Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES: (X)      NO: ( )

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).

YES: ( )      NO: (X)

Number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date:

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS

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

Note 1: Basis of Presentation

The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All inter-company transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform with current period presentation. The net income reported for the six-months ended June 30, 2004 is not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any other interim periods.

The consolidated balance sheet at December 31, 2003 has been derived from audited consolidated financial statements at that date. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements included in the Registrant's annual report on Form 10-K for the year ended December 31, 2003, and notes thereto.

Note 2: Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, income tax estimates, and interest income recognition on loans, and the valuation of intangible assets.

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 inherent risk of loss in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions, collateral values, 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 Allowance for Loan Losses and Provision in Part I, Item 2 of this report on Form 10-Q for a detailed description of management’s estimation process and methodology related to the reserve for loan losses.

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 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 June 30, 2004 and December 31, 2003, there was no valuation allowance for deferred tax assets, which are included in other assets and amounted to $1,908 and $700, respectively.

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 the 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.

In connection with acquisitions, the Company generally records as assets on its financial statements both goodwill and identifiable intangible assets such as core deposit intangibles. The Company evaluates whether the carrying value of its goodwill has become impaired, in which case the value is reduced through a charge to its earnings. Core deposit and other identifiable intangible assets are amortized to expense over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The valuation techniques used by the Company to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors. Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company’s results of operations.

Note 3: Goodwill and Other Intangible Assets

A summary of goodwill, by subsidiary, capitalized on the Company’s consolidated balance sheet follows:

During the first quarter of 2004, the Company acquired $2,858 in goodwill in connection with the acquisition of a branch in Rockland, Maine by its wholly owned subsidiary, Bar Harbor Bank & Trust (the "Bank").

The Company has a finite-lived intangible asset capitalized on its consolidated balance sheet in the form of a core deposit intangible asset related to the Bank’s acquisition of the Rockland branch. The core deposit intangible asset is being amortized over an estimated useful life of six years, and is included in other assets on the June 30, 2004 consolidated balance sheet. There was no such intangible asset at December 31, 2003.

A summary of the core deposit intangible asset follows as of June 30, 2004:

Amortization expense on the core deposit intangible asset is expected to total $34 for the remainder of 2004, $67 for each year 2005 thru 2009.

Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity, such as the Company’s dilutive stock options.

Note 5: Stock Based Compensation

The Company has a stock-based compensation plan that is described more fully in Notes 1 and 16 to the Consolidated Financial Statements in the Company’s 2003 Annual Report on Form 10-K. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based compensation cost has been reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the grant date.

Had compensation costs for the plan been determined based on the fair value of the options at the grant dates consistent with the method described in SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands except for per-share data):

The Company is expected to contribute $454 to the foregoing plans in 2004. As of June 30, 2004, the Company had contributed $234 to the plans.

Note 7: Commitments and Contingencies

The Company is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.

Exposure to credit loss in the event of nonperformance by the counter-party to the financial instrument for commitments to make loans, unused lines of credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. At June 30, 2004 and December 31, 2003, commitments to extend credit and unused lines of credit totaled $110,627 and $98,874, respectively. Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, these amounts do not necessarily represent future cash commitments. Collateral obtained upon funding of the commitment is determined on a case-by-case basis using management’s credit evaluation of the borrower.

The Company guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are frequently issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Typically, these standby letters of credit have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Standby letters of credit totaled $1,657 at June 30, 2004 and $5,050 at December 31, 2003. As of June 30, 2004, the fair value of the standby letters of credit was not material to the Company’s consolidated financial statements.

Note 8: Financial Derivative Instruments

At June 30, 2004 the Company had two outstanding derivative instruments with notional principal amounts totaling $20 million, both of which were interest rate swap agreements. The details are summarized as follows:

The Company is required to pay a counter-party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon interest rates of 6.04% and 6.25%, respectively over the term of each agreement.

Financial instruments are reviewed as part of the asset/liability management process and are factored into the Company’s overall interest rate risk position. The Company regularly reviews the credit quality of the counter-party from which the interest rate swap agreements have been purchased. The notional amounts of the agreements do not represent exposure to credit loss. The Company is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements.

These interest rate swap agreements were designated as cash flow hedges at December 31, 2003 and had total unrealized gains of $86. The fair value of these instruments, net of tax, was recorded as a component of accumulated other comprehensive income on the consolidated balance sheet. Changes in fair value were recorded as a component of other comprehensive income.

During the first quarter of 2004, these interest rate swap agreements were de-designated as cash flow hedges and, prospectively from the time of de-designation, changes in their fair value and current period net cash flows related to these agreements are recorded in the consolidated statement of income and included as part of noninterest income. The unrealized gain on these interest rate swap agreements at December 31, 2003 of $86 remained in other comprehensive income, net of tax, and is being accreted into interest income over the remaining terms of the respective swap agreements.

During the quarter ended June 30, 2004, the Company recorded a loss of $727 related to the unrealized depreciation of these interest rate swap agreements and $129 in income related to the net cash flows during the quarter resulting from the agreements. As of June 30, 2004, net unrealized loss on the agreements stood at $399. For the six months ended June 30, 2004, the income related to the net cash flows amounted to $296.

As more fully described in Part I, Item 1 of the Company’s Annual Report on Form 10-K, and Part I, Item 2, Other Events of the Company’s March 31, 2004 Form 10-Q, in December 2003 the Company’s Board of Directors approved a restructuring plan for its wholly owned subsidiary, BTI Financial Group ("BTI"). The restructuring plan simplified and aligned BTI’s brand names and operating model with the Bank. During the first quarter of 2004 the principal elements of the plan were completed, with the results of all operations now viewed as a single strategic unit by the chief operating decision maker.

The Company has determined that its operations are solely in the community banking industry and include the traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. Accordingly, segment information is not required with respect to investment management, trust and brokerage services provided by the Company (which total less than 10% of total revenue).

In July 2004, the Financial Accounting Standards Board ("FASB") issued guidance regarding SFAS No. 133 Implementation Issue No. G25, "Cash Flow Hedges:  Using the First-Payments Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans", in which the FASB indicated the first-payments-received technique for identifying the hedged forecasted transactions (that is, the hedged interest payments) can be used in a cash flow hedge of the variable prime-rate-based or other variable non-benchmark-rate-based interest payments for a rolling portfolio of pre-payable interes-bearing loans (or other interest-bearing financial assets), provided all other conditions for a cash flow hedge have been met.   Entities that choose to use the first-payments-received technique are still required by SFAS 133 (as amended) to assess the effectiveness of the cash flow hedging relationship and to recognize ineffectiveness in earnings attributable to overhedges.   The effective date of the guidance for each reporting entity is the first day of the first fiscal quarter beginning after August 9, 2004.  Early application of the guidance covering this Implementation Issue is permitted.  Implementation of this guidance could have a significant impact on the Company's consolidated financial statements or results of operations when adopted.

In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2. The FSP supersedes FSP No. 106-1, which was issued to address the accounting impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act includes a prescription drug benefit under Medicare Part D and a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. FSP No. 106-2 applies only to sponsors of single-employer plans for which (1) the employer concludes that prescription drug benefits under the plan are actuarially equivalent to Medicare Part D and thus qualify for the subsidy, and (2) the expected amount of the subsidy will offset or reduce the employer-sponsor's share of the plan's prescription drug coverage. The FSP provides accounting guidance and required disclosures. For public companies, the FSP is effective for the first interim or annual period beginning after June 15, 2004. The effects of the Act on the accumulated projected benefit obligation or net periodic postretirement benefit cost are not reflected in the Financial Statements or accompanying notes. FSP No. 106-2 is not expected to have a material effect on the Company's consolidated financial statements or results of operations.

Statement of Financial Accounting Standards ("SFAS") No. 133 Implementation Issue C13, "When a loan Commitment Is Included in the Scope of Statement 133", requires commitments to originate mortgage loans that will be held for sale upon origination to be accounted for as derivatives, but does not provide guidance on how the fair value of those commitments should be measured. In a December 2003 speech, the SEC staff indicated it believes loan commitments are written options and therefore should never result in the recognition of an asset under SFAS No. 133. Rather, the staff indicated lenders should initially recognize a liability for loan commitments, with the offsetting debit recognized as a derivative loss to the extent a premium is not received from the potential borrower. The staff indicated it would not object to a registrants recognizing loan commitments as assets provided it discontinues that practice for commitments entered into in the first reporting period beginning after March 15, 2004 and provided assets recorded on loan commitments entered into prior to that date are reversed when the related loan closes or the commitment expires. The guidance did not have a significant impact on the Company’s consolidated financial statements or results of operations.

At its March 2004 meeting, the Emerging Issues Task Force ("EITF") ratified the consensus reached with regard to Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The consensus provides guidance regarding the meaning of other-than-temporary impairment and its application to investments accounted for under Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The consensus also requires certain quantitative and qualitative disclosures relating to investments with unrealized losses that have not been recognized as other-than-temporary impairments.

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities, (or VIEs). The objective of this interpretation is to provide guidance on how to identify a VIE and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in the company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. FIN 46 was effective for all VIE’s created after January 31, 2003. However, the FASB postponed that effective dates to December 31, 2003. In December 2003, the FASB issued a revised FIN 46 (FIN 46 R), which has an effective date of March 31, 2004 for VIE’s created prior to February 1, 2003, except for special purpose entities, which much adopt either FIN 46 or FIN 46 R as of December 31, 2003. The adoption of FIN 46 did not have an impact on the Company's financial position or results of operations.

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

The following discussion and analysis of the financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Form 10-Q. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries.

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

Use of Non-GAAP Financial Measures: Certain information is discussed on a fully taxable equivalent basis. Specifically, included in second quarter 2004 and 2003 net interest income was $419 and $404, respectively, of tax-exempt interest income from certain investment securities and loans. For the six-months ended June 30, 2004 and 2003, the amount of tax-exempt income included in net interest income was $782 and $802, respectively. An amount equal to the tax benefit derived from this tax-exempt income has been added back to the interest income and net interest income totals discussed in this Management’s Discussion and Analysis, resulting in tax-equivalent adjustments of $184 and $173 in the second quarter of 2004 and 2003 respectively, and $338 and $343 in tax-equivalent adjustments for the six-months ended June 30, 2004 and 2003, respectively. The analysis of net interest income tables included in this Form 10-Q provide a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.

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

FORWARD LOOKING STATEMENTS DISCLAIMER

The following discussion, as well as certain other statements contained in this Form 10-Q, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 (the "PSLRA"). You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. For these statements, the Company claims the protection of the safe harbor for forward-looking statements provided by the PSLRA.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

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

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

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

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

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

        (vi) The potential need to adapt to changes in information technology systems, on which the Company is highly dependant, could present operational issues or require significant capital spending;

        (vii) Acts or threats of terrorism and actions taken by the United States or other governments as a result of such threats, including military action, could further adversely affect business and economic conditions in the United States generally and in the Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s common stock; and

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

The forward looking statements contained herein represent the Company's judgment as of the date of this Form 10-Q, and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the succeeding discussion, or elsewhere in this Form 10-Q, except to the extent required by federal securities laws.

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

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of its December 31, 2003 report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:

Allowance for Loan Losses - Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income and when a greater amount of provisions for loan losses is necessary the result is lower net income. Refer to Part I, Item 2, Allowance for Loan Losses and Provision in this Report on Form 10-Q, for further discussion and analysis concerning the allowance.

Income Taxes – The Company estimates its income taxes for each period for which a statement of income is presented. This involves estimating the Company’s actual current tax liability, as well as assessing temporary differences resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from 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 June 30, 2004 and December 31, 2003, there was no valuation allowance for deferred tax assets, which are included in other assets and amounted to $1,908 and $700, respectively.

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 any 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 - The valuation technique used by the Company to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors.  Any changes in the estimates used by the Company to determine the carrying value of its goodwill and identifiable intangible assets, or which otherwise adversely affect their value or estimated lives, would adversely affect the Company's results of operations.  Refer to Note 2 of the consolidated financial statements in Part I, Item 1 of this Form 10-Q for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.

Overview

The Company reported consolidated net income of $803 or fully diluted earnings per share of 25 cents for the three-months ended June 30, 2004, compared with $1,412 or fully diluted earnings per share of 43 cents for the same quarter in 2003, representing decreases of $609 and 18 cents, or 43.1% and 41.9%, respectively. The annualized return on average assets ("ROA") and average shareholders’ equity ("ROE") amounted to 0.50% and 5.78%, respectively, compared with 1.03% and 10.57% for the same quarter in 2003.

For the six-months ended June 30, 2004, consolidated net income amounted to $2,239 or fully diluted earnings per share of 70 cents, compared with $2,716 or fully diluted earnings per share of 84 cents for the same period in 2003, representing decreases of $477 and 14 cents, or 17.6% and 16.7%, respectively. The ROA and ROE amounted to 0.72% and 7.45% respectively, compared with 1.00% and 10.20% for the first six-months of 2003.

A variety of factors impacted the Company’s second quarter and year-to-date results of operations, including a mark-to-market adjustment of $727 in the second quarter  and $399 for the first six-months of 2004, representing unrealized depreciation on interest rate swap agreements; a year-to-date decline of $572 in net gains on the sale of investment securities; and the impact of continued low interest rates on net interest income. In addition, second quarter and year-to-date results include a variety of atypical expenses including: costs related to the Company’s recently announced corporate re-branding and market research initiatives amounting to $200; "other-than-temporary" impairment write-downs of certain non-marketable equity investments amounting to $174; the recording of a $160 loss allowance associated with certain trust activities; and $120 in costs associated with the Bank’s previously announced completion of a branch office acquisition in the community of Rockland, Maine.

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

For the quarter ended June 30, 2004, net interest income on a fully tax equivalent basis amounted to $5,008, compared with $5,032 during the second quarter of 2003, representing a decrease of $24, or 0.5%. For the six months ended June 30, 2004, net interest income on a fully tax-equivalent basis amounted to $9,977, compared with $10,068 during the same period in 2003, representing a decrease of $91, or 0.9%.

The decline in net interest income was principally attributed to declines in the net interest margin, as total average earning assets for the six months ended June 30, 2004 increased $75,503 or 14.6%, compared with the same period in 2003. For the three and six months ended June 30, 2004, the net interest margin amounted to 3.28% and 3.39% respectively, compared with 3.88% and 3.93% during the same periods in 2003, representing declines of 60 and 54 basis points, respectively.

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

Net Interest Income Analysis: The following tables set forth an analysis of net interest income by each major category of interest earning assets and interest bearing liabilities for the three and six-months ended June 30, 2004, and 2003, respectively:

1.  For purposes of these computations, non-accrual loans are included in average loans.
2.  For purposes of these computations, investment securities and available for sale securities are at amortized cost and net unrealized gains (losses) on available-for-sale securities are recorded in other assets.
3.  For purposes of these computations, reported on a tax equivalent basis.

Net 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.

The Bank’s strategy of maintaining an asset sensitive balance sheet has contributed to the net interest margin decline over the past year, as interest rates declined to forty-five year lows. While an asset sensitive balance sheet pressures the net interest margin and net interest income in an extended flat or declining interest rate environment, it typically strengthens it in a rising rate environment, a scenario management anticipates is more likely to occur. The Bank has been deliberate in its efforts to manage 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. Management believes that maintaining an asset sensitive balance sheet is important to the Company’s long-term success and such posture better positions it for rising interest rates and an improving economy. The Bank’s interest rate sensitivity position is more fully described in Part I, Item 3 of this report on Form 10-Q, Quantitative and Qualitative Disclosures About Market Risk.

The decline in total interest income attributed to lower yields was largely offset by growth in average earning assets, which increased $93,830 and $75,503, or 18.0% and 14.6%, when comparing the three and six month periods ended June 30, 2004 with the same periods in 2003, respectively. As depicted on the succeeding rate / volume analysis tables, the volume of interest earning assets added to the balance sheet since the second quarter of 2003 contributed $4,721 to second quarter 2004 interest income, offset by a reduction of $4,742 due to the impact of lower yields and interest rates. For the six-months ended June 30, 2004, the volume of interest earning assets contributed $4,308 to interest income, offset by a reduction of $4,529 due to the impact of lower yields and interest rates.

Interest Expense - Total interest expense for the quarter ended June 30, 2004 amounted to $2,840 compared with $2,837 for the same quarter in 2003, representing an increase of $3, or 0.1%. For the six months ended June 30, 2004, total interest expense amounted to $5,548 compared with $5,678 for the same period in 2003, representing a decline of $130, or 2.3%.

The decrease in interest expense was principally attributed to a 42 basis point decline in the average cost of interest bearing liabilities between periods, from 2.57% during the first six-months of 2003 to 2.15% for the same period in 2004. The decline in the cost of interest bearing funds was principally attributed to the historically low interest rate environment, prompting management to reduce rates on non-maturity deposits while maturing time deposits were being replaced at prevailing lower rates. The total average cost of interest bearing deposits amounted to 1.33% during the six-months ended June 30, 2004, compared with 1.71% during the same period in 2003, representing a decline of 38 basis points.

The cost of borrowings amounted to 3.28% in the current quarter, compared with 3.83% in the second quarter of 2003, representing a decline of 55 basis points. The decline was principally attributed to the replacement of maturing borrowed funds at prevailing low interest rates.

Consistent with the Bank’s asset and liability management strategies, a portion of the Bank’s borrowings have longer maturities than the funding provided by traditional deposits in order to preserve the sensitivity of net interest income in a rising interest rate environment. While the use of longer maturity borrowings to fund earning assets naturally results in less net interest income, they more closely match the maturities of fixed rate earning assets being added to the balance sheet, and lessen the exposure to interest rate risk.

The decline in total interest expense resulting from lower interest rates was largely offset by increases in interest bearing liabilities of $93,575 and $73,560, or 20.8% and 16.5%, when comparing the three and six month periods ended June 30, 2004, respectively. As depicted on the rate / volume analysis tables below, the volume of interest bearing liabilities contributed $2,155 to second quarter 2004 interest expense, offset by a reduction of $2,152 due to lower interest rates. For the six months ended June 30, 2004, the impact of lower interest rates reduced interest expense by $1,976, offset by an increase of $1,846 due to the volume of interest bearing liabilities.

Rate / Volume Analysis: The following tables set forth a summary analysis of the relative impact on net interest income of changes in the average volume of interest earning assets and interest bearing liabilities, and changes in average rates on such assets and liabilities. The income from tax-exempt assets has been adjusted to a fully tax equivalent basis, thereby allowing uniform comparisons to be made. Because of the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes to volume or rate. For presentation purposes, changes which are not solely due to volume changes or rate changes have been allocated to these categories in proportion to the relationships of the absolute dollar amounts of the change in each.

In addition to net interest income, non-interest income is a significant source of revenue for the Company and an important factor in its results of operations. For the quarter ended June 30, 2004, total non-interest income amounted to $811 compared with $1,703 for the same quarter in 2003, representing a decrease of $892, or 52.4%. For the six months ended June 30, 2004, total non-interest income amounted to $2,652 compared with $3,438 during the same period in 2003, representing a decline of $786, or 22.9%.

Net Gains on the Sale of Securities: During the second quarter of 2004, yields on the five and ten-year U.S. Treasury notes climbed to two year highs, reducing the unrealized gains in the Bank’s available for sale securities portfolio. During the three-months ended June 30, 2004 there were no net gains on the sale of securities recorded, compared with $203 during the second quarter of 2003. For the six-months ended June 30, 2004, net gains on the sale of securities amounted to $193 compared with $765 during the same period in 2003, representing a decline of $572, or 74.8%. The interest rate environment during the first six-months of 2004 and characteristics of the Bank’s securities portfolio did not present as much opportunity or need for securities repositioning transactions, as was the case during the first six-months of 2003.

There is no assurance that the recording of securities gains will continue in future reporting periods at 2004 and 2003 levels. It is important to note, however, that the available for sale investment securities portfolio is managed on a total return basis, in concert with well-structured asset/liability management policies. The Bank will continue to respond to changes in market interest rates, changes in securities pre-payment or extension risk, changes in the availability of and yields on alternative investments, and its needs for adequate liquidity.

Net Loss on Interest Rate Swap Agreements: During the three-months ended June 30, 2004, the Bank recorded a net loss on interest rate swap agreements amounting to $598. For the six-months ended June 30, 2004, the net loss amounted to $103. No such income or loss was recorded during the same periods in 2003.

As more fully enumerated in Part I, Note 8 of the consolidated interim financial statements of this report, in 2004 the Company de-designated its interest rate swap agreements as cash flow hedges. In prior reporting periods, changes in the fair value of the interest rate swap agreements were recorded on the consolidated balance sheet in other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties were recorded as interest income. Prospectively, from the time of their de-designation, changes in their fair value and current period net cash flows are being recorded in non-interest income. This change may create potential earnings volatility over the remaining life of the agreements, consistent with volatility in the U.S. Treasury curve.

For the quarter ended June 30, 2004, the Company recorded in non-interest income unrealized depreciation of $727 representing a mark-to-market adjustment for interest rate swap agreements, compared with an unrealized gain of $328 recorded in the prior quarter. For the six-months ended June 30, 2004 the total unrealized loss on interest rate swap agreements amounted to $399. The size of the second quarter mark-to-market adjustment reflects the significant upward shift in the U.S. Treasury yield curve between reporting periods. For example, the three-year U.S. Treasury note closed the quarter ending June 30, 2004, 114 basis points higher than where it stood on March 31, 2004. Short-term increases in U.S. Treasury yields will tend to increase the unrealized loss, while declines will decrease the unrealized losses. However, if the interest rate swap agreements are held to maturity, all cumulative unrealized appreciation or depreciation recorded in non-interest income will net to zero and have no cumulative impact on earnings.

During the three and six-months ended June 30, 2004, the net positive cash flows from the interest rate swap agreements amounted to $129 and $296, compared with $105 and $196 during the same periods in 2003. In 2003 this income was recorded in interest income, whereas in 2004 this income was recorded in non-interest income.

The Bank’s interest rate swap agreements are discussed in further detail under Item 2 of this Form 10-Q, Derivative Instruments / Counter-party Risk and is incorporated herein by reference.

Trust and Other Financial Services: For the three and six-months ended June 30, 2004 income from trust and other financial services amounted to $507 and $990 compared with $629 and $1,203 during the same periods in 2003, representing declines of $122 and $213, or 19.4% and 17.7%, respectively.

Income from trust and other financial services is principally derived from fee income related to client assets managed and held in custody and, to a lesser extent, brokerage services. The decrease in fee income in part reflects a decline of $9,376, or 5.0%, in the market value of managed assets when comparing June 30, 2004 with the same date in 2003. While the total returns on the managed asset portfolio and new client relationships were accretive to the managed asset portfolio over the past twelve months, this growth was more than offset by closed accounts, including two large relationships amounting to approximately $14,000. Revenue from brokerage activities also posted three and six-month declines compared with 2003 levels, principally reflecting lower trading volume, including sales of mutual funds and annuity products.

At June 30, 2004, total managed assets at Bar Harbor Trust Services, a wholly owned subsidiary of the Bank, stood at $178,002, compared with $176,127 at December 31, 2003, and $187,378 at the June 30, 2003.

Other Non-interest Income: Income generated from service charges on deposit accounts, merchant and visa credit card processing, and miscellaneous service fees, collectively grew $77 on a year-over-year basis, posting increases of 5.2%, 4.8%, and 16.2% respectively, compared with the first six-months of 2003. During the three-months ended June 30, 2004, growth in service charges on deposit accounts and merchant and visa credit card processing slowed to 0.8%, and 0.6% respectively, compared with the same quarter in 2003.

For the three and six-months ended June 30, 2004, total non-interest expenses amounted to $4,620 and $9,217 compared with $4,448 and $9,100 for the same periods in 2003, representing increases of $172 and $117, or 3.9% and 1.3%, respectively.

Salaries and Employee Benefits: For the three and six-months ended June 30, 2004, salaries and employee benefit expenses amounted to $2,092 and $4,526 compared with $2,367 and $4,825 during the same periods in 2003, representing declines of $275 and $299, or 11.6% and 6.2%, respectively. The year-over-year declines in salaries and benefit expenses were principally attributed to lower staffing levels and a decrease in employee incentive compensation.

Branch Acquisition Expenses: Included in first quarter and year-to date 2004 non-interest expenses were a variety of non-recurring costs associated with the Bank’s acquisition of a branch office in the community of Rockland, Maine, amounting to approximately $120. These expenses are included in salaries and benefits, occupancy, furniture and equipment, and other operating expenses.

Re-branding and Market Research Expenses: Included in second quarter 2004 non-interest expenses were a variety of costs associated with the Company’s recently announced corporate re-branding and market research initiatives amounting to $200, of which $160 was recorded in other operating expense and the balance recorded in occupancy expense. The Company introduced updated logos and simplified corporate identities, together with a comprehensive marketing program offering certain new banking product packages such as Home Plus and Ideal Checking.

Occupancy, Furniture and Equipment Expenses: For the three and six-months ended June 30, 2004, occupancy, furniture and equipment expenses amounted to $723 and $1,432 compared with $653 and $1,295 during the same periods in 2003, representing increases of $70 and $137, or 10.7% and 10.6%, respectively. The increases were attributed to a number of factors including both one-time and ongoing expenses associated with the Rockland branch acquisition, expenses associated with the Company’s re-branding initiative, and normal increases in a variety of occupancy related costs.

Other Operating Expenses: For the three and six-months ended June 30, 2004, other operating expenses amounted to $1,567 and $2,896 compared with $1,218 and $2,650 during the same periods in 2003, representing increases of $349 and $246, or 28.7% and 9.3%, respectively.

Included in 2004 year-to-date other operating expenses were the write-down of certain non-marketable venture capital equity investment funds considered "other-than-temporarily" impaired amounting to $174, of which $120 was recorded during the second quarter. These investment funds, originating as far back as 1987, generally represent "socially responsible" venture capital investments in small businesses throughout Maine and New England, with the objective of generating gains through the subsequent sale of those investments, as well as periodic dividends to investors. The total amount of the 2004 impairment write-downs represented 25.3% of their book value.

During the three months ended June 30, 2004, Bar Harbor Trust Services, a second tier subsidiary of the Company, recorded a loss amounting to $160 associated with a trust account investment authorized by the beneficiaries of the trust, however subsequently deemed by management as inappropriate. Second quarter 2004 other operating expenses also included $53 in non-recurring systems conversion expenses associated with the Company’s previously announced restructuring of BTI Financial Group, a wholly owned subsidiary of the Company, as well as the previously discussed costs associated with the Company’s re-branding and market research initiatives.

During the three and six-months ended June 30, 2004 the Bank recorded provisions for loan losses amounting to $30 and $120 compared with $150 and $300 during the same periods in 2003, representing decreases of $120 and $180, or 80.0% and 60.0%, respectively.

The provision for loan losses reflects the amount necessary to maintain the Allowance for Loan Losses ("allowance") at a level that, in management’s judgment, is appropriate for the amount of inherent risk of loss in the current loan portfolio. Non-performing loans have declined $239 and $1,196, or 16.0% and 48.8% compared with December 31, 2003 and June 30, 2003, respectively, and remain at low levels. While year-to-date 2004 net charge-offs of $467 have shown an increase compared with the first six-months of 2003, they are not considered reflective of the overall credit quality of the loan portfolio, as $313 of year-to-date charge offs were attributed to one relationship. The allowance for loan losses expressed as a percentage of non-performing loans strengthened to 393% at June 30, 2004, compared with 353% and 215% at December 31, 2003 and June 30, 2003.

The Company's effective tax rate for the three and six-month periods ended June 30, 2004 amounted to 18.5% and 24.2%, compared with 28.1% and 27.8% for the same periods in 2003, respectively. The income tax provisions for these periods are less than the expense that would result from applying the federally statutory rate of 34% to income before income taxes principally because of the impact of tax exempt interest income on certain investment securities, loans and bank owned life insurance. The effective tax rates posted year-over-year declines, principally due to the disproportionate amounts of non-taxable income included in pre-tax earnings.

The increase in total assets from December 31, 2003 was driven by a $45,575 increase in securities, combined with $33,532 in loan growth, including loans acquired in connection with the Bank’s acquisition of a branch office in the community of Rockland, Maine.

Loan Portfolio

The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine. The following table represents the components of the Bank's loan portfolio, net of deferred loan origination fees and costs, as of June 30, 2004, December 31, 2003 and June 30, 2003.

LOAN PORTFOLIO SUMMARY

Total Loans: Total loans at June 30, 2004 amounted to $416,940, representing an increase of $33,532 or 8.7% compared with December 31, 2003, and an increase of $45,706 or 12.3%, compared with June 30, 2003.

The increase in loan balances compared with December 31, 2003 reflects $12,343 in loans acquired in connection with the February 13, 2004 Rockland branch acquisition, principally consumer real estate loans. At June 30, 2004 the Rockland branch loan portfolio totaled $17,320, representing post-acquisition loan growth of $4,977 at that branch, or 40.3%, the majority of which was attributed to commercial lending. The Rockland branch loan portfolio contributed 51.7% to the Bank’s year to date loan growth.

Excluding the Rockland branch loan portfolio, the $16,212 increase in total loans during the first six-months of 2004 was led by strong growth in commercial lending. Following record refinancing activity over the past two years and a rise in interest rates that began in the latter part of 2003, consumer real estate loan originations slowed during the first half of 2004, but growth continued as new purchase transactions regained their dominance in the loan origination pipeline.

Loan origination activity has benefited from a still favorable market interest rate environment, a stable local economy, and initiatives designed to expand the Bank's product offerings and attract new customers while continuing to leverage its existing customer base.

At June 30, 2004 real estate loans comprised 84.4% of the loan portfolio, compared with 87.4% at December 31, 2003 and 83.1% at June 30, 2003. 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 and origination pipeline, 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 of the real estate loan portfolio.

TOTAL NONPERFORMING LOANS

The June 30, 2004 allowance calculation incorporates loss estimates relating to issues in the Maine wild blueberry industry, to which the Bank has extended credit, and is principally centered in Washington County, Maine. During the fourth quarter of 2003 certain legal matters developed regarding the blueberry industry, the uncertainties of which warranted recognition of credit risk. While more recent developments appear favorable, at June 30, 2004 the adequacy analysis of the allowance incorporates management’s estimate of inherent losses with respect to this industry segment.

There were no material changes in loan concentrations during the three-month period ended June 30, 2004.

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, management considers the allowance for loan losses at June 30, 2004, to be appropriate for the risks inherent in the loan portfolio and resident in the local and national economy as of that date.

Investment Securities

The investment securities portfolio consists of mortgage-backed securities, United States Government agency securities, obligations of state and political subdivisions and, to a lesser extent, 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.

At June 30, 2004, total investment securities amounted to $203,962, compared with $158,387 and $142,252 at December 31, 2003 and June 30, 2003, representing increases of $45,575 and $61,710, or 28.8% and 43.4%, respectively.

The investment securities portfolio has historically declined during the first half of the year, as cash flows are usually redeployed to absorb seasonal deposit outflows associated with the Bank’s market area. This trend did not continue during the first six months of 2004 as deposits from the Rockland branch acquisition and a new institutional market fund offered to clients of Bar Harbor Trust Services, a wholly owned subsidiary of the Bank, were sufficient to more than offset seasonal deposit declines.

During the second quarter of 2004 the Bank increased its securities portfolio by $39,468, or 24.0%. Securities added to the portfolio predominately consisted of U.S. Government Agency mortgage-backed securities with an average duration of approximately two years. This action was taken as market yields climbed to a two-year high, presenting some long awaited opportunities. Given the historically low interest rate environment and related interest rate risk considerations, during the year ended December 31, 2003 the Bank exercised restraint and chose not to increase the securities portfolio, despite its strong capital position and appetite for net interest income.

In light of the low interest rate environment over the past year and the high degree of rate volatility, the Bank’s investment strategy has been focused on maintaining a portfolio with relatively short average duration, thereby reducing the exposures associated with sustained increases in interest rates. This was accomplished through investments in securities with predictable cash flows and relatively short average lives; 10-year fully amortizing mortgage-backed securities and other high coupon mortgage-backed 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 held to maturity ("HTM") are those where the Bank has the positive intent and ability to hold until maturity. At December 31, 2003, the HTM portfolio consisted exclusively of long-term, tax-exempt municipal bonds, with one exception; namely, a $461 mortgage-backed security ("MBS") originally purchased in 2002 for Community Reinvestment Act ("CRA") benefits, amounting to $1,518. The underlying collateral consisted of low-income housing loans in the state of Maine. By their nature, CRA investments have higher purchase premiums because of the positive CRA effect. In this case, the original premium paid by the Bank amounted to $31. Subsequent to the purchase, the Bank’s primary regulator advised that the MBS did not qualify for CRA credit because the loans were not in the Bank’s immediate market area, in effect diminishing the value of the unamortized premium recorded on the Bank’s balance sheet. During the first quarter of 2004, the Bank sold the bond and realized a gain of $16, and no longer holds any MBS’s in its HTM portfolio.

Deposits

The most significant funding source for earning assets continues to be core customer deposits that are gathered through the Bank's retail branch network. At June 30, 2004 total deposits amounted to $376,488 compared with $339,080 and $317,078 at December 31, 2003 and June 30, 2003, representing increases of $37,408 and $59,410, or 11.0% and 18.7%, respectively.

A portion of the Bank’s deposit base has historically been seasonal in nature, with balances declining during winter and early spring while peaking in the fall. The seasonal outflow of deposits has typically been replaced with cash flows from the securities portfolio or short-term borrowings. This trend did not continue during the first six months of 2004, as deposits from the Rockland branch acquisition and a new institutional money market account offered to clients of Bar Harbor Trust Services were sufficient to more than offset seasonal deposit outflows.

The $37,408 increase in deposits at June 30, 2004 compared with December 31, 2003 was principally attributed to $20,459 in deposits at the acquired Rockland branch office and $17,407 in deposits from the new institutional money market account offered to clients of Bar Harbor Trust Services.

Comparing June 30, 2004 with the same date in 2003, total deposits increased $59,410, or 18.7%. Excluding acquired deposits from the Rockland branch and the new institutional money market account, total deposits at June 30, 2004 represented an increase of $21,544, or 6.8%, compared with the same date in 2003.