FORM 10-K

Annual Report pursuant to Section 15(d) of the Securities and Exchange Act of 1934 for the fiscal year ended December 31, 2003. Commission File No. 0-13666

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

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

Title of Class: Common Stock --- Par Value: $2.00 per share
(Securities registered pursuant to Section 12(g) of the Act)

Documents incorporated by Reference:

1. Certain information required in response to Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K are incorporated by reference from the Bar Harbor Bankshares Proxy Statement for the 2004 annual meeting of stockholders, prepared pursuant to Regulation 14A of the General Rules and Regulations of the Commission and filed with the Commission on March 29, 2004.

Certain 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:

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.

PART I

ITEM 1. BUSINESS

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").

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. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. 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 all of the deposit account products it offers 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 to which the Bank offers a wide variety of products and services.

Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and loan needs of its retail customers. The Bank’s retail products and services include interest bearing checking accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, student loans, credit cards, installment loans, and overdraft protection. Overdraft protection is offered via a standby credit product. Secured and unsecured installment loans are provided for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rental, wire transfers, bank-by-mail services, check collection services, foreign currency exchange, money orders, Travelers Checks, and US Savings Bonds. The Bank also staffs a customer service center, providing customers with immediate responses to their questions and needs.

Electronic Banking Services: The Bank continues to offer free, on-line real-time Internet banking services, including free check image and electronic bill payment, through its dedicated website at www.bhbt.com. Additionally, the Bank offers TeleDirect, an interactive voice response system through which customers can check account balances and activity, as well as initiate money transfers between their accounts. Automated Teller Machines (ATMs) are located at each of the eleven branch locations, as well as two machines in non-Bank locations. These ATM’s access major networks throughout the United States, including Plus, NYCE, and major credit card companies. Additionally, the Bank is a member of Maine Cash Access, providing customers with surcharge-free access to over 150 ATM’s throughout the state of Maine. Visa debit cards are also offered, providing customers with free access to their deposit account balances at point of sale locations throughout most of the world.

Commercial Products and Services: The Bank serves the small business market throughout Down East and Mid Coast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate purchases, working capital, real estate development, 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 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 offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. During 2003 the Bank started offering Premier E-corp, an on-line real-time Internet banking service for businesses. This service allow business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and order both domestic and foreign wire transfers. Other commercial banking services include merchant credit card processing, night depository, and coin and currency handling.

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 Services"), 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. These companies were organized to provide a comprehensive array of, financial planning, investment management, and trust services to individuals, businesses, not-for-profit organizations, and municipalities of varying assets size.

BTI Restructuring Plan: In the fourth quarter of 2003 the Board of Directors approved a restructuring plan for BTI. Pursuant to this plan, the portfolio management professionals at Block were unified as one team with Trust Services. Block subsequently discontinued operations as an independent subsidiary of BTI. All services provided by Block to clients of Trust Services remained unchanged.

Also pursuant to the restructuring plan, during the first quarter of 2004 Trust Services will become a wholly owned subsidiary of the Bank, and discontinued operations as an independent subsidiary of BTI. All products and services provided by Trust Services will remain unchanged. In addition to investment management and financial planning, Trust Services offers revocable, irrevocable, charitable remainder and testamentary trust management, as well as estate planning and management services such as probate, estate settlement, and tax return preparation. The staff includes credentialed investment and trust professionals with extensive experience. At December 31, Trust Services had 737 accounts, with assets under management and held in custody amounting to $176 million and $33 million, respectively.

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. Pursuant to the BTI restructuring plan, Dirigo will discontinue its operations as a stand - -alone broker-dealer subsidiary of BTI. The Bank has retained Infinex Investments, Inc. ("Infinex") as a full service third party broker-dealer, which will be conducting business as Bar Harbor Financial Services ("BHFS"), starting in the second quarter of 2004. It is planned that Infinex will assume responsibility for all of the customer accounts of Dirigo. Infinex was formed by a group of member banks, and is currently the largest provider of third party investment and insurance services to banks and their customers in New England. Management believes that through Infinex / BHFS, the Company will be able to take advantage of the expertise, capabilities, and experience of a much larger broker-dealer in a more cost-effective manner. It is anticipated that this transaction will be completed in the second quarter of 2004.

One of the principal goals underlying the restructuring plan was to simplify and more closely align the Company’s brand names and operating model without diminishing functionality. The Company anticipates the changes will enable it to improve customer service, broaden its product offerings, and achieve increased operating efficiencies. The Company believes that by reducing the number of brand names under which it operates, a clearer message will be presented to its customers and the marketplace.

The Company expects the overall restructuring plan will be completed by the end of the second quarter of 2004. Once the restructuring plan is complete, the BTI corporate entity will be formally retired and dissolved.

Despite Maine’s strong natural resource heritage and the independent nature of its people, Maine’s economic vitality has become dependant on regional and national activity. As Maine’s economy has transitioned from an agricultural and industrial foundation towards a service and information-based economy, it has become increasingly dependant on the global market place. As in other states, Maine’s economy is being shaped and propelled by several factors including its population dynamics, the changing composition of the job base, globalization, fiscal devolution, technology, and the increases of women in the workforce.

Housing appreciated in Maine during 2003 as it did elsewhere in New England. House prices increased 7.9% on a year-over-year basis, representing a modest deceleration from the 10.7% rate posted over the two previous full years. Housing construction accelerated more in Maine than in other New England states.

The Northern New England economy continued to improve and strengthen throughout the year. Demand for residential real estate within the region is still strong primarily due to historical lows in long-term interest rates and limited inventory. Retailers in New England reported increases in sales in the fourth quarter compared with prior periods. The lumber and homebuilding sector continue to report strength in residential construction and home improvements. Along with the increase in overall economic activity, there were modest improvements in the labor markets. These improvements generally took the form of reduced layoffs or modestly increased hiring, although new hiring was still quite minimal.

The Company competes principally in Down East and Mid Coast Maine, which can generally be characterized as rural areas. The Company considers its primary market areas to be in Hancock, Knox, and Washington counties, each in the state of Maine. According to the most recent Census Bureau Report, the population of these three counties is 52,336, 40,147 and 33,573 respectively, representing a combined population of approximately 135,000. Their economies are based primarily on tourism, health care, fishing, 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, savings and loan institutions, and credit unions. Other competitors in the Company’s primary market area include financing affiliates of consumer durable goods manufacturers, insurance companies, brokerage firms, investment advisors, and other non-bank financial service providers.

As a bank holding company and state-chartered commercial bank, respectively, the Company and the Bank are subject to extensive regulation and supervision, including, in many cases, regulation that limits the type and scope of their activities. The non-bank financial service providers that compete with the Company and the Bank may not be subject to such extensive regulation, supervision, and tax burden. Competition from nationwide banks, as well as local institutions, continues to be aggressive.

The Bank has generally 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.

No material part of the Company’s business is dependent upon one, or a few customers, or upon a particular industry segment, the loss of which would have a material adverse impact on the operations of the Company.

MANAGEMENT AND EMPLOYEES

The Company has three principal officers: Joseph M. Murphy, President and Chief Executive Officer; Gerald Shencavitz, Senior Vice President, Chief Financial Officer and Treasurer; and Judith W. Fuller, Corporate Secretary. Marsha C. Sawyer serves as the Clerk of the Company.

Joseph M. Murphy also serves as Chief Executive Officer of the Bank. Dean S. Read serves as President of the Bank. Gerald Shencavitz also 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 a President of BTI, and Senior Vice Presidents in charge of retail banking, lending, credit administration / risk management, 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. 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 there under, 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, 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. 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.

Until June 30, 2003, Maine law previously provided that a corporation’s board of directors could 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 limitations were repealed effective as of July 1, 2003. Under current Maine corporation law, the directors of a corporation may make distributions to its shareholders if (subject to restriction by the articles of incorporation), (1) the corporation’s assets exceed its liabilities (plus any amounts payable to preferred classes of stock), and (2) the corporation is able to pay its debts as they become due in the usual course of business (i.e., it must not be insolvent). These new limitations generally apply to investor owned Maine financial institutions and financial institution holding companies.

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, 2003, 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, 2003.

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, 2003.

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.

Safety and Soundness Standards: The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), as amended, directs each federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk, asset growth, compensation, asset quality, earnings, and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing federal banking agencies to publish guidelines rather than regulations covering safety and soundness.

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.

USA Patriot Act: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, together with the implementing regulations of various federal regulatory agencies, have caused financial institutions, including the Bank and BTI, to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions. It also requires the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHC Act, or under the Bank Merger Act. Management believes the Company is in compliance with all of the requirements prescribed by the Patriot Act and all applicable final implementing regulations.

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.

Sarbanes-Oxley Act of 2002 – On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley act of 2002 ("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 S-O Act implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America and better protect investors from the type of corporate wrongdoings that occurred at Enron and WorldCom, among other companies. The S-O Act’s principal provisions, many of which have been interpreted through regulations released in 2003, provide for and include, among other things:

1. The creation on an independent, public company accounting oversight board which is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review. The new board is funded with mandatory fees paid by all public companies. The new legislation also improves the Financial Accounting Standards Board, giving it full financial independence from the accounting industry.
2. The strengthening of auditor independence from corporate management by, among other things, limiting the scope of consulting services that auditors can offer public company audit clients.
3. A heightened responsibility of public company directors and senior managers for the quality of the financial reporting and disclosures made by their companies. Among other things, the new legislation provides for a strong public company audit committee that will be directly responsible for the appointment, compensation, and oversight of the work performed by the public company auditors.
4. Provisions which will deter wrongdoing. CEO’s and CFO’s now have to certify that company financial statements fairly represent the company’s financial condition. If a misleading financial statement later results in a restatement, the CEO and CFO must forfeit and return to the company any bonus, stock or stock option compensation received in the twelve months following the misleading financial report. The new legislation also prohibits any company officer or director from attempting to mislead or coerce an auditor. Among other reforms, the new legislation empowers the SEC to bar certain persons from serving as officers or directors of a public company; prohibits insider trades during pension fund "blackout periods"; directs the SEC to adopt rules requiring attorneys to report securities law violations; and requires that civil penalties imposed by the SEC go into a disgorgement fund to benefit harmed investors.
5. Requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the Company;
6. A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on non-preferential terms and in compliance with other bank regulatory requirements;
7. The imposition of a broad range of new corporate disclosure requirements. Among other things, the new legislation requires public companies to report all off balance sheet transactions and conflicts, as well as to present any pro forma disclosures in a way that is not misleading and in accordance with requirements established by the SEC. The new legislation also accelerated the required reporting of insider transactions, which now generally must be reported by the end of the second business day following a covered transaction; requires that annual reports filed with the SEC include a statement by management asserting that they are responsible for creating and maintaining adequate internal controls and assessing the effectiveness of those controls; and requires companies to disclose whether or not they have adopted an ethics code for senior financial officers, and, if not, why not, and whether the audit committee includes at least one "financial expert", a term which has been defined by the SEC in accordance with specified requirements. The new legislation also requires the SEC, based on certain enumerated factors, to regularly and systematically review corporate filings.

The Company has taken steps to comply with and anticipates that it will incur additional expenses in continuing to comply with the provisions of the S-O Act and its underlying regulations. Management believes that such compliance efforts have strengthened the Company’s overall financial reporting and corporate governance structure and does not expect that such compliance has to date, or will in the future have a material impact on the Company’s results of operations or financial condition.

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

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 on Form 10-K.

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

ITEM 2. PROPERTIES

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

1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building, which houses its banking facilities and administrative offices, and an adjacent 35-car customer parking lot. The building was renovated in 1998.

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

3. An office is located at 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975 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 at 19 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 at the corner of Main and Bridge Streets, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994, to house an ATM that helps to better meet the needs at that location.

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

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

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

10. An office is located at 20 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 office is located at 245 Camden St. (Route 1) in Rockland, Maine. The property consists of a building that was purchased from Androscoggin Savings Bank in February 2004. The branch facility was built in 1977 and is adequate for the Bank’s needs at that location.

12. An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data centers. The building was constructed in 1996, with occupancy taking place in January of 1997. The Operations Center is currently adequate for the Company’s needs.

13. The Company owns and occupies a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The Bank, Trust Services, and Dirigo, occupy portions of this facility. The facility was renovated in 2001.

A parcel of land adjacent to the Blue Hill branch was purchased in 1981 but has not been developed. Other real estate includes two out parcels (one improved) contiguous to the Company’s 135 High Street, Ellsworth location.

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 7 of the Consolidated Financial Statements contained in this report on Form 10-K and are incorporated herein by reference.

As previously reported, Roselle M. Neely filed a complaint dated May 31, 2002 in the United States District Court for the District of Maine, naming the Company, the Bank, Trust Services, certain other subsidiaries, and certain existing or former management personnel as defendants. The complaint related to a trust established by Mrs. Neely, for which Trust Services had acted as trustee since May 2000 and for which the Bank formerly acted as trustee. Mrs. Neely alleged in part that Trust Services improperly disregarded her investment instructions and that the defendants engaged in excessive trading of securities for the trust. The plaintiff sought money damages and punitive damages, plus interest and costs.

The parties settled this matter in December 2003 without any finding or admission of liability. Pursuant to a joint stipulation, the Court dismissed the case on January 15, 2004. The settlement, the terms of which are confidential, involved payment of a stipulated sum on behalf of the defendants. The payment had no material effect on the Company’s financial condition or results of operations.

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 2003.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The common stock of the Company is traded on the American Stock Exchange ("AMEX") under the trading symbol BHB. Quarterly stock prices, and dividends paid during the last two years are summarized below. High and low stock prices are based on quotations provided by the American Stock Exchange. Per share data information has been adjusted to reflect the 100% stock dividend described previously in Part I, Item 1 of this report.

Dividends paid by the Company in 2003 and 2002:

As of March 19, 2004, the Company had 1,057 registered shareholders of record. The Company declared and distributed dividends totaling $0.76 per share during 2003, representing an earnings payout ration of 45.8%. In the first quarter of 2004 the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholders of record as of the close of business on February 20, 2004.

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

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

In March 2004, the Company announced a second stock repurchase plan, authorizing open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005.

Share Repurchase Program

Incentive Stock Option Plan

The following table provides information as of December 31, 2003 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.

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

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

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

(Dollars in thousands, except per share data):

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2003, 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 discussed below is presented on a fully taxable equivalent basis. Specifically, included in 2003, 2002 and 2001 net interest income was $1,602, $1,488 and $499 of tax-exempt interest income from certain tax-exempt investment securities and loans, which effectively resulted in tax-equivalent adjustments of $684, $613, and $193 thousand, respectively. The analysis of net interest income tables in 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 2002 and prior years' financial statements have been reclassified to conform with the presentation used in 2003.

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

Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2003 the Company had consolidated assets of $584 million and was one of the larger independent community banking institutions in Maine.

The Company’s principal asset is all of the capital stock of the Bank, incorporated in the late 19^th century. With eleven branch office locations, the Company is a diversified financial services provider, offering a full range of banking services and products to individuals, businesses, governments, and not-for-profit organizations throughout Down East and Mid Coast Maine. These include commercial banking, consumer banking, trust, investment management, and brokerage services.

Major Sources of Revenue

The principal source of the Company’s revenue is net interest income generated by the Bank, representing the difference or spread between interest and loan fee income from its earning assets and the interest expense paid on deposits and borrowed funds. The Bank’s earnings are supplemented with investment securities income while its source of funds is supplemented with borrowings from the Federal Home Loan Bank. The Company’s non-interest income is principally derived from service fees on deposit accounts generated by the Bank and fees received for trust, investment management and brokerage accounts generated from financial services.

The Company, as a diversified financial services provider, pursues a strategy of achieving long-term sustainable growth, profitability, and shareholder value, without sacrificing its soundness. The Company works toward achieving this goal by focusing on increasing the Bank’s loan and deposit market share in the coastal communities of Maine, either organically or by way of strategic acquisitions. The Company believes one of its more unique strengths is an understanding of the financial needs of coastal communities and the businesses vital to Maine’s coastal economy, namely: tourism, hospitality, retail establishments and restaurants, seasonal lodging and campgrounds, fishing, lobstering, boat building, and marine services. Consistent with this strategy, in the fourth quarter of 2003 the Company announced the Bank’s expansion into Knox County, Maine, by acquiring an existing branch banking office in the vibrant community of Rockland, with approximately $21 million in deposits and $12 million in loans.

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

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

Management has numerous policies and control processes in place which provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions, which if were changed or altered, could impact the Company’s financial condition and results of operations. The foregoing matters are more fully enumerated and discussed throughout this report on Form 10-K.

Summary Financial Condition

• Assets - Led by strong loan growth in both the consumer and commercial loan portfolios, total average assets amounted to $560,837 during 2003, representing an increase of $41,898, or 8.1%, compared with 2002. Total assets ended the year at $583,746, representing an increase of $29,928, or 5.4%, compared with December 31, 2002.
• Loans: Total average loans increased $41,989 or 12.9% during 2003, ending the year at $383,408. Loan growth was led by exceptionally strong consumer real estate lending. Origination activities benefited from a favorable market interest rate environment, a stable local economy, and initiatives designed to expand the Company’s product offerings and attract new customers, while continuing to leverage and serve its existing customer base. Consumer real estate loans, including home equity loans, averaged $229,615 during 2003, representing an increase of $34,100, or 17.1% compared with the prior year. The commercial loan portfolio also posted solid growth during 2003, ending the year at $127,901, or 10.0% higher than December 31, 2002.
• Investment Securities: The investment securities portfolio, including Federal Funds Sold and time deposits with other banks, continued to serve as a key source of revenue for the Company during 2003. This portfolio averaged $153,040 during 2003, representing a decline of $1,247 or 0.8% compared with the prior year. In light of the historically low interest rate environment, the Company chose not to increase the size of the portfolio during 2003, and directed cash flows and funding sources in support of strong loan growth.
• Deposits: The primary source of funding for the Company’s earning assets continued to be core customer deposits, gathered through a network of ten banking offices throughout Down East Maine. Total average deposits amounted to $322,414 during 2003, representing an increase of $18,939 or 6.2%, compared with 2002. While all categories of deposits posted year-over-year increases, the growth in 2003 was led by non-maturity transaction accounts, specifically, demand deposit, money market and NOW accounts.
• Borrowings: Borrowed funds principally consist of advances from the Federal Home Loan Bank, and to a lesser extent, securities sold under agreements to repurchase. Borrowings are principally utilized to support the Company’s investment securities portfolio and, to a lesser extent, fund loan growth. Average borrowed funds amounted to $176,810 during 2003, representing an increase of $19,660 or 12.5%. The increase in borrowed funds was entirely utilized to fund loan originations, as loan growth outpaced deposit growth throughout the year, while the investment portfolio declined.
• Shareholders' Equity: During 2003 the Company continued to exceed regulatory requirements for "well capitalized" institutions, which it considers vital in promoting depositor and investor confidence and promoting a solid foundation for future growth. At December 31, 2003, the Company’s Tier I Leverage, Tier I Risk Based and Total Risk Based Capital ratios stood at 8.9%, 13.4%, and 14.7%, compared with 5.0%, 6.0% and 10.0% for "well capitalized" financial institutions, respectively.

Net income for the year ended December 31, 2003, amounted to $5,207, or $1.63 per fully diluted share of capital stock, compared with $4,565 or $1.40 per fully diluted share in 2002, representing increases of 14.1% and 16.4% respectively.

• Net Interest Income: Net interest income continued to be the principal component of the Company’s income stream. The Company’s net interest income amounted to $19,504 in 2003, representing an increase of $215, or 1.1%, over the amount recorded in 2002. Driven by historically low interest rates, and consistent with industry-wide trends and the Company’s asset sensitive balance sheet, the Company’s net interest margin remained under pressure throughout the year, as yields on earning assets declined at a faster pace than deposit rates and other funding sources. The increase in net interest income was entirely attributed to average earning asset growth of $40,742 during 2003, as the net interest margin declined 27 basis points to 3.75%, compared with 2002. On a tax equivalent basis, the 2003 net interest margin amounted to 3.88%, compared with 4.15% during 2002.
• Provision for Loan Losses / Credit Risk: The Company expensed a provision for loan losses totaling $540 during 2003, representing a decrease of $560 or 50.9% compared with 2002, significantly contributing to the Company’s 2003 earnings growth. The decrease in the 2003 provision reflects an overall strengthening in credit quality, aided by a continuation of low net charge-off experience. At December 31, 2003 the Company’s total non-performing loans amounted to $1,494, or 0.39% of total loans, and the reserve for loan losses expressed as a percent of non-performing loans stood at 353%. Net charge-offs remained at low levels during 2003, totaling $237, or 0.06% of average loans outstanding, following $294 in 2002. At year-end, the allowance for loan losses amounted to 1.38% of total loans, compared with 1.42% at December 31, 2002.
• Non-interest Income: Total non-interest income amounted to $7,339 in 2003, compared with $6,701 earned in the prior year, representing an increase of $638, or 9.5%. The growth in non-interest income was principally attributed to an $807 increase in net gains on the sale of investment securities compared with the prior year, significantly contributing to the Company’s 2003 earnings growth. Service charges on deposit accounts amounted to $1,509, representing a modest increase of $26, or 1.8%, compared with 2002. Income from trust and other financial services amounted to $2,192, a decline of $69, or 3.1%, compared with 2002.
• Non-interest Expense: Total non-interest expense amounted to $19,204 in 2003, compared with $18,336 in 2002, representing an increase of $868, or 4.7%. Salaries and employee benefit expenses increased $599 or 6.5%, reflecting strategic adjustments to the Company’s workforce, some one-time employee severance payments, employee compensation increases, and higher subsidized health and retirement benefits. Non-interest expenses also included a variety of non-recurring charges recorded at BTI during 2003, principally relating to corporate restructuring activities, operating cost improvements, legal proceedings, and a write-down of goodwill at Dirigo.
• Performance Ratios: Return on average assets (ROA), and return on average equity (ROE) are two industry measures by which the financial performance of a banking institution is generally measured. During 2003 the Company’s ROA amounted to 0.93%, compared with 0.88% in 2002, representing an improvement of 5.7%. The Company’s ROE amounted to 9.66% in 2003, compared with 8.64% in the prior year, representing an improvement of 11.8%.

As more fully enumerated in Part I, Item 1 of this report, in the fourth quarter of 2003 the Company’s Board of Directors approved a re-structuring plan for BTI. While the corporate structure and legal entities will change, all financial services provided will essentially remain the same. As more fully discussed under Item 7, segment reporting, and Item 8, Note 8 of the Consolidated Financial Statements, Line of Business Reporting, the 2003 net loss at BTI amounted to $759 compared with a 2002 net loss of $1,133, representing a reduction in loss of $374, or 33.6%. The Company believes the changes outlined in the BTI re-structuring plan will improve operating efficiencies and future performance.

Other Matters and Events

• Legal Proceedings: During 2003 all previously reported legal proceedings were resolved, none of which had a material impact on Company earnings.

• Stock Repurchase Plan: As more fully enumerated under Item 7 in this report on Form 10-K, in the first quarter of 2004 the Company announced its second stock repurchase plan under which the Company may purchase up to 10% of its outstanding shares of common stock.

• Tangible Book Value: At December 31, 2003 the Company’s tangible book value amounted to $16.85 compared with $16.04 at December 31, 2002.

Reflecting trends in the National and Regional economies, the Company’s market area generally witnessed little economic growth during 2003, and interest rate decreases in 2002 and 2003 compressed the Company’s net interest margin. Though these developments have not had a materially adverse affect on the Company to date, the Company continues to monitor them closely as discussed throughout this report. The economies and real estate markets in the Company’s primary market areas will continue to be significant determinants of the quality of the Company’s assets in future periods and, thus, its results of operations, liquidity, and financial condition. The Company believes future economic activity will in part depend on stronger employment, consumer confidence, personal consumption expenditures, and business expenditures for new capital equipment. Other factors which could effect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this report on Form 10-K.

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.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:

Allowance for Loan Losses - Management believes the allowance for loan losses 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 provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated 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.

Income Taxes – The Company estimates its income taxes for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary timing differences, resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that the recovery is not likely a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2003, there was no valuation allowance for deferred tax assets.

Interest Income Recognition on Loans - Interest income on loans is included in income as earned based upon the unpaid principal balance of the loan. The Company’s policy is to discontinue the accrual of interest, and to reverse and uncollected interest recorded on loans, when scheduled payments become contractually past due in excess of 90 days or, in the judgment of management, the ultimate collectibility of principal or interest becomes doubtful.

Goodwill and Other Intangible Assets - Management utilizes numerous techniques to estimate the value of various intangible 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, 2003, the carrying value of goodwill amounted to $300. 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 intangible assets including mortgage-servicing rights. The use of different estimates or assumptions could produce different estimates of carrying value.

FINANCIAL CONDITION

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.

The Company’s objectives in managing its balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company is deliberate in its efforts to maintain adequate liquidity, under prevailing and forecasted economic conditions, and to maintain an efficient and appropriate mix of core deposits and borrowed funds.

Earning Assets

For the year ended December 31, 2003, the Company’s total average earning assets amounted to $520,741, compared with $479,999 in 2002, representing an increase of $40,742, or 8.5%. The increase in earning assets was entirely attributed to growth in the consumer and commercial loan portfolios, as the investment securities portfolio posted year-over-year decline.

The tax-equivalent yield on total average earning assets amounted to 6.00% in 2003, compared with 6.81% in the prior year, representing a decline of 81 basis points. Despite the earning asset growth during 2003, total interest earned amounted to $31,263, compared with $32,677 in the prior year, representing a decline of $1,414, or 4.3%.

Over the past three years there have been thirteen interest rate decreases resulting in a historical 550 basis point drop in the federal funds targeted rate during this period. Further, there have been significant parallel shifts in the U.S. Treasury yield curve. This trend was most profound during the quarter ended June 30, 2003, when the yield on the benchmark 10-year Treasury note dropped to as low as 3.07% and the federal funds targeted rate fell to 1.00%, in both cases representing forty-five year lows. This historically low interest rate environment 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 2003 decline in interest income.

Led by consumer and commercial loan growth, the Company’s total assets ended the year at $583,746, representing an increase of $29,928, or 5.4%, compared with December 31, 2003.

Construction and Development Loans: Total construction and development loans amounted to $12,639 at December 31, 2003 compared with $16,270 at December 31, 2002, representing a decrease of $3,631, or 22.3%. Construction and development loans are principally consumer in nature and represent 3.3% of the loan portfolio at December 31, 2003, compared with 4.6% at the prior year-end. The decrease in 2003 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.

Mortgage Loans: Mortgage loans, which include consumer real estate, home equity and commercial, accounted for 84.1% of total loans at year-end, compared with 81.9% at December 31, 2002. At December 31, 2003, total mortgage loans amounted to $322,579, compared with $287,990 at December 31, 2002, representing an increase of $34,589, or 12.0%. 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.

At December 31, 2003, real estate loans comprised 87.4% of the loan portfolio, compared with 86.6% at December 31, 2002. The continued strength in the local real estate markets, both residential and commercial, has led to record property values in the Bank’s market area. Recognizing the impact this trend may have on the loan portfolio, the Bank periodically reviews its underwriting standards to ensure that the quality of the loan portfolio is not jeopardized by unrealistic loan to value ratios or debt service levels. To date there has been no significant deterioration in the performance or risk characteristics in the real estate portfolio.

Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $11,719 at December 31, 2003 compared with $11,053 at December 31, 2002, representing an increase of $666 or 6.0%. This category of loans represented 3.1% of the portfolio at December 31, 2003, unchanged compared with the same date in 2002.

Commercial and Industrial Loans: Commercial and industrial loans represented 5.0% of the year-end loan portfolio, compared with 5.7% at December 31, 2002. Included in this category of loans are certain loans related to the blueberry industry. The Banks market area demographics generally limit the size and growth potential in this particular category of loans. At December 31, 2003 commercial and industrial loans totaled $19,167, compared with $20,010 at the same date in 2002, representing a decrease of $843, or 4.2%. The decrease in commercial and industrial loans was principally attributed to certain loan payoffs that were not replaced with new loan growth. Additionally, continued strengthening of credit standards has somewhat limited the amount of unsecured or partially secured loan growth in this category of the portfolio.

Loans to Individuals for Household, Family and Other Personal Expenditures: Personal consumer loans, including credit card loans and student loans, totaled $11,775 at December 31, 2003 compared with $12,818 at December 31, 2002, representing a decrease of $1,043, or 8.1%. This category of loans represented 3.1% of the portfolio compared with 3.6% at December 31, 2002. The decline in balances from 2002 was generally attributed to the application of stricter credit underwriting standards, pay-downs, and customer debt consolidation resulting from the continued declining rate environment. The Bank has not campaigned aggressively for these types of loans over the past couple of years, while competition from the financing affiliates of consumer durable goods manufacturers has been strong.

All Other Loans: All other loans represented 1.2% of the portfolio at December 31, 2003 compared with 0.8% in 2002. The balance of all other loans at December 31, 2003 totaled $4,554 compared with $2,684 at December 31, 2002, representing an increase of $1,870, or 69.7%. This category of loans principally includes loans to government municipalities and not-for-profit organizations. The Bank competed aggressively for government municipality loans during 2003, given their typically short maturities and interest rate risk characteristics. Municipality relationships also presented opportunities for providing a variety of other products and services.

Loan Interest Income Summary: During 2003 the total average tax-equivalent yield on loans amounted to 6.48%, compared with 7.30% in 2002, representing a decline of 82 basis points. Over the past three years there have been thirteen interest rate decreases in the Federal Funds targeted rate totaling 550 basis points, the last being 25 basis points during the second quarter of 2003. Consequently, the yields on short-term and variable rate loan products have declined precipitously during this period. The historically low interest rate environment, including a significant downward parallel shift in the U.S. Treasury yield curve during 2003, following a similar shift during 2002, caused a dramatic increase in both consumer and commercial loan refinancing activity. Consequently, a sizeable portion of the Bank’s higher yielding loans was replaced with new loans at prevailing low interest rates.

Total tax-equivalent interest income from loans amounted to $23,813 in 2003, compared with $23,788 in 2002, representing a decrease of $25, or 0.1%. The decrease in interest rates contributed $2,857 to this decline, while the increase in loan volume offset this amount by $2,882.

Mortgage Loan Servicing: As more fully disclosed in Note 6 to the financial statements, the Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2003, the unpaid balance of mortgage loans serviced for others totaled $12,334 compared with $28,569 at December 31, 2002, representing a decrease of 56.8%. The decline in 2003 balances was attributed to accelerated serviced mortgage loan prepayments, resulting from 2003 loan refinancing activity prompted by historically low interest rates. Pursuant to the Bank’s asset and liability management strategy, and in light of its strong capital position, this run-off was not replaced with additional sold loans. Rather, loans originated during 2003 were held in the Bank’s loan portfolio.

The following table shows fixed rate loans and leases reported by remaining maturity, and floating rate loans by next repricing date, for the years ending December 31, 2003, and 2002.

The investment securities portfolio, including Fed Funds Sold, money market funds and time deposits with other banks, represented 29.4% of the Company’s average interest earning assets during 2003 and generated 23.8% of total interest income, compared with 32.1% and 27.2% during 2002, respectively.

The investment securities portfolio primarily consists of mortgaged-backed securities, United States Government agency securities, obligations of state and political subdivisions, and corporate bonds. The overall objective of the Bank’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.

Total Investment Securities: At December 31, 2003 total investment securities amounted to $159,297 compared with $162,300 at December 31, 2002, representing a decrease of $3,003, or 1.9%. The 2003 average investment securities balance amounted to $153,040, compared with $154,287 in 2002, representing a decrease of $1,247, or 0.8%. Given the historically low interest rate environment, interest rate risk and strong loan demand, the Bank exercised restraint by not increasing the investment portfolio footings during 2003, despite its strong capital position and appetite for net interest income.

During 2003 the financial markets experienced significant interest rate volatility with the two, five and ten year U.S. Treasury’s reaching lows of 1.10%, 2.07%, and 3.13%, and highs of 2.12%, 3.63%, and 4.61%, respectively. This interest rate environment prompted accelerated pay-downs on mortgage-backed securities and the exercise of callable features on other securities. These securities were replaced pursuant to a strategy that focused on maintaining a portfolio with relatively short duration, thereby reducing exposure to sustained increases in interest rates. This was achieved through investments in securities with predictable cash flows and relatively short average lives; 10-year fully amortizing mortgage-backed securities and high coupon securities, for example. While sacrificing some yield in the near-term, the Bank’s objectives were to maintain a reasonable level of net interest income, manage longer-term interest rate and market risk, and position the portfolio for a rising interest rate environment and an improving economy.

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. Premiums paid on mortgaged backed securities are amortized proportionate to the three month trailing average Constant Payment Rate (CPR) of each securitized pool of mortgages.

Securities available for sale totaled $124,422 at December 31, 2003, compared with $128,826 at December 31, 2002, representing a decrease of $4,404, or 3.4%. Securities available for sale represented 78.1% of total investment securities at December 31, 2003, compared with 79.4% at December 31, 2002.

The balances of securities held for sale are stated net of fair value adjustments reflecting net unrealized gains of $692, and $3,284 at December 31, 2003 and 2002, respectively. The 2003 decline in unrealized gains was primarily due to higher interest rates at December 31, 2003 compared with the same date last year, sales of securities during 2003, and accelerated pay-downs of high yielding securities during 2003.

The following table summarizes the available for sale portfolio over the past three years:

Net Securities Gains: For the year ended December 31, 2003, net gains on the sale of securities amounted to $1,257 compared with $450 in 2002. As more fully discussed under the Results of Operations section of this report, changes in market interest rates during 2003 and 2002 presented attractive opportunities for repositioning a portion of the investment securities 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 Bank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts 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 $33,965 at December 31, 2003, compared with $31,545 at December 31, 2002, representing an increase of $2,420, or 7.7%. Securities held to maturity represented 21.3% of total investment securities as of December 31, 2003, compared with 19.4% at the same date in 2002. Securities held to maturity predominately represent tax-exempt, bank qualified, municipal bonds, the majority of which were purchased in the fourth quarter of 2001.

At December 31, 2003, investments held to maturity had net unrealized gains of $1,128, compared with $532 at December 31, 2002.

At December 31, 2003, investments held to maturity portfolio had a weighted average expected life of 11.1 years, and was generating a tax-equivalent yield of 7.10%.

The following table summarizes the held to maturity portfolio over the past three years:

Other Securities: Other securities consist of money market funds, overnight Federal Funds sold, and time deposits with other banks. At December 31, 2003, other securities totaled $910 compared with $1,929 at the same date in 2002, representing a decrease of $1,019, or 52.8%.

Credit Risk: The Bank evaluates and monitors the credit risk of its investments utilizing a variety of resources including external credit rating agencies. At December 31, 2003, 94.3% of the investment portfolio was rated "AAA", principally consisting of mortgage-backed securities. The Bank held no investment securities below a credit rating of "A" at that date.

Investment Securities Interest Income: During 2003 the total aggregate tax-equivalent yield on the investment securities portfolio amounted to 4.93%, compared with 5.91% at the same date in 2002. 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 during 2003 had relatively short average lives or were variable rate and consequently, lower yielding.

Total tax-equivalent interest income from investment securities amounted to $7,450 in 2003, compared with $8,889 in 2002, representing a decrease of $1,439, or 16.2%. The decrease in yields accounted for the decline, as year-over-year volume essentially remained the same.

Investment Securities Maturity Distribution: The following tables summarize the maturity distribution of the held to maturity and available for sale portfolios at December 31, 2003, based upon the final maturity date of the security. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers may have the right to prepay.

Investment Securities Concentrations: The Bank 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 Company’s shareholders’ equity.

Impaired Investments: The investment securities portfolio contains certain investments where amortized cost exceeds fair market value, which at December 31, 2003 amounted to $648. Unrealized losses that are considered other-than-temporary are recorded as an impairment expense on the Company’s Income Statement. In evaluating whether impairments are other-than-temporary, management considers a variety of factors including the nature of the investment(s), the cause of the impairment(s), the number of investment positions that are in an unrealized loss position, and the severity and duration of the impairment(s). Other data considered by management includes, for example, industry analyst reports, sector credit ratings, volatility of the security’s market price, and or any other information considered relevant.

At December 31, 2003, management determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.

The following table summarizes temporarily impaired investment securities and their approximate fair values at December 31, 2003. All securities referenced are debt securities. At December 31, 2003 the Bank did not hold any common stock or equity securities in its investment securities portfolio.

DECEMBER 31, 2003

At December 31, 2003 the total unrealized losses on temporarily impaired investments amounted to $648, representing, 1.4% of their carrying value. Unrealized losses on investment securities that have been in an unrealized loss position for more than twelve months amounted to $277 thousand, or 2.0% of their carrying value.

At December 31, 2003 the total number of investment positions in an unrealized loss position amounted to 72, represented by 57 mortgage backed-securities, 6 municipal bonds, 5 government agency bonds and 4 corporate bonds. At that same date there were no individual investment positions where the unrealized loss exceeded 3.6% of its carrying value.

Management believes the unrealized losses in the investment portfolio at December 31, 2003 were attributed to interest rates, and particularly resulted from the volatile movements in the U.S. Treasury curve over the past two years. Specifically, certain debt securities were purchased in an interest rate environment lower than where the U.S. Treasury yield curve stood on December 31, 2003. Subsequent to December 31, 2003 the yield curve posted a sharp decline, with the 10-year U.S. Treasury, for example, closing as low as 3.68%, or 57 basis points lower than where it stood at year-end.

Funding Sources

The Bank utilizes various traditional sources of funding to support its earning asset portfolios, principally customer deposits and borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member. Average total funding in 2003 amounted to $499,224, compared with $460,625 in 2002, representing an increase of $38,599, or 8.4%.

The most significant source of funding for earning assets continued to be customer deposits, gathered throughout the Bank’s branch office network. During 2003, total average deposits accounted for 61.9% of the funding required to support the Company’s earning asset portfolios, compared with 63.2% during 2002.

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

Total Deposits: At December 31, 2003 total deposits amounted to $339,080, compared with $322,015 at December 31, 2002, representing an increase of $17,065, or 5.3%. Total average deposits amounted to $322,414 during 2003, compared with $303,475 during 2002, representing an increase of $18,939 or 6.2%. While all categories of deposits posted year-over-year increases, the growth in 2003 was led by non-maturity transaction accounts; namely: demand deposit, money market and NOW accounts. Depositor preference during 2003 appeared to be that of greater liquidity, given general economic and market conditions.

The following table summarizes the components of the Bank’s total average deposit portfolio:

SUMMARY OF DEPOSIT PORTFOLIO

Demand Deposits: Non-interest bearing demand deposits, which are principally commercial in nature, ended 2003 at $49,880 compared with $46,001 at December 31, 2002, representing an increase of $3,879, or 8.4%, compared with December 31, 2002. Total average demand deposits amounted to $45,607 during 2003, representing an increase of $1,934, or 4.4%. Demand deposits represented 14.1% of total average deposits during 2003, compared with 14.4% in the prior year. The Bank offers its business customers with a variety of cash management products including a Cash Management Sweep Account. Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Demand deposits also include balances generated by way of the Bank’s Merchant Credit Card Processing Program.

NOW Accounts: The Bank offers NOW accounts to individuals and not-for-profit organizations. During 2003 the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its elderly and retired customers. At December 31, 2003, total NOW accounts stood at $60,287, representing an increase of $10,115 or 20.2% compared with the same date in 2002. During 2003 total average NOW accounts amounted to $54,221, compared with $48,739 during 2002, representing an increase of $5,482, or 11.2%.

Savings Accounts: Savings accounts, which also include money market accounts, represented 32.2% of total deposits at December 31, 2003, compared with 33.8% at the same date in 2002. The Bank offers statement savings accounts, and as a community oriented financial institution continues to offer the more traditional passbook savings accounts.

The Bank also offers a tiered-rate, competitively priced money market account, Investors Choice, providing businesses and individuals with short-term investment alternatives. During 2003, a period of historically low interest rates, customers appeared to demonstrate a thirst for the higher liquidity offered through the Investors Choice money market account, versus more traditional longer-term certificates of deposit.

At December 31, 2003, total savings accounts amounted to $109,309, compared with $108,982 at the same date in 2002, representing an increase of $327, or 0.3%. Total average savings accounts amounted to $104,275 during 2003, representing an increase of $8,761, or 9.2%, compared with 2002.

Time Deposits: Total time deposits ended 2003 at $119,604 compared with $116,860 at December 31, 2002, representing an increase of $2,744 or 2.4%. Total average time deposits amounted to $118,311 during 2003, representing an increase of $2,762, or 2.4%, compared with 2002. The relatively sluggish growth in this category of deposits was in part due to depositors’ apparent hesitation to invest in longer term fixed rate certificates at historically low yields. Additionally, in light of the extended low rate environment and its resulting pressure on the Bank’s net-interest margin, during 2003 the Bank did not compete for time deposits as aggressively as it has in the past, with respect to pricing. In pricing non-customer relationship time deposits, the Bank will consider other available sources of funding which may be offered at more attractive terms and prices, including borrowed and brokered funds.

Time deposits in denominations of $100 or greater totaled $18,784 at December 31, 2003 compared with $15,185 at December 31, 2002, representing an increase of $3,599, or 23.7%. Time deposits in denominations over $100 amounted to 5.5% of total deposits at December 31, 2003, compared with 4.7% at the same date in 2002. Included in time deposits of $100 or greater were brokered deposits. Total brokered deposits at December 31, 2003 amounted to $5,988, or 1.8% of total deposits, compared with $5,988 and 1.9% at December 31, 2002.

The following schedule summarizes the maturity distribution of time deposits of $100 or more:

Borrowed funds consist of securities sold under agreement to repurchase and borrowings from the FHLB. Advances from the FHLB are secured by stock in the FHLB, U.S. Treasury and Government Agency notes, mortgage-backed securities, and qualifying first mortgage loans.

The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. 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 Bank’s ability to select desired amounts, terms and maturities on a daily basis.

Total Borrowed Funds: At December 31, 2003, total borrowed funds amounted to $186,431, compared with $170,501 at December 31, 2002, representing an increase of $15,930, or 9.3%. Average 2003 borrowed funds balances amounted to $176,810, compared with $157,150 during 2002, representing an increase of $19,660, or 12.5%.

The increase in borrowed funds during 2003 was utilized to fund loan growth, as the Bank’s investment securities portfolio declined on a year-over-year basis.

As of December 31, 2003, total short-term borrowings, including repurchase agreements, amounted to $58,525, compared with $47,943 at December 31, 2002, or 31.4% and 28.1% of total borrowings, respectively. Conversely, long-term borrowings at December 31, 2003 totaled $127,906, compared with $122,558 at December 31, 2002, or 68.6% and 71.9% of total borrowings, 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 few years, the Bank has added longer term borrowings to the balance sheet in order to hedge the interest rate risk associated with the growth in longer-term, fixed rate, earning assets generated during periods of historically low interest rates. While this strategy has pressured net interest income in the short-term, management believes it positions the Company well for rising interest rates and an improving economy.

Interest Expense Summary: For the year ended December 31, 2003, total interest expense amounted to $11,075, compared with $12,775 in 2002, representing a decrease of $1,700, or 13.3%. The total cost of the Bank’s interest bearing liabilities amounted to 2.44% in 2003, compared with 3.06% in 2002, representing a decline of 62 basis points.

Capital Resources

Consistent with its long-term goal of operating a sound and profitable organization, the Company continues to be a "well capitalized" bank holding company according to regulatory standards. In 2003, 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.

Stock Repurchase Plans: In November 1999, the Company announced a stock repurchase plan. The Board of Directors of the Company at that time 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 subsequently authorized the continuance of that program through December 31, 2003. As of December 31, 2003, the Company had repurchased 339,814 shares of stock under the plan, at a total cost of $6,151 and an average price of $18.10 per share. The share repurchase program terminated on December 31, 2003. The Company records the repurchased shares as treasury stock.

In March 2004, the Company announced a second stock repurchase plan. The Board of Directors of the Company authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and will continue through December 31, 2005. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time-to-time, without prior notice. The Company’s believes that a stock repurchase plan is a prudent use of capital at this time. The Company anticipates that the stock repurchase plan will be immediately accretive to the return on average equity and earnings per share.

Cash Dividends: 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 continued at this rate through 2003. 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. In the first quarter of 2004 the Company increased its quarterly dividend by 5.3% to $0.20 per common share. The dividend was paid March 15, 2004 to shareholders of record as of the close of business on February 20, 2004.

The Company’s 2003 dividend payout ratio amounted to 45.8%, compared with 53.6% in 2002.

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

Net interest income is the principal component of the Company’s income stream and represents the difference or spread between interest and loan fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.

Total Net Interest Income: For the year ended December 31, 2003, net interest income on a fully tax- equivalent basis amounted to $20,188 compared with $19,902 and $17,870 in 2002 and 2001, representing increases of $286 and $2,032, or 1.4% and 11.4%, respectively.

The increase in 2003 net interest income was entirely attributed to a $40,742 increase in average earning assets during the year, as the 2003 net interest margin declined 27 basis points to 3.88%, compared with 2002. The net interest margin in 2001 amounted to 4.18%.

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 Bank’s earning asset yields and the cost of its interest bearing funds. During 2003, the yield on average earning assets amounted to 6.00%, compared with 6.81% and 7.86% in 2002 and 2001, representing declines of 81 and 105 basis points, respectively. Similarly, the cost of interest bearing liabilities amounted to 2.44% in 2003, compared with 3.06% and 4.29% in 2002 and 2001, representing declines of 62 and 123 basis points, respectively. Driven by record loan refinancing activity and accelerated cash flows from the investment portfolio during 2003, the decline in yields on earning assets outpaced the decline in the cost of interest bearing liabilities by 19 basis points.

During 2003 the Bank pursued a number of strategies to achieve a reasonably stable net interest margin in an extended low interest rate environment, while it continued to manage exposure to rising rates over the longer-term horizon. These strategies included a repositioning of a portion of the investment securities portfolio, utilization of interest rate swap agreements, and effective loan and deposit pricing strategies, orchestrated within well-established asset/liability management policies and the overall management of balance sheet interest rate risk.

During 2003 the Bank successfully marketed 10-year, fully amortizing 10-year mortgage products, including a bi-weekly payment 10-year mortgage product. While 10-year fully amortizing products generate lower yields than longer-term products, their cash flow characteristics diminished the degree of long-term interest rate risk, and better-positioned the Bank for rising interest rates in the future.

The Bank continued to utilize longer-term borrowings to fund a portion of earning asset growth during 2003 as it had during 2002. While the use of longer-term borrowing maturities naturally resulted in less net interest income, they more closely matched the maturities of fixed rate earning assets that were added to the Bank’s balance sheet, thereby preserving the sensitivity of net interest income in a rising rate environment.

The Bank has been deliberate in its efforts to hedge the interest rate risk associated with the addition of fixed rate earning assets to the balance sheet during a period of historically low interest rates. As more fully enumerated under the Market Risk section of this report, the Bank maintained its asset sensitive balance sheet during 2003, and believes it is positioned to benefit from rising rates and an improving economy.

The following tables summarize the Company’s average balance sheets and the components of net interest income, including a reconciliation of tax equivalent adjustments, for the years ended December 31, 2003, 2002 and 2001:

(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.

Interest Margin: The net interest margin, expressed on a tax-equivalent basis, is determined by dividing tax-equivalent net interest income by average interest-earning assets. The interest rate spread represents the difference between the average tax-equivalent yield earned on interest earning-assets and the average rate paid on interest bearing liabilities. The net interest margin is generally higher than the interest rate spread due to the additional income earned on those assets funded by non-interest bearing liabilities, primarily demand deposits and shareholders’ equity.

As previously discussed, the tax-equivalent net interest margin amounted to 3.88% in 2003, compared with 4.15% and 4.18% during 2002 and 2001, respectively.

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

As depicted on the foregoing table, the net interest margin peaked at 4.25% during the first quarter of 2002, and reached a two year low of 3.73% during the third quarter of 2003, representing a decline of 52 basis points. The margin decline in the third quarter of 2003 immediately followed the peak of loan re-financing activity, in part triggered by the sharp second quarter drop in the U.S. Treasury yield curve, at which time longer-term interest rates dipped to historical lows. Accelerated prepayments on fixed rate loans and investment securities, combined with accelerated amortization of premiums in the investment portfolio, drove this decline. During the fourth quarter of 2003, the net interest margin began to strengthen, and loan prepayments and investment securities cash flow began to slow. In line with the current interest rate environment, management anticipates the net interest margin will continue to stabilize into the first quarter of 2004.

Rate / Volume Analysis: As previously discussed, the Bank’s tax-equivalent net interest income increased $286 during 2003 compared with 2002. The volume of interest earning assets added to the balance sheet during 2003 contributed $1,764 to this increase, but was offset by $1,478 due to the impact of lower yields and interest rates.

(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, 2003, total non-interest income amounted to $7,339, compared with $6,701 and $7,984 in 2002 and 2001, representing an increase of $638, or 9.5%, and a decrease of $1,283, or 16.1%, respectively.

For the year ended December 31, 2003, total non-interest expense amounted to $19,204, compared with $18,336 and $18,489 in 2002 and 2001, representing an increase of $868, or 4.7%, and a decrease of $153, or 0.8%, respectively.

Segment Reporting: As more fully disclosed in Note 8 to the Consolidated Financial Statements, the Company manages and operates two lines of business: Community Banking and Financial Services. Community Banking includes lending and deposit gathering activities and related services to businesses and consumers. Financial Services, consists of trust services, investment portfolio management, and broker-dealer operations. The business lines are identified by the entities through which the products or services are delivered. The following discussion and analysis of other operating income and expenses focuses on each business segment separately: