, a former officer and employee of BTI and its subsidiary Dirigo Investments, resigned all of her positions in January 2002 and made demands for severance benefits under her employment agreement.

The disputes between the Company and Ms. McFee regarding her demands under her employment agreement have been submitted to a binding arbitration proceeding in order to determine the rights of the parties. The arbitration proceeding for Ms. McFee’s claims under her employment agreement was conducted during the week of March 3, 2003. A decision of the arbitrator has not been issued as of the date of this report.

As previously reported, Roselle M. Neely ("Neely") filed a complaint dated May 31, 2002 in the United States District Court for the District of Maine (the "Neely Complaint") naming the Company, the Bank, Trust, certain other subsidiaries, and certain existing or former management personnel as defendants. The complaint relates to a trust established by Mrs. Neely (the "Neely Trust"), for which Trust has acted as trustee since May 2000 and for which the Bank formerly acted as trustee. Mrs. Neely alleges in part that Trust improperly disregarded her investment instructions and that Block engaged in excessive trading for the purpose of generating commissions for its affiliated broker-dealer. She seeks an unspecified amount of money damages and punitive damages, plus interest and costs. The Company has filed an answer denying all allegations of wrongdoing, and is actively defending against these claims. The case presently is scheduled for trial in May 2003.

Mrs. Neely had also filed suit against the Bank and Trust in Probate Court in Penobscot County, Maine in January 2002, seeking to appoint a new corporate trustee for the Neely Trust. In that suit Mrs. Neely alleged that the Bank failed to give her notice of the appointment of Trust as a successor trustee. The suit was amended in June 2002 to add allegations similar to those contained in the Neely Complaint. The Bank and Trust denied all allegations of wrongdoing, and filed a counterclaim seeking declaratory judgment from the Probate Court. The suit was resolved with the consent of all parties in January 2003, through court approval of Trust’s resignation as trustee and pending appointment of a successor trustee.

The Company and its subsidiaries are also party to certain other ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management 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 2002.

High and low trades for each quarter of 2002 and 2001 are listed below per records from the American Stock Exchange, where the Company’s common stock is traded under the symbol BHB.

As of March 25, 2003, there were 1,056 registered holders of record of Bar Harbor Bankshares common stock.

The following table sets forth selected consolidated financial data for the last five years

(Dollars in thousands, except per share data):

The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the three-years ended December 31, 2002, should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this 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 information is discussed on a fully taxable equivalent basis. Specifically, included in 2002, 2001 and 2000 net interest income was $1,488, $499 and $327 of tax-exempt interest income from certain tax-exempt investment securities and loans, which effectively resulted in a reduction of the Company’s income tax expense of $613, $193, and $123 thousand, respectively. The tables included on pages 30-32 of this 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 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.

Certain amounts in the 2001 and prior years financial statements have been reclassified to conform with the presentation used in 2002.

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

FORWARD LOOKING STATEMENTS DISCLAIMER

The foregoing discussion, as well as certain other statements contained in this Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 (the "PSLRA"). 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. For these statements, the Company claims the protection of the safe harbor for forward-looking statements provided by the PSLRA.

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:

(i) the Company’s success is dependant to a significant extent upon general economic conditions in Maine and Maine’s ability to attract new business;

(ii) the Company’s earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Bank and thus the Bank’s results of operations may be adversely affected by increases or decreases in interest rates;

(iii) the banking business is highly competitive and the profitability of the Company depends on the Bank’s ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and nontraditional institutions such as credit unions and finance companies;

(iv) a significant portion of the Bank’s loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other more intangible factors which are considered in making commercial loans and, accordingly, the Company’s profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;

(v) a significant delay in or inability to execute strategic initiatives designed to grow revenues and or control expenses; and

(vi) significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company’s business environment or affect its operations.

The forward looking statements contained herein represent the Company’s judgment as of the date of this Form 10-K, 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 foregoing discussion, or elsewhere in this Form 10-K, except to the extent required by federal securities laws.

Management’s discussion and analysis of the Company’s financial condition are based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States. 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 and review of goodwill for impairment, 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.

Management believes the allowance for loan losses is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance for loan losses, which is established through a charge to the provision for loan losses, is based on management’s evaluation of the level of allowance required in relation to the probable loss exposure 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 properties to be foreclosed. The use of different estimates or assumptions could produce different provisions for loan losses. Refer to the discussion of Credit Risk in the Risk Management section and Note 1 of the Notes to Consolidated Financial Statements for a detailed description of management’s estimation process and methodology related to the reserve for loan losses.

Management utilizes numerous techniques to estimate the value of various assets held by the Company. Management utilized various methods to determine the appropriate carrying value of goodwill as required under Statement of Financial Accounting Standards ("SFAS") No. 142. At december 31, 2002, the carrying value of goodwill amounted to $375.  Goodwill from a purchase acquisition is subject to ongoing periodic impairment tests. Goodwill is evaluated for impairment using several standard valuation techniques including discounted cash flow analyses, as well as an estimation of the impact of business conditions. Different estimates or assumptions are also utilized to determine the appropriate carrying value of other assets including, but not limited to, premises and equipment, mortgage servicing rights, and overall collectibility of loans and receivables. The use of different estimates or assumptions could produce different estimates of carrying value.

SUMMARY FINANCIAL OVERVIEW

Net income for the year ended December 31, 2002, amounted to $4,565, or $1.40 per fully diluted share of capital stock, compared with $3,511 or $1.06 per fully diluted share in 2001, representing increases of 30% and 32% respectively.

Summary financial highlights for 2002 follow:

• Total average assets amounted to $518,939, representing an increase of $50,690, or 10.8%, compared with 2001. Total assets ended the year at $553,818, representing an increase of $66,615, or 13.7%, compared with December 31, 2001.
• Led by exceptionally strong consumer real estate lending, total loans at December 31, 2002 stood at $351,535, representing an increase of $53,565, or 18.0%, compared with the prior year.
• The Company’s investment securities portfolio averaged $162,099 in 2002, representing an increase of $10,417 or 6.9%, compared with 2001.
• Deposit growth continued in 2002 ending the year at $322,015, or 10.3% higher than December 31, 2001. Growth was experienced in both personal and non-personal deposit accounts.
• On a tax-equivalent basis, the Company’s net interest income before the provision for loan losses amounted to $20,190, representing an increase of $1,856, or 10.1%, over that recorded in 2001. The increase in net interest income was entirely attributed to $52,401 in average earning asset growth between periods, as the 2002 net interest margin declined seven basis points to 4.14% compared with 2001.
• The Company expensed a provision for loan losses totaling $1,100, representing a decrease of $900 or 45.0% compared with 2001. The Bank continued to maintain its non-performing loans at significantly lower levels than in prior years and attributes this improvement to the strengthening of its credit administration process and underwriting standards, aided by a healthy local economy. At December 31, 2002, total non-performing loans amounted to $1,174, or 0.33% of total loans, compared with $2,342, or 0.79% at the same date last year. Net charge offs to average outstanding loans during 2002 amounted to 0.09% compared with 0.73% in 2001. At December 31, 2002, the Company’s allowance for loan losses expressed as a percent of non-performing loans stood at 424%, compared with 178% at the same date last year.
• Non-interest income amounted to $6,413 compared with $7,520 earned in 2001, representing a decrease of $1,107, or 14.7%. These results were principally attributed to revenue declines at BTI Financial Group, as fees generated from the market value of assets under management and retail brokerage transactions were depressed by the sharp declines in the stock market, restrained investor confidence, and an overall slowdown in retail investor activities.
• BTI Financial Group recorded a net after tax loss of $1,133 for 2002, representing an increase in net loss of $118 thousand compared with 2001. During the first half of 2002 the Company completed implementation of SFAS No. 142, "Goodwill and Other Intangible Assets," which requires goodwill to be tested for impairment rather than amortized over a period of time. Included in BTI’s 2002 net loss is an after tax charge of $247 thousand recorded in the first quarter, resulting from a write down of goodwill related to the acquisition of Dirigo Investments, Inc. In response to depressed market conditions and declining revenues, BTI adjusted its capacity and reduced expenses in the most recent quarter to align income opportunities more closely.
• The Company’s total non-interest expense for the year amounted to $18,336, representing a decrease of $153 or 0.8%, compared with 2001. The decline in 2002 was aided by a one time restructuring charge of $618 recorded at BTI in the fourth quarter of 2001. Excluding the restructuring charge, non-interest expense in 2002 increased 2.6%, compared with the prior year.
• The Company’s capital grew 2.5% to $53,836 in 2002, after the payment of $2,445 in shareholder dividends and stock repurchases of $1,563. Total 2002 dividends per share were $0.76, the same amount paid in the prior year. The Company continues to exceed regulatory guidelines for "well capitalized" institutions. At December 31, 2002, Tier I leverage, Tier I risk based and total risk based capital ratios stood at 8.9%, 13.2%, and 14.5%, respectively.
• The return on total average shareholders’ equity amounted to 8.64% in 2002 compared with 6.72% in the prior year, representing an increase of 28.6%.

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 were 94.0%, 93.0%, and 93.1% of total average assets during 2002, 2001 and 2000, 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 funds.

For the year ended December 31, 2002, total average earning assets amounted to $487,811, compared with $435,410 and $438,878 in 2001 and 2000, representing an increase of 12.0% and a decrease of 0.8%, respectively. The yield on total average earning assets amounted to 6.76% in 2002, compared with 7.83% and 8.08% in 2001 and 2000, representing declines of 107 and 25 basis points respectively. Total 2002 interest on earning assets amounted to $32,965, compared with $34,085 and $35,456 in 2001 and 2000, representing declines of $1,120 and $1,371, or 3.3% and 3.9%, respectively.

Over the past two years there have been twelve interest rate decreases resulting in a historical 525 basis point drop in the federal funds targeted rate over this period. Further, during 2002 there was a significant parallel shift in the yield curve, with the 2, 5, 10 and 30-year Treasury Bonds declining 160, 173, 134 and 78 basis points, respectively. The historically low interest rate environment has caused sharp yield declines on the Company’s variable rate earning assets, and prepayment speeds on fixed rate earning assets to increase dramatically. These were the principal factors underlying the 2002 decline in earning asset yields and total interest income on the Company’s total earning assets.

Total Loans: At December 31, 2002 total loans amounted to $351,535, compared with $297,970 and $271,381 at December 31, 2001 and 2000, representing increases of $53,565 and $26,589, or 18.0% and 9.8% respectively. The 2002 increase in total loans over 2001 was principally attributed to consumer real estate loans, which grew $35,909 or 24.0%, and ended the year at $185,468. Home equity loans were the second largest contributor to 2002 loan growth, posting an increase of $13,001 or 61.2% over the December 31, 2001 total of $21,238.

Construction and Development Loans: Total construction and development loans amounted to $16,270 at December 31, 2002 compared with $20,348 at December 31, 2001, representing a decrease of $4,078, or 20.0%. Construction and development loans are principally consumer in nature and represent 4.6% of the loan portfolio at December 31, 2002, compared with 6.8% at the prior year-end. The decrease in 2002 construction and development loans was generally attributable to timing, as the balances from the prior year migrated from construction status to completed homes with permanent financing arrangements. The construction loan volume was not replaced.

Mortgage Loans: Mortgage loans, which include consumer and commercial, accounted for 81.9% of total loans at year-end, compared with 77.1% at December 31, 2001. At December 31, 2002, total mortgage loans amounted to $287,990, compared with $229,634 and $208,815 at December 31, 2001 and 2000, representing increases of $58,356 and $20,819, or 25.4% and 10.0% respectively. The increase in mortgage loans was principally attributed to strong consumer mortgage loan originations driven by historically low interest rates, accelerated refinancing activity, and a robust demand for real estate in the Company’s primary market area, Hancock County. Commercial mortgage loans increased $3,926 between periods to $71,184, or 5.8%.

Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $11,053 at December 31, 2002 compared with $7,149 at December 31, 2001, representing an increase of $3,904 or 54.6%. This category of loans represented 3.1% of the portfolio at December 31, 2002, compared with 2.4% at the prior year-end. The increase in 2002 balances was principally attributed to an increase in loans related to the blueberry industry in Washington County.

Commercial and Industrial Loans: Commercial and industrial loans represented 5.7% of the year-end loan portfolio, compared with 7.4% and 8.7% at December 31, 2001 and 2000 respectively. At December 31, 2002 commercial and industrial loans totaled $20,010, compared with $22,158 at the prior year-end, representing a decrease of $2,148, or 9.7%. The decrease in commercial and industrial loans was principally attributed to certain loan payoffs that were not replaced with new loan growth. A continued tightening of credit standards generally reduced the amount of unsecured or partially secured loans in this category of the portfolio.

All Other Loans: All other loans represented 0.8% of the portfolio at December 31, 2002 compared with 1.2% at the prior year-end. The balance of all other loans at December 31, 2002 totaled $2,684 compared with $3,699 at December 31, 2001, representing a decrease of $1,015, or 27.4%. This category of loans principally include loans to government municipalities and not for profit organizations.

Loan Interest Income Summary: During 2002 the total average yield on loans amounted to 7.30%, compared with 8.58% and 8.85% in 2001 and 2000, representing declines of 128 and 27 basis points, respectively. Over the past two years there have been twelve interest rate decreases in the Federal Funds targeted rate totaling 525 basis points. Consequently, the yields on short-term and variable rate loan products have declined precipitously during this period. Furthermore, during 2002 a significant parallel shift in the yield curve occurred with the five, ten and thirty year Treasury Bonds declining to 2.73%, 3.81% and 4.78% at year-end, respectively. The historically low interest rate environment caused a dramatic increase in both consumer and commercial loan refinancing activity. Consequently, a large portion of the Company’s higher yielding loans were replaced with loans at prevailing low interest rates.

Total interest income from loans amounted to $23,788 in 2002, compared with $24,355 in 2001, representing a decrease of $567, or 2.3%. The decrease in interest rates contributed $7,334 to this decline, while the increase in loan volume offset this amount by $6,767.

Mortgage Loan Servicing: As more fully disclosed in Note 6 to the financial statements, the Company from time to time will sell mortgage loans to other institutions and investors. The sale of loans allows the Company 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, 2002, the unpaid balance of mortgage loans serviced for others totaled $18,306 compared with $45,800 and $52,800 at December 31, 2001 and 2000, representing decreases of 60.0% and 13.2%, respectively. The decline in 2002 balances was attributed to accelerated serviced mortgage loan prepayments, resulting from 2002 loan refinancing activity prompted by historically low interest rates. Pursuant to the Company’s asset and liability management strategy, this run-off was not replaced with additional sold loans.

INVESTMENT SECURITIES

The investment securities portfolio, including Fed Funds Sold, money market funds and time deposits with other banks, represented 33.2% of the Company’s average interest earning assets during 2002 and generated 27.8% of total interest income.

The investment securities portfolio primarily consists of United States Government agency securities, obligations of state and political subdivisions, corporate bonds, and mortgage backed securities. The overall objective of the Company’s investment strategy for this portfolio is to maintain an appropriate level of liquidity, diversify earning assets, manage interest rate risk, and generate acceptable levels of net interest income. The investment securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.

On January 1, 2001, the Company, as allowed under Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," repositioned a significant part of the investment portfolio from held to maturity to available for sale.

Total Investment Securities: At December 31, 2002 total investment securities amounted to $162,300 compared with $142,073 and $154,464 at December 31, 2001 and 2000, representing an increase of $20,227 and a decrease of $12,391, or 14.2% and 8.0%, respectively. The 2002 average investment securities balance amounted to $162,099, compared with $151,682 in 2001, representing an increase of $10,417, or 6.9%.

The 2002 interest rate environment prompted accelerated pay-downs on mortgage-backed securities and the exercise of callable features on other securities, the resulting portfolio run-off from which was more than replaced. During 2002 the Company principally invested in securities with relatively short duration and average lives, and securities with variable rate features. While sacrificing some yield in the near term, the Company’s objective was to maintain a reasonable level of net interest income, manage longer-term interest rate risk and market risk, and position the portfolio for a rising rate environment in the near future.

Securities Available for Sale: The securities available for sale portfolio is managed on a total return basis with the objective of exceeding the return that would be experienced if investing solely in U.S. Treasury instruments. This category of investments is used for liquidity purposes while simultaneously producing earnings. The designation of "available for sale" is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments.

Investment securities classified as 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 statement of income. Premiums and discounts are recognized in interest income using the interest method over the estimated life of the security.

Securities available for sale totaled $128,826 at December 31, 2002, compared with $106,743 at December 31, 2001, representing an increase of $22,083, or 20.7%. Securities available for sale represented 79.4% of total investment securities at December 31, 2002, compared with 75.1% at December 31, 2001. The December 31, 2002 and 2001 balances are stated net of fair value adjustments reflecting net unrealized gains of $3,284, and $2,587, respectively.

Net Securities Gains: For the year ended December 31, 2002, net gains on the sale of securities amounted to $450 compared with none in 2001 and 2000. The majority of 2002 sales were corporate securities amounting to $12,024. Changes in market interest rates during 2002 presented attractive opportunities for repositioning a relatively small portion of the portfolio, while maintaining an informed and reasonable level of balance sheet interest rate risk.

Securities Held to Maturity: The securities held to maturity portfolio is managed for yield and earnings generation, liquidity through cash flow, and interest rate risk characteristics within the framework of the entire balance sheet.

Investment securities held to maturity are those where the Company 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 that are recognized in interest income using the interest method. Premiums are amortized to the earliest call date, while discounts are accreted to maturity.

Securities held to maturity totaled $31,545 at December 31, 2002, compared with $26,866 at December 31, 2001 and $116,306 at December 31, 2000, representing an increase of $4,679, or 17.4% and $89,440, or 76.9%. Securities held to maturity represented 19.4% of total investment securities as of December 31, 2002, compared with 18.9% and 75.2% at December 31, 2001 and 2000, respectively.

The decrease in securities held to maturity in 2001 compared with 2000 was attributed to a transfer of securities totaling $113,856 from held to maturity to available for sale in January 2001, offset by the addition of $25,109 of bank qualified municipal bond purchases in the fourth quarter of 2001 that were classified as held to maturity.

At December 31, 2002, investments held to maturity had net unrealized gains of $532, compared with unrealized losses of $1,923 and $61 at December 31, 2001 and 2000, respectively.

At December 31, 2002, investments held to maturity portfolio had a weighted average expected life of 9.7 years, a modified duration of 8.6 years, and was yielding 7.10%.

Other Securities: Other securities consist of money market funds, overnight Federal funds sold, time deposits with other banks and other non-marketable securities. The 2002 average balance of other securities amounted to $6,461, compared with $11,530 in 2001, representing a decrease of $5,069, or 44.0%. The 2002 decrease was principally attributed to the temporary investment of excess liquidity in 2001 resulting from seasonal deposit flows and accelerated investment portfolio run-off.

Investment Securities Interest Income: During 2002 the total yield on the investment securities portfolio amounted to 5.66%, compared with 6.41% and 6.83% in 2001 and 2000, representing declines of 75 and 42 basis points, respectively. The declining interest rate environment over the past two years has resulted in a significant increase in prepayment speeds on high coupon mortgage backed securities, an acceleration of premium amortization, and the exercise of call features on certain securities. Securities replaced or added to the investment securities portfolio in 2002 were primarily variable rate or had short average lives and, consequently, lower yields.

Total interest income from investment securities amounted to $9,177 in 2002, compared with $9,730 in 2001, and $11,464 in 2000, representing decreases of $553, or 5.7%, and $1,734, or 15.1%, respectively. The decrease in interest rates contributed $1,462 at the 2002 decline, while the increase in volume offset this amount by $909.

Available for sale securities are included based upon the final maturity date of the security.

The Company does not hold any securities for a single issuer, other than U. S. Government agencies, where the aggregate book value of the securities exceed 10% of the Bank’s shareholders’ equity.

FUNDING SOURCES

The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Average total funding in 2002 amounted to $460,625, compared with $409,959 in 2001, representing an increase of $50,666, or 12.4%.

Deposits: During 2002, total average deposits accounted for 65.9% of the funding required to support the Company’s earning asset portfolios. At December 31, 2002 total deposits amounted to $322,015, compared with $291,833 and $278,076 at December 31, 2001 and 2000, representing increases of $30,182 and $13,757, or 10.3% and 4.9%, respectively. Average 2002 deposit balances amounted to $303,475, compared with $279,923 in 2001, representing an increase of $23,552, or 8.4%.

The increase in 2002 deposits was led by money market and savings accounts, posting a year-over-year increase of $17,842 or 19.6%, and ending the year at $108,982. Depositor preference during 2002 appeared to be that of greater liquidity, given general economic and market conditions. NOW accounts also showed solid growth in 2002, ending the year at $50,172, or 9.8% higher than December 31, 2001.

Time deposits, excluding brokered funds, ended the year at $110,872 compared with $108,896 at December 31, 2001, representing an increase of $1,976 or 1.8%. The sluggish growth in this category of deposits was presumably due to depositors’ unwillingness to commit to longer term fixed rate investments at historically low rates.

Non-interest bearing demand deposits ended the year at $46,001, representing a decline of $111, or 0.2%, compared with December 31, 2001. Demand deposits represented 14.2% of total deposits at December 31, 2002, compared with 15.8% at the prior year-end.

Time deposits in denominations of $100 or greater totaled $15,185 at December 31, 2002 compared with $13,905 at the same date last year, representing an increase of $1,280 or 9.2%. The 2002 increase was attributed to the purchase of $5,988 in long-term brokered deposits at rates considered favorable to the Company. Total brokered deposits at December 31, 2002 amounted to $5,988, or 1.9% of total deposits, compared with none in the prior year.

Borrowed Funds: Borrowed funds consist of securities sold under agreement to repurchase and borrowings from the Federal Home Loan Bank (FHLB). Advances from the FHLB are secured by stock in the FHLB, U.S. Treasury and Agency notes, mortgage-backed securities, and qualifying first mortgage loans.

Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Company’s ability to select desired terms and maturities.

At December 31, 2002, total borrowed funds amounted to $170,501, compared with $136,059 and $131,318 at December 31, 2001 and 2000, representing increases of $34,442 and $4,741, or 25.3% and 3.6%, respectively. Average 2002 borrowed funds balances amounted to $157,150, compared with $130,036 in 2001, representing an increase of $27,114, or 20.8%.

The increase in borrowed funds during 2002 was principally utilized to fund loan growth and to a lesser extent growth in the Company’s investment securities portfolio.

As of December 31, 2002, total short-term borrowings, including repurchase agreements, amounted to $47,943, compared with $46,159 and $86,318 at December 31, 2001 and 2000 respectively. Conversely, long-term borrowings at December 31, 2002 totaled $122,558, compared with $89,900 and $45,000 at December 31, 2001 and 2000, representing increases of 36.3% and 99.8%, respectively.

Borrowing maturities are managed in concert with the Bank’s asset and liability management strategy, and are closely aligned with the ongoing management of balance sheet interest rate risk. Over the past two years, new borrowings and the replacement of scheduled maturities were predominately redirected to longer- term advances from the FHLB. This strategy was in response to opportunities presented by historically low interest rates and, more importantly, the addition and/or replacement of long-term, fixed rate assets on the balance sheet.

Interest Expense Summary: For the year ended December 31, 2002, total interest expense amounted to $12,775, compared with $15,751 in 2001, and $17,616 in 2000, representing decreases of $2,976, or 18.9%, and $1,865, or 10.5%, respectively. The total cost of the Company’s interest bearing liabilities amounted to 3.06% in 2002, compared with 4.29% and 4.70% during 2001 and 2000, representing declines of 123 and 41 basis points, respectively.

Declining interest rates over the past two years was the principal factor underlying the decreases in the Company’s cost of interest bearing funds and total interest expense. The decline in interest rates contributed $7,091 to the 2002 decrease in interest expense, while increased levels of interest-bearing liabilities offset this amount by $4,115.

SUMMARY OF DEPOSIT PORTFOLIO

CAPITAL RESOURCES

Consistent with its long-term goal of operating a sound and profitable organization, Bar Harbor Bankshares continues to be a "well capitalized" company according to regulatory standards. In 2002, the Company continued to maintain a strong capital position, which is vital in promoting depositor and investor confidence and providing a solid foundation for future growth. Historically, most of the Company’s capital requirements have been provided through retained earnings and this continues to be the case.

On December 8, 1998, the board of directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data included in the Form 10-K have been restated to reflect the 100% stock dividend.

In November 1999, Bar Harbor Bankshares announced a stock buyback plan. The Board of Directors of the Company has authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares. The Board of Directors has authorized the continuance of this program through December 31, 2003. As of December 31, 2002, the Company had repurchased 269,154 shares of stock under this plan, at a total cost of $4,561 and an average price of $16.94. The Company holds the repurchased shares as treasury stock.

The Company has historically paid regular quarterly cash dividends on its common stock. In the third quarter of 1999, the Company increased its quarterly dividend from $0.17 per share to $0.19 per share. Quarterly dividends have continued at this rate through 2002. Each quarter the board of directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook and other relevant factors.

The Company’s principal source of funds to pay cash dividends and support its commitments is from its banking subsidiary, Bar Harbor Banking and Trust Company. As discussed herein, under "Regulatory Matters" the Bank’s principal regulatory agency, the FDIC, currently limits Bank dividends to current earnings excluding securities gains while maintaining a Tier 1 leverage capital ratio of 8.0%, without prior approval. The Bank is in full compliance with these requirements and does not anticipate any impact on its ability to pay future dividends at historical levels.

During 2002, the Company’s shareholders’ equity grew $1,298, or 2.5%, after the payment of $2,445 in shareholder dividends, stock repurchases of $1,563, and an increase of $640, net of tax, in value through market appreciation of securities available for sale and derivative instruments.

As depicted in Note 13 to the financial statements, the Bank’s capital ratios exceed all regulatory requirements for a "well capitalized" bank.

Except as may be noted in "Supervision and Regulation" herein above, or "Regulatory Matters" herein below, there are no known trends, events or uncertainties nor any recommendations by any regulatory authority that are reasonably likely to have a material effect on the Company’s liquidity, capital resources, or operating results.

RESULTS OF OPERATIONS

For the year ended December 31, 2002, net interest income amounted to $20,190 compared with $18,334 and $17,840 in 2001 and 2000, representing increases of $1,856 and $494, or 10.1% and 2.8% respectively. The increase in 2002 net interest income was entirely attributed to a $52,401 increase in average earning assets between periods, as the 2002 net interest margin declined seven basis points to 4.14% compared with 2001. The net interest margin in 2000 amounted to 4.06%.

Of the $1,856 increase in 2002 net interest income, $3,561 was attributed to increased volume, offset by $1,705 due to changes in interest rates.

As more fully enumerated under the "earning assets" discussion in this report, the declining interest rate environment over the past two years has had a relatively significant impact on the Company’s earning asset yields and the cost of its interest bearing funds. During 2002, the yield on average earning assets amounted to 6.76%, compared with 7.83% and 8.08% in 2001 and 2000, representing declines of 107 and 25 basis points, respectively. Likewise, the cost of interest bearing liabilities amounted to 3.06% in 2002, compared with 4.29% and 4.70% in 2001 and 2000, representing declines of 123 and 41 basis points, respectively.

Over the past two years the cost of interest bearing liabilities has declined at a faster rate than the yields on interest earning assets, 16 basis points faster in 2002 and 16 basis points faster in 2001. These differentials helped support the relative stability of the Company’s net interest margin during this period, without increasing its exposure to rising rates over the longer term. The Company attributes this success to timely and effective pricing strategies, orchestrated within well-established asset/liability management policies and the overall management of balance sheet interest rate risk.

(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 and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

(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 and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

(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 and allowance for loan losses are recorded in other assets.
(3) For purposes of these computations, reported on a tax equivalent basis.

RATE/VOLUME ANALYSIS

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

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

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. Likewise, non-interest expense represents a significant category of expense for the Company, second only to interest expense.

For the year ended December 31, 2002, total non-interest income amounted to $6,413, compared with $7,520 and $7,066 in 2001 and 2000, representing a decrease of $1,107, or 14.7%, and an increase of $454, or 6.4%, respectively.

For the year ended December 31, 2002, total non-interest expense amounted to $18,336, compared with $18,489 and $16,615 in 2001 and 2000, representing a decrease of $153 and an increase of $1,874, or 0.8% and 11.3%, respectively.

Non-interest Income: Non-interest income from Community Banking represented 67.0% of the Company’s total 2002 non-interest income, compared with 56.0% and 81.6% in 2001 and 2000, respectively.

For the year ended December 31, 2002, the Bank’s total non-interest income amounted to $4,298, compared with $4,214 and $5,768 in 2001 and 2000, representing an increase of $84 and a decrease of $1,554, or 2.0% and 26.9%, respectively.

The increase in 2002 non-interest income was attributed to $450 in net gains on the sale of investment securities, compared with none during 2001. Changes in market interest rates during 2002 presented attractive opportunities to reposition a relatively small portion of the Bank’s investment securities portfolio. There is no assurance that the recording of securities gains will continue in future reporting periods at 2002 levels. It is important to note, however, that the available for sale investment securities portfolio is managed on a total return basis, in concert with well-structured asset/liability management policies. The Bank will continue to respond to changes in market interest rates, changes in securities pre-payment or extension risk, changes in the availability of and yields on alternative investments, and its needs for liquidity.

Offsetting the increase in 2002 income from securities gains was a $381, or 20.4%, decline in service charges on deposit accounts compared with 2001. In December of 2000 the Bank implemented various product and service fee enhancements and improved its management over fee waivers. These actions substantially improved non-interest income during the first half of 2001. However, as was generally anticipated, the initial impact on fee income was not fully sustained in the months following implementation, as many low balance accounts were either consolidated or closed, and certain customer habits, including overdraft activity, showed substantial change. Led by a decline in mortgage loan servicing fees, other fee income also declined in 2002, decreasing $213 from 2001 levels.

Non-interest Expense: Non-interest expense from Community Banking represented 77.6% of the Company’s total 2002 non-interest expense, compared with 72.2% and 76.1% in 2001 and 2000, respectively.

For the year ended December 31, 2002, the Bank’s total non-interest expense amounted to $14,221, compared with $13,344 and $12,652 in 2001 and 2000, representing increases of $877 and $692, or 6.6% and 5.5%, respectively.

The increase in 2002 non interest expense was principally attributed to employee compensation increases, increases in subsidized employee health insurance, deferred executive compensation, and certain additions to the Bank’s workforce. The year-over-year increase in salaries and employee benefits amounted to $818, or 12.6%. Charitable contributions during 2002 were also higher than 2001 levels, increasing $76 to a total of $183, or 2.15% of the Bank’ total pre-tax income.

Salaries and employee benefit expenses accounted for a substantial portion of the 2001 increase in non-interest expenses compared with 2000, and were principally attributed to staff additions in customer service, credit administration, and operational areas of the Bank. Also contributing to the 2001 increase in non-interest expense was the software depreciation resulting from the conversion of all core applications to a new and improved integrated platform during 2000 and the implementation of on-line, real-time internet banking applications in early 2001.

Non-interest Income: Non-interest income from Financial Services (BTI Financial Group) represented 36.7% of the Company’s total 2002 non-interest income, compared with 45.3% and 45.9% in 2001 and 2000, respectively.

For the year ended December 31, 2002, total non-interest income at BTI amounted to $2,352, compared with $3,407 and $3,243 in 2001 and 2000, representing a decrease of $1,055 and an increase of $164, or 31.0% and 5.1%, respectively. Included in 2001 non-interest income is an adjustment of $322 representing a full accrual of fee income. Excluding this adjustment, total 2001 non-interest income decreased $158 or 4.9% compared with 2000.

The decline in 2002 non-interest income was principally attributed to a significant decline in the market value of assets under management at Block Capital Management (Block) and Bar Harbor Trust Services (Trust). Fees charged to clients are derived principally from the market values of assets managed. At December 31, 2002, assets under management totaled $180,774, compared with $238,679 and $305,474 at December 31, 2001 and 2000, representing declines of $57,905 and $66,795, or 24.3% and 21.9%, respectively. The two-year decline in managed assets was principally attributed to the significant declines in the stock market over this same period. The decline in managed assets was also attributed to lost business, as investor confidence has been seriously eroded by depressed securities markets, corporate scandals, troubled economies both here and abroad, and overall geo-political tensions and uncertainties.

For the year ended December 31, 2002, total revenue at Block and Trust amounted to $1,822, compared with $2,673 in 2001, and $2,611 in 2000, representing a decrease of $851, or 31.8%, and an increase of $62 or 2.4%, respectively.

Restrained investor confidence, particularly in the retail brokerage sector, also impacted 2002 performance at Dirigo, BTI’s full service brokerage subsidiary. After posting a 2001 revenue increase of $157, or 26.0%, 2002 revenue at Dirigo investments declined. For the year ended December 31, 2002, total revenue at Dirigo amounted to $464, compared with $760 in 2001, representing a decrease of $296, or 38.9%. It is anticipated that the 2001 expansion of Dirigo’s market area via the opening of an office in Bangor, Maine, the strengthening of professional brokerage staff during 2002, and the ongoing expansion of its product offerings, will have a stabilizing impact on Dirigo’s future revenue.

Non-interest Expense: Non-interest expense from Financial Services represented 20.3% of the Company’s total 2002 non-interest expense, compared with 26.9% and 23.2% in 2001 and 2000, respectively.

For the year ended December 31, 2002, total non-interest expense at BTI amounted to $3,720, compared with $4,979 and $3,857 in 2001 and 2000, representing a decrease of $1,259 and an increase of $1,122, or 25.3% and 29.1%, respectively.

The decline in 2002 non-interest expense was attributed to a number of factors. Salaries and employee benefit expenses declined $343, or 16.9%, and were principally the result of management and staffing changes. Marketing expense declined $270 from 2001 levels, and was principally attributed to large scale marketing campaigns conducted in early 2001, shortly following the formation of BTI, and to a lesser extent, more effective utilization of marketing dollars during 2002. Expense reductions were achieved in a variety of other operating areas as BTI pursued austerity initiatives to more closely match expenses with revenues. Offsetting a portion of the 2002 expense reductions was a $210 increase in occupancy costs associated with the purchase and renovation of a new BTI headquarters complex and occupied in May 2001, and the expansion of office facilities in Bangor, Maine.

The increase in 2001 non-interest expense over 2000 was principally attributed to salaries and employee benefits expenses, start up marketing and legal expenses, and occupancy costs associated with the expansion of BTI.

In response to declining revenues and eroding profitability, BTI implemented a variety of expense reduction measures in the fourth quarter of 2002. It is anticipated these measures will further reduce BTI’s current year operating expenses and favorably impact its future profitability.

Accounting Change: During the first half of 2002 the Company completed its implementation of SFAS No. 142, "Goodwill and Other Intangible Assets," which requires goodwill to be tested for impairment rather than amortized over a period of time. The Company estimated the value of goodwill utilizing several standard valuation techniques, including discounted cash flows, as well as an estimation of the impact of current business conditions on the long-term value of the goodwill carried on the balance sheet. Management and the Board of Directors determined the impact of the overall deterioration of the stock and bond markets on investor activities within its target market area had negatively impacted the value of the Company’s goodwill balance related the acquisition of Dirigo. This resulted in an estimation of impairment of $247, net of tax. As depicted in Note 21 of the Company’s financial statements, the Company recorded an after tax charge of $247 in the first quarter of 2002.

Included in BTI’s 2001 non-interest expense is $73, representing the amortization of Dirigo goodwill. Pursuant to SFAS No. 142, no goodwill amortization expense was recorded in 2002.

The Company’s effective income tax rate in 2002 amounted to 26.6%, compared with 32.1% and 33.5% in 2001 and 2000, respectively. The decline in the effective income tax rate was principally attributed to increases in the Company’s tax-exempt interest income, primarily resulting from the addition of tax-exempt securities to the Company’s investment securities portfolio.

RISK MANAGEMENT

Credit Risk

Credit risk is managed through loan officer authorities, loan policies, the Bank’s Senior Loan Committee, oversight from the Bank’s Senior Credit Officer, the Directors 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 function that 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 is in doubt. Loans are generally placed on non-accrual status when principal and/or interest is 90 days overdue. Consumer loans are generally charged off when principal and/or interest payments are 120 days overdue.

The Company continued to maintain its non-performing loans at significantly lower levels than in prior years and attributes this improvement to a strengthening of its credit administration processes and underwriting standards, aided by a healthy local economy. During 2000, the Company established a centralized loan collection and managed asset department, and enhanced collection efforts for problem loans.

Over the past two years, the ratio of non-performing loans to total loans declined 266 basis points and, as of December 31, 2002, stood at their lowest level in six years. Non-performing loans declined $1,168 or 49.9% in 2002, following a decline of $5,771 or 71.1% in 2001. At December 31, 2002, total non-performing loans amounted to $1,174, or 0.33% of total loans, compared with $2,342 or 0.79% at the prior year-end, and $8,113 or 2.99% at December 31, 2000.

The 2001 reduction in non-performing loans was principally attributed to one relationship with non-accruing aggregate outstanding loans at December 31, 2000, of $3,100, of which $1,000 was charged off and the balance repaid upon asset liquidation, a $700 repayment by one particular customer, and other loans brought current.

At December 31, 2002, the Company’s allowance for loan losses expressed as a percent of non-performing loans was 424%, compared with 178% and 52% at December 31, 2001 and 2000, respectively.

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, present and expected conditions, and adequate to provide for probable losses that have already occurred. Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves to reflect current economic conditions, industry specific risks, and other observable data. Loan loss provisions are recorded, and the allowance is increased, when loss is identified and deemed likely.

Specific reserves 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 $986 as of December 31, 2002, compared with $2,191 and $6,907 as of December 31, 2001 and 2000, respectively. The related allowances for loan losses on these impaired loans was $120, $517 and $2,200 as of December 31, 2002, 2001 and 2000, respectively. The amount of interest income not recorded on impaired loans was $183, $182 and $220 as of December 31, 2002, 2001 and 2000, respectively.

No portion of the allowance is restricted to any loan or group of loans, and the entire allowance is available to absorb realized losses. The amount and timing of realized losses and future allowance allocations may vary from current estimates.

The Company’s loan charge off experience improved significantly during 2002. For the year ended December 31, 2002 net loans charged off amounted to $294, compared with $2,067 in 2001 and $1,009 in 2000, representing a decrease of $1,773 and an increase of $1,058, or 85.8% and 104.9%, respectively. The 2001 increase in loan charge-offs included one large credit exceeding $1,000.

For the year ended December 31, 2002, the Company provided $1,100 to the allowance for loan losses, compared with $2,000 in 2001, representing a decrease of $900, or 45%. The provision for loan losses ("provision") in 2002 was 0.34% of average loans, in 2001 was 0.70%, and in 2000 was $952, or 0.35% of average loans. The 2002 decrease in the provision for loan losses was attributed, in part, to one large credit exceeding $1,000 that was charged off in 2001, the repayment of certain previously classified loans, and an overall strengthening of credit quality in the loan portfolio. Portfolio characteristics and relatively stable economic conditions also contributed to the lower provision in 2002.

At December 31, 2002, the loan loss adequacy analysis resulted in a need for specific reserves of $3,555, general reserves of $850, impaired reserves of $120, and other reserves of $450. Specific reserves are determined by way of individual review of commercial loan relationships in excess of $250, combined with reserves calculated against total outstandings by category using the Company’s historical loss experience and other observable data.

General reserves account for the risk and probable loss inherent in certain pools of industry and geographic concentration within the loan portfolio. Loan concentrations continue to reflect the Company’s business region. The loan portfolio includes $34,943 of loans to the hospitality industry, or 9.9% of total loans, compared with $34,464, or 11.6%, at December 31, 2001. There were no major changes in loan concentrations during 2002. However, changes were made to the allowance calculation to incorporate loss estimates relating to emerging issues in the blueberry industry, to which the Company has extended credit, and principally centered in Washington County, Maine. Over the past two to three years, blueberry inventories have grown as increased supplies have exceeded demand both here and abroad and prices have softened. As of December 31, 2002, approximately $300 has been included in the allowance representing management’s estimate of inherent losses associated with this industry segment.

Management reviews impaired loans to insure such loans are transferred to non-accrual and written down when necessary. The review includes specific analysis of commercial relationships over $250. Smaller homogeneous loans are not individually reviewed, but are reserved collectively. Impaired reserves consider all consumer loans that are over 90 days past due and impaired commercial loans which are fully reserved within the specific reserves via individual review and specific allocation of potential loss for loans relationships over $250, and pool reserves for smaller impaired loans. The Bank had no troubled debt restructurings at December 31, 2002, and all of its impaired loans were considered collateral dependent and were adequately reserved. Total reserves against impaired loans were $120 at December 31, 2002.

Loan delinquency levels have remained at low levels during 2002. However, existing loan documentation and/or structural weaknesses for certain loans written in prior years continue to impede collection efforts in certain cases and have impacted probable losses. These weaknesses are historical in nature and do not necessarily reflect current loan underwriting and documentation standards. The extent of these problems in the entire loan portfolio is not entirely known; however, it is known that such problems exist and, accordingly, the allowance for loan losses incorporates this knowledge.

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, 2002 to be appropriate for the risks inherent in the loan portfolio, and resident in the local and national economy as of that date.

Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.

The responsibility for balance sheet risk management oversight is the function of the Bank’s Asset/Liability Committee ("ALCO"), chaired by the Chief Financial Officer and composed of various members of corporate senior management. ALCO meets regularly to review balance sheet structure, formulate strategy in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank’s net interest income. Interest rate risk arises naturally from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank’s balance sheet.

The Bank’s interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Board of Directors.

The Bank’s Asset Liability Management Policy, approved annually by the Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

Interest rate risk is monitored through the use of two complementary measures: static gap analysis ("gap") and earnings simulation modeling. While each measurement may have its limitations, taken together they form a reasonably comprehensive view of the magnitude of the Bank’s interest rate risk, the level of risk over time, and the quantification of exposure to changes in certain interest rate relationships.

The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The Bank also utilizes an outside consultant to perform rate shocks of its balance sheet, and to perform a variety of other analysis for the ALCO. The model simulates the behavior of interest income and expense of all on and off-balance sheet instruments under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

Interest rate gap analysis provides a static view of the maturity and re-pricing characteristics of the Bank’s on and off-balance sheet positions. Gap is defined as the difference between assets and liabilities re-pricing or maturing within specified periods. An asset-sensitive position, or "positive gap", indicates that there are more rate sensitive assets than rate-sensitive liabilities re-pricing or maturing within a specified time period, which would imply a favorable impact on net interest income during periods of rising interest rates. Conversely, a liability-sensitive position, or "negative gap", generally implies a favorable impact on net interest income during periods of falling interest rates. There are certain limitations inherent in static gap analysis. These limitations include the fact that it is a static measurement and it does not reflect the degrees to which interest earning assets and interest bearing liabilities may respond non-proportionally to changes in market interest rates. Although the ALCO reviews all assumptions used in the model in detail, assets and liabilities do not always have clear re-pricing dates, and re-pricing may occur earlier or later than assumed in the model.

The Bank’s static interest rate sensitivity gap is pictured below:

The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product specific assumptions for deposits accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions, are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different rate scenarios. Interest income and interest expense are then simulated under several rate conditions including:

• A flat interest rate scenario in which today’s prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption.
• A 100 and 200 basis point rise or decline in interest rates applied against a parallel shift in the yield curve over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
• Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes.
• An extension of the foregoing simulations to each of two, three, four and five-year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, the balance sheet has growth similar to the first twelve months modeled for each of the rate conditions, as well as re-pricing opportunities driven by maturities, cash flow, and adjustable rate products which will continue to change the balance sheet profile for each of the rate conditions.

Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken in order to maintain the balance sheet interest rate risk within established policy guidelines.

The following table summarizes the Bank’s net interest income sensitivity analysis as of December 31, 2002, over one and two year horizons. In light of the Federal Funds Rate of 1.25% on the date presented, the analysis incorporates a declining interest rate scenario of 100 basis points, compared with 200 basis points as shown at December 31, 2001. The table also summarizes net interest income sensitivity under a non-parallel shift in the yield curve, whereby short term interest rates rise 200 and 400 basis points, a scenario which management believes is more likely, given the current shape of the yield curve.

The following table summarizes the Banks net interest income sensitivity analysis as of December 31, 2001, utilizing a 200 basis point decline in interest rates and a 200 and 300 point increase in interest rates. This simulation assumed a parallel shift in the yield curve.

Managing the Bank’s interest rate risk sensitivity has been challenging during this period of historically low interest rates. During 2002, the yield curve showed a relatively sharp, downward, parallel shift. As was anticipated by management through use of the model, the Bank’s 2002 net interest income was moderately impacted and, were it not for the growth in earning assets, would have resulted in a year-over-year decline.

At December 31, 2002, the Bank continued to maintain a moderately asset sensitive balance sheet, positioning itself for an eventual rise in interest rates. Should interest rates remain flat for an extended period of time, and assuming no earning asset growth and a static balance sheet, management believes that net interest income will continue showing slight to moderate declines. Management expects short- term interest rates may be susceptible to further declines during 2003, with the balance of the yield curve holding relatively constant. Management believes that the current level of interest rate risk is acceptable.

The Bank engages an independent consultant to periodically review its interest rate risk position and the reasonableness of assumptions used, with periodic reports provided to the Bank’s Board of Directors. At December 31, 2002, there were no significant differences between the views of the independent consultant and Management regarding the Bank’s interest rate risk exposure.

The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayments on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment/refinancing levels deviating from those assumed, the impact of interest rate change caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals, product preference changes, and other such variables. The sensitivity analysis also does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.

Derivative instruments and hedging activities: As part of the Bank’s overall interest rate risk management strategy, management periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant adverse effect on net interest income, the net interest margin and cash flows. Derivative instruments that management periodically uses as part of its interest rate risk management strategy include interest rate swaps, caps and floors. A policy statement, approved by the Board of Directors of the Bank, governs use of these instruments.

At December 31, 2002, the Bank had one derivative instrument outstanding, an interest rate swap, compared with none at the prior year-end. The details are summarized as follows:

The $10 million interest rate swap hedges a defined pool of the Bank’s home equity loans yielding an interest rate of prime, which at December 31, 2002 was 4.25%. The bank is required to pay a counter- party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon an interest rate of 6.425% over the term of the agreement.

The credit risk associated with the interest rate swap agreement is the risk of non-performance by the counter-party to the agreement. However, management does not anticipate non-performance by the counter-party, and monitors risk through its asset/liability management policies and procedures.

The interest rate swap agreement, which qualifies as a cash flow hedge, has an original maturity of two years and as of December 31, 2002 had an unrealized gain of $272 thousand. In accordance with the Statement of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 137, and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", the unrealized gain is recorded in the statement of condition with the offset recorded in the statement of other comprehensive income. The use of the interest rate swap agreement increased interest income by $119 during 2002.

Liquidity Risk

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Company actively manages its liquidity position through target ratios established under its asset/liability management policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Company to employ strategies necessary to maintain adequate liquidity.

The Company uses a basic surplus/deficit model to measure its liquidity over 30- and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Company’s policy is to maintain its liquidity position at a minimum of 5% of total assets. At December 31, 2002, liquidity, as measured by the basic surplus/deficit model, was 9.0% for the 30-day horizon and 6.1% for the 90-day horizon. A portion of the Company’s deposit bases is seasonal in nature, with balances typically declining in the Winter months through late Spring, during which period the Company’s liquidity position tightens.

At December 31, 2002, the Company had $15,414 in unused lines of credit, and qualifying collateral availability to support a $28,000 increase in its line of credit with the Federal Home Loan Bank. The Company also had capacity to borrow funds on a serviced basis utilizing certain un-pledged securities.

The Company maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company.

Off-Balance Sheet Risks

Commitments to extend credit: The Company makes contractual commitments to extend credit and extends lines of credit, which are subject to the Company’s credit approval and monitoring procedures. As more fully described in Note 17 to the financial statements, at December 31, 2002 and 2001, commitments to extend credit in the form of loans, including unused lines of credit and commitments to originate loans, amounted to $71,142 and $67,595 respectively. Increases in the unused lines of credit on home equity loans, combined with commercial lines of credit at year-end, are responsible for the $3,547 increase in unused lines and commitments compared with 2001. In the opinion of management, there are no material commitments to extend credit that represent unusual risks.

Letters of credit and stand-by letters of credit: The Company guarantees the obligations or performance of customers by issuing letters of credit and standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing 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 origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. At December 31, 2002 and 2001, outstanding letters of credit and standby letters of credit totaled $2,800 and $5,059 respectively.

Counter-party risk: Pursuant to its asset/liability management policy, the Bank may enter into interest rate swap and floor agreements under which the Bank and the swap or floor counter-party would be obligated to exchange interest payments on notional principal amounts. For swap and floor transactions, the contract or notional amount does not represent exposure to credit loss. The Bank would be exposed to risk should the counter-party default in its responsibility to pay interest under the terms of the swap or floor agreement. The Bank controls counter-party risk through credit approvals, limits, and monitoring procedures. As more fully described herein under market risk, at December 31, 2002 the Company had one derivative instrument outstanding, an interest rate swap with a notional amount of $10 million, compared with none during 2001 and 2000. At December 31, 2002 and 2001, there were no interest rate caps or floor agreements in place.

REGULATORY MATTERS

As previously reported, the Bank in the third quarter of 2001, entered into an agreement ("Agreement") with its principal regulators, the FDIC and the BFI.

Pursuant to that Agreement, the Bank has increased its allowance for loan losses, developed a classified asset reduction plan for certain commercial relationships, revised its credit administration plan, implemented certain revisions in its asset appraisal procedures, established a minimum capital threshold of 8% or 3% above the regulatory minimum of 5% for "well capitalized" banks, improved certain account reconciliation procedures, addressed certain weaknesses in its information systems, improved its procedures to ensure its compliance with the "Bank Secrecy Act," and initiated a long-term strategic planning process which has recently been completed and will be refreshed at least annually. The Bank has also implemented a policy of paying dividends to its parent, the Company, only from current earnings, exclusive of gains on the sale of securities, without prior approval of its principal regulators.

The Bank is providing updates covering the status of the foregoing items to its principal regulators on a quarterly basis. In management’s judgment, the Bank is adequately addressing the matters set forth in the Agreement.

Recently Issued Accounting Standards

Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," requires that goodwill reflected on the Company’s balance sheet be no longer amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of the statement. The Company adopted SFAS No. 142 effective January 1, 2002. The Company determined that goodwill was impaired as of January 1, 2002, the date of adoption, and the impairment loss, net of taxes, was recognized as a cumulative effect of a change in accounting principle in the Company’s Consolidated Statement of Income.

SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" addresses financial accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires the recognition of certain costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan.

SFAS No. 147, "Acquisitions of Certain Financial Institutions" amends SFAS 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions" to exclude from its scope most acquisitions of financial institutions. Such transactions should be accounted for in accordance with SFAS No. 141, "Business Combinations". SFAS No 147 is effective on October 1, 2002.

SFAS No. 148 contains enhanced disclosure requirements for stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. Adoption of the Statement in 2002 had no impact on the Company’s consolidated financial condition and results of operations.

Statement of Position (SOP) 01-6, "Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others," was issued in December 2001. The SOP is effective for financial statements issued for fiscal years beginning after December 15, 2001. The SOP reconciles and conforms the accounting and financial reporting provisions established by various Audit and Accounting Industry Guides. Adoption of this Statement had no impact on the Company’s consolidated financial condition and results of operations.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Board of Directors
Bar Harbor Bankshares

We have audited the accompanying consolidated balance sheets of Bar Harbor Bankshares and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with U. S. generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ BERRY, DUNN, McNEIL & PARKER

Portland, Maine
February 14, 2003