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

For the quarter ended: September 30, 2004                      Commission File No. 841105-D

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

(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 consolidated interim financial statements.

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

The accompanying notes are an integral part of these unaudited consolidated interim 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 three and nine-months ended September 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: Management’s Use of Estimates

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

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, income tax estimates, and 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, and the amount and timing of realized losses and future allowance allocations could vary from current estimates. While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance, which also may necessitate future additions or reductions to the allowance, based on information available to them at the time of their examination.

The 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 income tax return and financial reporting 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 past taxes paid and/or 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 September 30, 2004 and December 31, 2003, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.

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 September 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 September 30, 2004:

Amortization expense on the core deposit intangible asset is expected to total $17 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

On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and its Subsidiaries Incentive Stock Option Plan of 2000 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 costs have 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):

Note 6: Retirement Plans

The Company is expected to contribute $454 to the foregoing plans in 2004. As of September 30, 2004, the Company had contributed $343 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 September 30, 2004 and December 31, 2003, commitments to extend credit and unused lines of credit totaled $115,405 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 primarily issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. 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 $1,155 at September 30, 2004 and $2,205 at December 31, 2003. As of September 30, 2004, the fair value of the standby letters of credit was not significant to the Company’s consolidated financial statements.

Note 8: Financial Derivative Instruments

At September 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. Current period net cash flows representing net amounts received from or paid to counter-parties were recorded as interest income.

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

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 interest-bearing loans, provided all other conditions for a cash flow hedge have been met. During the third quarter of 2004 the Company designated its interest rate swap agreements as cash flow hedges and, prospectively from the time of this designation, changes in their fair value are being recorded in other comprehensive income, while current period net cash flows representing net amounts received from or paid to counter-parties are recorded as interest income.

At September 30, 2004, December 31, 2003 and September 30, 2003, the fair value of the interest rate swap agreements were $28, $86 and $388, respectively, and included in other assets on the consolidated balance sheet.

At September 30, 2004 the net unrealized loss on these interest rate swap agreements included in other comprehensive income, net of tax, amounted to $1. At December 31, 2003 and September 30, 2003 the net unrealized gains on these interest rate swap agreements included in other comprehensive income, net of tax, amounted to $57 and $256, respectively.

During the quarter ended September 30, 2004, the Company recorded in non-interest income unrealized appreciation of $428 representing a mark-to-market adjustment for interest rate swap agreements prior to their designation as cash flow hedges, compared with an unrealized loss of $728 recorded in the quarter ended June 30, 2004, and an unrealized gain of $328 recorded in the quarter ended March 31, 2004. For the nine-months ended September 30, 2004, the net unrealized gain on interest rate swap agreements recorded in non-interest income amounted to $29. No such amounts were recorded in non-interest income during 2003.

For the three and nine-months ended September 30, 2004, the total net cash flows received from counter-parties amounted to $89 and $386, respectively, compared with $128 and $324 during the same periods in 2003. Of the $89 in net cash flows received from counter-parties during the three-months ended September 30, 2004, $79 was recorded in non-interest income and $10 in interest income. Of the $386 in net cash flows received from counter-parties during the nine-months ended September 30, 2004, $376 was recorded in non-interest income and $10 in interest income. The $324 in net cash flows received during the nine-months ended September 30, 2003 was recorded in interest income.

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 third party brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities.

SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information" requires public companies to report certain financial information about operating segments for which such information is available and utilized by the chief operating decision maker in deciding how to allocate resources and in assessing performance. In prior reporting periods the Company had also included Financial Services as a business segment and, accordingly, provided segment reporting for that segment. 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. For the year ended December 31, 2003 revenue from Financial Services represented only 5.8% of the Company’s total revenue. In these circumstances, segment information is not required with respect to investment management, trust and third party brokerage services provided by the Company.

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 interest-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, if any.    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.  During the third quarter of 2004 the Company implemented this guidance and designated it prime-rate-based interest rate swap agreements as cash flow hedges. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements or results of operations for the periods ended September 30, 2004, however, prospectively the adoption of the guidance could have a significant impact on the Company’s consolidated financial position.

In March 2004, the FASB Emerging Issues Task Force ("EITF") reached a consensus on Issue 03-1, "The Meaning of Other Than Temporary Impairment (Issue 03-1)". The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an investment is impaired. An investment is considered impaired if its fair value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and debt securities that can contractually be prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost, an impairment is presumed to be other-than-temporary unless: the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. For other debt securities, an impairment is deemed other-than-temporary if: the investor does not have the ability and intent to hold the investment until a forecasted market price recovery (may mean until maturity), or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment loss equal to the difference between the investments cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and cannot be adjusted for subsequent recoveries in fair value, unless required by other authoritative literature.

On September 30, 2004, the FASB issued FSP EITF Issue 03-01-1, which delayed the effective date for the measurement and recognition guidance of an impairment loss that is other-than-temporary (i.e. steps 2 and 3 of the impairment model) contained in paragraphs 10-20 of EITF 03-1. Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue 03-1a. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. steps of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22 have not been deferred and should be applied based on the transition provisions in EITF 03-1. Based on the composition of the investment portfolio held at September 30, 2004, EITF 03-1 is not expected to have a material effect on the Company's financial position 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 such registrant 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.

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 third quarter 2004 and 2003 net interest income was $437 and $416, respectively, of tax-exempt interest income from certain investment securities and loans. For the nine-months ended September 30, 2004 and 2003, the amount of tax-exempt income included in net interest income was $1,219 and $1,218, 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 $193 and $179 in the third quarter of 2004 and 2003 respectively, and $531 and $522 in tax-equivalent adjustments for the nine-months ended September 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.

(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 increase 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 historical taxes paid and future taxable income and, to the extent that the recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of September 30, 2004 and December 31, 2003, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.

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.

SUMMARY OVERVIEW

The Company reported consolidated net income of $1,943 or fully diluted earnings per share of $0.61 for the three-months ended September 30, 2004, compared with $1,229 or fully diluted earnings per share of $0.38 for the same quarter in 2003, representing increases of $714 and $0.23, or 58.1% and 60.5%, respectively. The annualized return on average assets ("ROA") and average shareholders’ equity ("ROE") amounted to 1.15% and 13.71%, respectively, compared with 0.87% and 9.29% for the same quarter in 2003.

As more fully enumerated below, several factors contributed favorably to the Company’s third quarter performance compared with the same quarter in 2003, the more significant of which included: a $551 increase in net interest income; the recording of $428 a mark-to-market adjustment for unrealized appreciation on interest rate swap agreements; a $136 increase in net gains on the sale of investment securities; and a $90 decline in the provision for loan losses.

For the nine-months ended September 30, 2004, consolidated net income amounted to $4,182 or fully diluted earnings per share of $1.30, compared with $3,945 or fully diluted earnings per share of $1.23 for the same period in 2003, representing increases of $237 and $0.07, or 6.0% and 5.7%, respectively. The ROA and ROE amounted to 0.87% and 9.52% respectively, compared with 0.95% and 9.85% for the first nine-months of 2003.

As more fully enumerated below, the more significant factors unfavorably impacting the Company’s year-to-date results of operations compared with the same period in 2003 included: a decline of $436 in net gains on the sale of investment securities; a $317 increase in marketing and public relations costs principally related to the Company’s previously announced corporate re-branding and market research initiatives; other-than-temporary impairment write-downs of certain non-marketable equity investments amounting to $189 compared with none during 2003; and the recording of a $160 loss associated with certain trust activities. The foregoing items were offset in part by a $465 increase in net interest income and a $270 decline in the provision for loan losses.

RESULTS OF OPERATIONS

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 September 30, 2004, net interest income on a fully tax equivalent basis amounted to $5,505, compared with $4,940 during the third quarter of 2003, representing an increase of $565, or 11.4%. The increase in net interest income was principally attributed to the $97,418 or 18.1% increase in average earning assets when comparing the three-months ended September 30, 2004 with the same period in 2003, as the net interest margin declined 20 basis points between periods.

For the nine-months ended September 30, 2004, net interest income on a fully tax-equivalent basis amounted to $15,482, compared with $15,008 during the same period in 2003, representing an increase of $474, or 3.2%. The increase in net interest income during the nine-months ended September 30, 2004 compared with the same period in 2003 was principally attributed to an $81,304 or 15.5% increase in average earning assets, as the net interest margin declined 41 basis points between these two periods.

Factors contributing to the changes in net interest income and the net interest margin are further enumerated in the following 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 nine-months ended September 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.

Management believes the Bank’s strategy of maintaining an asset sensitive balance sheet has contributed to the net interest margin decline over the past year. 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 its current strategy of 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.

In late June of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") began increasing short-term interest rates. As management anticipated, the three recent increases in the Federal Funds rate totaling 75 basis points favorably impacted the Bank’s net interest margin during the three-months ended September 30, 2004. For the quarter ended September 30, 2004 the Bank’s net interest margin was 3.45% compared with 3.28% during the quarter ended June 30, 2004, representing an improvement of 17 basis points.

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 increases in interest income were principally attributed to the growth in average earning assets between reporting periods, as earning asset yields posted declines of 37 and 68 basis when comparing the three and nine-month periods ended September 30, 2004 with the same periods in 2003. Principally reflecting the Federal Reserve’s recent increases in short-term interest rates, the yield on earning assets amounted to 5.28% during the current quarter ended September 30, 2004, compared with 5.14% during the quarter ended June 30, 2004.

As discussed above, the three and nine-month declines in total interest income attributed to lower yields were largely offset by growth in average earning assets. As depicted on the following rate / volume analysis tables, the volume of interest earning assets added to the balance sheet since the third quarter of 2003 contributed $2,824 to third quarter 2004 interest income, offset by a decline of $2,044 attributed to the impact of lower yields and interest rates. For the nine-months ended September 30, 2004, the volume of interest earning assets contributed $4,202 to interest income, offset by a decline of $3,643 attributed to the impact of lower yields and interest rates.

Interest Expense - Total interest expense for the quarter ended September 30, 2004 amounted to $2,943 compared with $2,728 during the same quarter in 2003, representing an increase of $215, or 7.9%. For the nine-months ended September 30, 2004, total interest expense amounted to $8,491 compared with $8,406 during the same period in 2003, representing an increase of $85, or 1.0%.

The increase in interest expense during the three and nine-months ended September 30, 2004 was principally attributed to the increases in average interest bearing liabilities amounting to $95,216 or 20.9%, and $81,349 or 18.1%, compared with the same periods in 2003, respectively. These increases were substantially offset by declines in the average cost of funds which during the three and nine-month periods ended September 30, 2004 amounted to 2.12% and 2.14%, compared with 2.37% and 2.50% during the same periods in 2003, representing declines of 25 and 36 basis points, respectively.

The declines in the average 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. During the three and nine-months ended September 30, 2004, the total average cost of interest bearing deposits amounted to 1.34% and 1.33%, compared with 1.49% and 1.64% during the same periods in 2003, representing declines of 15 and 31 basis points, respectively.

During the three and nine-months ended September 30, 2004, the average cost of borrowings amounted to 3.33% and 3.38%, compared with 3.74% and 3.85% during the same periods in 2003, representing declines of 41 and 47 basis points, respectively. These declines were principally attributed to the replacement of maturing borrowed funds at prevailing low interest rates. The disproportionate rate of decline in the current quarter compared with the nine-months ended September 30, 2004, reflects the impact of recent interest rate increases by the Federal Reserve on the Bank’s short-term borrowing base.

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 degree of exposure to interest rate risk.

As discussed above, the three and nine-month declines in total interest expense resulting from lower interest rates were largely offset by increases in interest bearing liabilities. As depicted on the rate / volume analysis tables below, the volume of interest bearing liabilities added to the balance sheet since the third quarter of 2003 contributed $1,820 to third quarter 2004 interest expense, offset by a reduction of $1,605 due to lower interest rates. For the nine-months ended September 30, 2004, the impact of lower interest rates reduced interest expense by $1,850, offset by an increase of $1,935 attributed 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 September 30, 2004, total non-interest income amounted to $2,498 compared with $1,919 for the same quarter in 2003, representing an increase of $579, or 30.2%. For the nine-months ended September 30, 2004, total non-interest income amounted to $5,150 compared with $5,357 during the same period in 2003, representing a decline of $207, or 3.9%.

Net Gains on the Sale of Securities: During the three-months ended September 30, 2004 net gains on the sale of securities amounted to $239 compared with $103 during the same period in 2003, representing an increase of $136, or 132.0%. During the nine-months ended September 30, 2004, net gains on the sale of securities amounted to $432 compared with $868 during the same period in 2003, representing a decline of $436, or 50.2%. The interest rate environment during the first nine-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 same period in 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. Bank management 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 the Bank’s needs for adequate liquidity.

Net Income on Interest Rate Swap Agreements: During the three and nine-months ended September 30, 2004, the Bank recorded net income on interest rate swap agreements amounting to $507 and $404, respectively, whereas no income or losses were recorded in non-interest income during the same periods in 2003.

As more fully enumerated in Part I, Note 8 of the consolidated interim financial statements of this report on Form 10-Q, in the first quarter of 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. From the time of their de-designation, changes in their fair value and current period net cash flows were recorded in non-interest income, creating potential earnings volatility, consistent with volatility in the U.S. Treasury curve.

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 interest-bearing loans, provided all other conditions for a cash flow hedge have been met. During the third quarter of 2004 the Company designated its interest rate swap agreements as cash flow hedges and, from the time of this designation, changes in their fair value are being 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 are recorded as interest income.

During the quarter ended September 30, 2004, the Company recorded in non-interest income an unrealized gain of $428 representing a mark-to-market adjustment for interest rate swap agreements prior to their designation as cash flow hedges, compared with an unrealized loss of $728 recorded in the quarter ended June 30, 2004, and an unrealized gain of $328 recorded in the quarter ended March 31, 2004. These changes reflected the movements in the U.S Treasury yield curve between reporting periods. For the nine-months ended September 30, 2004, the net unrealized gain on interest rate swap agreements recorded in non-interest income amounted to $29. No interest rate swap agreement mark-to-market gains or losses were recorded in non-interest income during 2003.

For the three and nine-months ended September 30, 2004, the net cash flows received from counter-parties and recorded in non-interest income amounted to $79 and $376. During the nine-months ended September 30, 2003, there were no net cash flows received from counter-parties 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 nine-months ended September 30, 2004 income from trust and other financial services amounted to $429 and $1,419 compared with $490 and $1,693 during the same periods in 2003, representing declines of $61 and $274, or 12.5% and 16.2%, respectively.

Income from trust and other financial services is principally derived from fee income related to the market value of client assets managed and held in custody and, to a lesser extent, third party brokerage services. The decrease in fee income in part reflects a decline in average managed assets when comparing the nine-months ended September 30, 2004 with the same period in 2003. Revenue from third party brokerage activities also posted three and nine-month declines compared with 2003 levels, principally reflecting lower trading volumes, including sales of mutual funds and annuity products.

At September 30, 2004, total managed assets at Bar Harbor Trust Services, a Maine non-depository trust company and second tier subsidiary of the Company, stood at $179,658, compared with $176,127 at December 31, 2003, and $171,017 at September 30, 2003.

Service Charges on Deposits: Income generated from service charges on deposit accounts totaled $395 and $1,149 during the three and nine-months ended September 30, 2004, representing a decrease of $24 or 5.7% and an increase of $13 or 1.1% compared with the same periods in 2003, respectively. The Bank has not increased its service charge fees on deposit accounts over the past few years, while customers have been closing and consolidating small accounts, moving to relationship products having lower fees, and reducing their volume of account overdrafts.

Credit Card Service Charges and Fees: This income is principally generated from merchant credit card processing fees. During the three and nine-months ended September 30, 2004 these fees amounted to $787 and $1,311 respectively, representing increases of 1.4% and 2.7% compared with the same periods in 2003.

For the three and nine-months ended September 30, 2004, total non-interest expenses amounted to $5,032 and $14,249 compared with $4,920 and $14,020 during the same periods in 2003, representing increases of $112 and $229, or 2.3% and 1.6%, respectively.

Salaries and Employee Benefit Expenses: For the three and nine-months ended September 30, 2004, salaries and employee benefit expenses amounted to $2,297 and $6,823 compared with $2,305 and $7,130 during the same periods in 2003, representing declines of $8 and $307, or 0.4% and 4.3%, respectively. The year-over-year declines in salaries and benefit expenses were principally attributed to lower employee incentive compensation and staffing levels compared with the same periods in 2003.

Branch Office Integration Expenses: Included in first quarter and year-to date 2004 non-interest expenses were a variety of costs related to integration activities 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.

Occupancy, Furniture and Equipment Expenses: For the three and nine-months ended September 30, 2004, occupancy, furniture and equipment expenses amounted to $709 and $2,141 compared with $682 and $1,977 during the same periods in 2003, representing increases of $27 and $164, or 4.0% and 8.3%, respectively. The increases were attributed to a number of factors including both one-time and ongoing expenses associated with the Bank’s acquisition of the Rockland branch office, 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 nine-months ended September 30, 2004, other operating expenses amounted to $1,445 and $4,341 compared with $1,434 and $4,084 during the same periods in 2003, representing increases of $11 and $257, or 0.8% and 6.3%, respectively.

Included in third quarter and year-to-date 2004 other operating expenses were a variety of costs associated with the Company’s previously announced corporate re-branding and market research initiatives. 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. For the nine-months ended September 30, 2004 marketing and public relations expenses amounted to $651 compared with $334 during the same period in 2003, representing an increase of $317, or 94.9%.

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 $189, of which $15 was recorded during the third quarter. No impairment write-downs were recorded during 2003. These investment funds, originating as far back as 1987 and in some cases qualifying for Community Reinvestment Act credit, generally represent socially responsible venture capital investments in small businesses throughout Maine and New England. The total amount of the 2004 impairment write-downs represented 28.1% of their book value recorded at cost.

Included in year-to-date other operating expenses was a loss recorded during the second quarter of 2004 at Bar Harbor Trust Services, amounting to $160 and associated with a trust account investment authorized by the beneficiaries of the trust, however subsequently deemed by management as inappropriate.

During the three and nine-months ended September 30, 2004 the Bank recorded provisions for loan losses amounting to $30 and $150 compared with $120 and $420 during the same periods in 2003, representing decreases of $90 and $270, or 75.0% and 64.3%, 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 $644 and $703, or 43.1% and 45.3% compared with December 31, 2003 and September 30, 2003, respectively, and remain at low levels. The allowance for loan losses expressed as a percentage of non-performing loans strengthened to 563% at September 30, 2004, compared with 353% and 339% at December 31, 2003 and September 30, 2003. While year-to-date 2004 net charge-offs of $645 have shown an increase of $515 compared with the first nine-months of 2003, management does not consider these as being reflective of the overall credit quality of the loan portfolio, as $506 of year-to-date charge offs were attributed to two relationships and were adequately provided for in the Bank’s previously recorded allowance for loan losses.

The Company's effective tax rate for the three and nine-month periods ended September 30, 2004 amounted to 29.3% and 26.7%, compared with 25.1% and 27.0% 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. For the three-months ended September 30, 2004, the effective tax rate posted a decline compared with the same quarter in 2003, principally due to non-taxable income bearing a smaller percentage of income before income taxes than the comparable period in 2003.

The increase in total assets from December 31, 2003 was driven by a $46,149 or 12.0% increase in loans, combined with a $17,810 or 11.2% increase in investment securities. The Company’s year- to-date asset growth was funded with a $58,095 or 17.1% increase in deposits, and an $11,115 or 6.0% increase in borrowed funds.

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 September 30, 2004, December 31, 2003 and September 30, 2003.

Total Loans: Total loans at September 30, 2004 amounted to $429,557, representing an increase of $46,149 or 12.0% compared with December 31, 2003, and an increase of $50,819 or 13.4%, compared with September 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.

Excluding the acquired Rockland branch loan portfolio, at September 30, 2004 total loans have increased $33,806 or 8.8% compared with December 31, 2003. Commercial lending contributed 62.7% to this growth while consumer lending contributed 37.3%.

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 nine-months of 2004, but growth continued as new purchase transactions accounted for an increasing proportion of the loan origination pipeline. In addition, home equity loan activity has been strong, accounting for almost half of the year-to-date 2004 increase in consumer real estate loans.

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 September 30, 2004 real estate loans comprised 85.7% of the loan portfolio, compared with 87.4% at December 31, 2003 and 83.9% at September 30, 2003. The continued strength in the local real estate markets, both residential and commercial, has led to historically high 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 in an effort 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.

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

Non-performing Loans: Non-performing loans include loans on non-accrual status, loans which have been treated as troubled debt restructurings and loans past due 90 days or more and still accruing interest. The following table sets forth the details of non-performing loans at the dates indicated:

TOTAL NON-PERFORMING LOANS

During the quarter ended September 30, 2004, non-performing loans remained at relatively low levels. At September 30, 2004, total non-performing loans amounted to $850, or 0.20% of total loans, compared with $1,494 or 0.39% at December 31, 2003, and $1,553 or 0.41% at September 30, 2003.

While the non-performing loan ratios continued to reflect the favorable quality of the loan portfolio during the three and nine-month periods ended September 30, 2004, the Bank is cognizant of soft economic conditions overall, and is managing credit risk accordingly. Future levels of non-performing loans may be influenced by economic conditions, including the impact of those conditions on the Bank's customers, interest rates, and other factors existing at the time. Management believes the economic activity and conditions in the local real estate markets will continue to be significant determinants of the quality of the loan portfolio in future periods and, thus, the Company’s results of operations and financial condition.

Other Real Estate Owned: When the Bank takes ownership of collateral property upon foreclosure of a real estate secured loan, the property is transferred from the loan portfolio to Other Real Estate Owned ("OREO") at its fair value. If the loan balance is higher than the fair value of the property, the difference is charged to the allowance for loan losses at the time of the transfer. At September 30, 2004, OREO, included in other assets, amounted to $34, compared with $34 at December 31, 2003 and $369 at September 30, 2003.

The allowance is maintained at a level that, in management’s judgment, is appropriate for the inherent risk of loss in the current loan portfolio.

Specific reserves for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures." The amount of loans considered to be impaired totaled $695 as of September 30, 2004, compared with $1,258 as of December 31, 2003. The related allowances for loan losses on these impaired loans amounted to $86 and $394, as of September 30, 2004 and December 31, 2003, respectively.

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

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

Loan loss provisions are recorded based upon overall aggregate data, and the allowance is increased when, on an aggregate basis, additional estimated losses are identified and deemed likely.

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

The Bank's loan loss experience showed an increase during the first nine-months of 2004 compared with the same period in 2003. Net charge-offs amounted to $645, or annualized net charge offs to average loans outstanding of 0.21%, compared with net charge-offs of $130, or annualized net charge offs to average loans outstanding of 0.05% during the nine-months ended September 30, 2003. Year-to-date 2004 net charge-offs have shown an increase of $515 compared with the first nine-months of 2003. The increase in net charge-offs was principally attributed to two relationships amounting to $506, and these were adequately provided for in the Bank’s previously recorded allowance for loan losses.

The following table details changes in the allowance for loan losses and summarizes loan loss experience by loan type for the nine-month periods ended September 30, 2004 and 2003.

The September 30, 2004 allowance calculation incorporates loss estimates relating to loans to borrowers involved in the Maine wild blueberry industry, 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 certain increases in credit risk. While more recent developments appear favorable, at September 30, 2004 the adequacy analysis of the allowance incorporates management’s estimate of inherent risk of loss with respect to this industry segment.

There were no material changes in loan concentrations during the three-month period ended September 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 September 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 September 30, 2004, total investment securities amounted to $176,197, compared with $158,387 and $154,312 at December 31, 2003 and September 30, 2003, representing increases of $17,810 and $21,885, or 11.2% and 14.2%, respectively.

The majority of the 2004 growth in the investment securities portfolio occurred during the second quarter of 2004. Securities added to the portfolio predominately consisted of mortgage-backed securities with average durations ranging between two and three years. This action was taken as market yields climbed to a two-year high, presenting some long awaited opportunities for the Bank to increase its earning assets and leverage its strong capital position.

In light of the low interest rate environment over the past couple of years and the high degree of interest rate volatility, the Bank’s investment strategy has been focused on maintaining a securities portfolio with an overall 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 such as, 10-year fully amortizing mortgage-backed securities and other high coupon mortgage-backed securities. The Bank’s strategy has been to position the securities portfolio defensively with a steady stream of future cash flows. 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 typically 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