Commission File Number: 841105-D

(207) 288-3314
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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 ____  NO     X   

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TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

                                                            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 consolidated balance sheet at December 31, 2005 has been derived from audited consolidated financial statements at that date. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2005, and notes thereto.

Note 2: Management’s Use of 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 the valuation of intangible assets.

Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. The ongoing evaluation process includes a formal analysis, which considers among other factors: the character and size of the loan portfolio, business and economic conditions, real estate market conditions, collateral values, changes in product offerings or loan terms, changes in underwriting and/or collection policies, loan growth, previous charge-off experience, delinquency trends, nonperforming loan trends, the performance of individual loans in relation to contract terms, and estimated fair values of collateral.

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.

Income Taxes: The Company estimates its income taxes for each period for which a statement of income is presented. The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information indicates that it is more likely than not that deferred tax assets will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of March 31, 2006 and December 31, 2005, there was no valuation allowance for deferred tax assets. Deferred tax assets are included in other assets on the consolidated balance sheet.

Goodwill and Identifiable Intangible Assets: In connection with acquisitions, the Company generally records as assets on its consolidated 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. Goodwill is evaluated for impairment at least annually, or upon a triggering event as defined by SFAS No. 142, using certain fair value techniques.

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 consolidated results of operations.

The following is a reconciliation of basic and diluted earnings per share for the three months ended March 31, 2006 and 2005:

(in thousands, except number of shares and per share data)

For the three months ended March 31, 2006, and 2005, the number of anti-dilutive options excluded from the earnings per share calculation was 81,513 and 12,627, respectively.

Note 4: Stock Based Compensation

On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and Subsidiaries Incentive Stock Option Plan of 2000 ("ISOP") for its officers and employees, which provides for the issuance of up to 450,000 shares of common stock. At March 31, 2006, 81,966 shares are still available for future stock option grants. The purchase price of the stock covered by each option shall be its fair market value, which must be equal to at least 100% of the fair market value on the date such option is granted. Vesting terms range from five to seven years. No option shall be granted after October 3, 2010, ten years after the effective date of the ISOP.

Implementation of New Accounting Standards: In December 2004, the Financial Accounting Standards Board ("FASB") issued a revision of Statement of Financial Accounting Standards ("SFAS") No. 123. SFAS No. 123(R), "Share-Based Payment", which makes significant changes to accounting for "payments" involving employee compensation and "shares" or securities, in the form of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was effective on January 1, 2006 for calendar-year public companies and is applied prospectively to stock options granted after the effective date and any unvested stock options at that date. The primary effect of the revised standard’s implementation on the Company is recognition of compensation expense associated with stock options.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R), using the modified-prospective-transition method. Under that transition method, compensation expense that the Company recognizes beginning in 2006 includes: (a) the compensation expense for all stock-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value; and (b) the compensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value. Because the Company elected to use the modified prospective transition method, results for prior periods have not been restated. Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value recognition and measurement principles of APB Opinion 25, "Accounting for Stock Issued to Employees", and related interpretations ("intrinsic value method"). Under the provisions of the Company’s ISOP, the exercise price per share of each option granted cannot be less than the fair market value of the underlying common shares on the date of the grant. Accordingly, the Company previously did not recognize any stock-based employee compensation expense in net income prior to January 1, 2006.

Impact of the Adoption of SFAS No. 123(R): As a result of adopting SFAS 123(R), the Company recorded an expense of $35 in the quarter ended March 31, 2006.

Comparable Disclosures: The following table illustrates the effect on the Company’s net income and earnings per share had the Company applied fair value recognition provisions of SFAS No. 123(R) to its stock-based employee compensation in 2005:

The fair value was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for stock option grants in the quarter ended March 31, 2006 and 2005:

Expected market price volatility for the grants in the quarter ended March 31, 2006, was determined by using the Company’s historical stock price volatility on a daily basis during the seven-year period ending March 31, 2006.

Stock Option Activity: The following table summarizes the Company’s stock option activity during the three months ended March 31, 2006:

The intrinsic value of the options exercised and cash received by the Company for options exercised for the period ended March 31, 2006 was approximately $54 and $64, respectively.

Stock Options Outstanding: The following table summarizes stock options outstanding by exercise price range at March 31, 2006:

The Company sponsors a limited post-retirement benefit program which funds medical coverage and life insurance benefits to a closed group of active and retired employees who meet minimum age and service requirements. It is the Company's policy to record the cost of post-retirement health care and life insurance plans based on actuarial estimates, which are dependent on claims and premiums paid. The cost of providing these benefits is accrued during the active service period of the employee.

The Company has non-qualified supplemental executive retirement plans for certain retired officers. These plans provide supplemental retirement benefits payable in installments over a period of years upon retirement or death. The Company recognized the net present value of payments associated with the agreements over the service periods of the participating officers. Interest costs continue to be recognized on the benefit obligations.

The Company also has supplemental executive retirement plans for certain executive officers. These plans provide a stream of future payments in accordance with individually defined vesting schedules upon retirement, termination, death, or in the event that the executive leaves the Company following a change of control event.

The Company is expected to contribute $342 to the foregoing plans in 2006. As of March 31, 2006, the Company had contributed $112 to the plans.

Note 6: Commitments and Contingent Liabilities

The Bank 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.

Commitments to originate loans, including unused lines of credit, are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the borrower.

The Bank 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. Exposure to credit loss in the event of non-performance by the counter-party to the financial instrument for standby letters of credit is represented by the contractual amount of those 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.

The following table summarizes the contractual amounts of commitments and contingent liabilities as of March 31, 2006 and December 31, 2005:

As of March 31, 2006, and December 31, 2005, the fair value of the standby letters of credit were not significant to the Company’s consolidated financial statements.

As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not have a significant effect on net income.

The Company recognizes all of its derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Bank designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Bank formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Bank also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items.

Changes in fair value of derivative instruments that are highly effective and qualify as a cash flow hedge are recorded in other comprehensive income or loss. For fair value hedges that are highly effective, the gain or loss on the hedge and the loss or gain on the hedged item attributable to the hedged risk are both recognized in earnings, with the differences (if any) representing hedge ineffectiveness. The Bank discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

At March 31, 2006 the Bank had four outstanding derivative instruments with notional principal amounts totaling $50,000. These derivative instruments were interest rate swap agreements and interest rate floor agreements, with notional principal amounts totaling $20,000 and $30,000, respectively. The details are summarized as follows:

The Bank 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.

The interest rate swap agreements were designated as cash flow hedges in accordance with 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".

At March 31, 2006, the fair market value of the interest rate swap agreements was ($745) compared with ($641) and ($590) at December 31, and March 31, 2005, respectively. The fair market values of the interest rate swap agreements were included in other liabilities on the consolidated balance sheets.

At March 31, 2006, the net unrealized loss on the interest rate swap agreements included in accumulated other comprehensive loss, net of tax, amounted to $492, compared with $423 and $389 at December 31 and March 31, 2005, respectively. Also included in accumulated other comprehensive income (loss) at March 31, 2006, was a net deferred loss, net of tax, of $9 related to the de-designation and re-designation of these interest rate swap agreements as cash flow hedges in 2004.

During the three months ended March 31, 2006, the total net cash flows received from (paid to) counter-parties amounted to ($52), compared with $22 during the same period in 2005. The net cash flows received from (paid to) counter-parties were recorded in interest income.

Interest Rate Floor Agreements:

At March 31, 2006, the unamortized premium net of the unrealized loss on the interest rate floor agreement amounted to $136, net of tax, and was recorded in accumulated other comprehensive loss on the consolidated balance sheet.

Accounting for Servicing Rights of Financial Assets: In March 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 156, "Accounting for Servicing of Financial Assets". This statement amends Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires companies to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. The statement permits a company to choose either the amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective as of the beginning of a company's first fiscal year after September 15, 2006 (January 1, 2007 for the Company). The Company does not anticipate that the adoption of SFAS 156 will have a material impact on its financial condition or results of operations.

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

Use of Non-GAAP Financial Measures: Certain information discussed below is presented on a fully taxable equivalent basis. Specifically, included in first quarter 2006 and 2005 net interest income was $477 and $435, respectively, of tax-exempt interest income from certain investment securities and loans. 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 $187 and $202 in the first quarter of 2006 and 2005, respectively. The analysis of net interest income table included in this Form 10-Q provides a reconciliation of tax-equivalent financial information to the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.

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

FORWARD LOOKING STATEMENTS DISCLAIMER

Certain statements, as well as certain other discussions contained in this report on Form 10-Q, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. 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.

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

The forward-looking statements contained herein represent the Company's judgment as of the date of this report on 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 report on 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, 2005 report on Form 10-K. The reader of the financial statements should review these policies to gain a greater understanding of how the Company’s financial performance is reported. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements:

Allowance for Loan Losses - Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, which is established through a provision for loan loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income, and when a greater amount of provision for loan losses is necessary the result is lower net income. Refer to Part I, Item 2 below, 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 March 31, 2006 and December 31, 2005, there was no valuation allowance for deferred tax assets, which are included in other assets on the consolidated balance sheet.

Goodwill and Other Intangible Assets - The valuation 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. Refer to Note 2 of the consolidated financial statements in Part I, Item 1 of this report on 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 $1,563 or fully diluted earnings per share of $0.50 for the three months ended March 31, 2006 compared with $1,213 or fully diluted earnings per share of $0.38 for the same quarter in 2005, representing increases of $350 and $0.12, or 28.8% and 31.2%, respectively. The annualized return on average assets ("ROA") and average shareholders’ equity ("ROE") amounted to 0.84% and 11.16%, respectively, compared with 0.74% and 8.77% for the same quarter in 2005.

As more fully enumerated below, the increase in first quarter 2006 net income compared with the same quarter in 2005 was principally attributed to:

• A $289 increase in realized gains on the sale of securities
• A $176 or 3.3% increase in net interest income
• A $170 or 6.5% decline in salaries and employee benefits expense
• A $145 gain on the sale of Bank owned real estate
• A $54 or 18.7% increase in service charges on deposit accounts

Total loans ended the quarter at $529,119, representing an increase of $14,427 or 2.8% compared with December 31, 2005, and an increase of $71,353 or 15.6% compared with the same date last year. Commercial loans continued to drive the overall growth of the Bank’s loan portfolio.

The Bank’s non-performing loans remained at low levels during the quarter, representing $896, or 0.17% of total loans at March 31, 2006. Reflecting the continued stable performance of the loan portfolio, during the first quarter of 2006 the Bank recorded a provision for loan losses of $28 thousand, compared with none during the first quarter of 2005.

Investment securities totaled $201,129 at March 31, 2006, representing an increase of $17,829 or 9.7% compared with December 31, 2005, and an increase of $37,700 or 23.1% compared with the same date last year.

At March 31, 2006, retail deposits totaled $392,380, representing an increase of $7,035 or 1.8% compared with December 31, 2005, and an increase of $33,568 or 9.4% compared with the same date last year.

Total borrowings amounted to $243,703 at March 31, 2006, representing increases of $4,007 and $24,640, or 1.7% and 11.3%, compared with December 31, and March 31, 2005, respectively.

The Company continued to exceed regulatory requirements for well-capitalized institutions, ending the quarter with a Tier I Capital Ratio of 7.29%.

At March 31, 2006 the Company’s tangible book value per share of common stock outstanding amounted to $17.30, compared with $16.83 at the same date in 2005.

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 paid 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 March 31, 2006, net interest income on a fully tax-equivalent basis amounted to $5,674, compared with $5,513 during the first quarter of 2005, representing an increase of $161, or 2.9%. The increase in net interest income was principally attributed to an increase in average earning assets of $94,457 or 15.0%, as the first quarter 2006 net interest margin was 37 basis points lower than the same quarter in 2005.

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 table summarizes the Company’s average balance sheets and components of net interest income, including a reconciliation of tax equivalent adjustments, for the three months ended March 31, 2006 and 2005, respectively:

Net Interest Margin: The net interest margin, expressed on a tax-equivalent basis, represents the difference between interest and dividends earned on interest-earning assets and interest paid to depositors and other creditors, expressed as a percentage of average earning assets.

The net interest margin 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.

For the three months ended March 31, 2006 the net interest margin amounted to 3.17%, representing a decline of 37 basis points compared with the same period in 2005.

In June of 2004, the Board of Governors of the Federal Reserve System (the "Federal Reserve") began increasing short-term interest rates. Through March 31, 2006, the Federal Funds targeted rate was increased fifteen times, ending the quarter at 4.75%. However, during this same period of time, the benchmark 10-year U.S. Treasury note declined 2 basis points, causing a dramatic 377 basis point flattening of the U.S. Treasury yield curve.

The Bank’s interest rate sensitivity position is more fully described below in Part I, Item 3 of this report on Form 10-Q, Quantitative and Qualitative Disclosures About Market Risk.

Interest Income: For the three months ended March 31, 2006, total interest income, on a fully tax-equivalent basis, amounted to $10,881 compared with $8,743 during the same period in 2005, representing an increase of $2,138, or 24.4%.

Comparing the first quarter of 2006 with the same quarter in 2005, the weighted average yield on the Bank’s loan portfolio increased 48 basis points to 6.45%, while the weighted average yield on the investment securities portfolio increased 38 basis points to 5.16%.

Comparing the first quarter of 2006 with the same quarter in 2005, the weighted average cost of deposits increased 110 basis points to 2.62%, while the weighted average cost of borrowed funds increased 67 basis points to 4.42%. The increase in the weighted average cost of deposits outpaced the weighted average cost of borrowed funds, reflecting the longer maturities in the Bank’s borrowing base that were not as susceptible to movements in short-term market interest rates, combined with a higher utilization of brokered time deposits. In addition, given highly competitive pricing pressures and the need to strengthen customer relationships, during the first quarter of 2006 the Bank more closely followed the market with respect to the re-pricing of maturity and non-maturity deposits, a trend that may continue in the future, given competitive market pressures.

Rate / Volume Analysis: The following table sets 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.

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 Bank’s current loan portfolio.

The Bank’s non-performing loans remained at low levels during the first quarter of 2006. Non-performing loans at March 31, 2006 amounted to $896, compared with $868 and $527 at December 31, and March 31, 2005, respectively. Non-performing loans expressed as a percentage of total loans stood at 0.17% at March 31, 2006, compared with 0.17% and 0.12% at December 31 and March 31, 2005. The allowance expressed as a percentage of non-performing loans amounted to 499% at March 31, 2006, compared with 535% and 911% at December 31 and March 31, 2005, respectively.

During the first quarter of 2006, net charge offs amounted to $202, or annualized net charge offs to average loans outstanding of 0.16%. While first quarter 2006 net charge offs were $172 higher than the same quarter in 2005, management does not consider this increase in net loan charge offs to be reflective of a deterioration of credit quality. In this regard, $193 thousand of the first quarter 2006 net charge offs were attributed to one credit, which was 100% provided for in the Bank’s previously recorded allowance.

Reflecting the continued stable performance of the loan portfolio, the Bank recorded a provision for loan losses of $28 in the first quarter of 2006, compared with none during the same quarter in 2005.

Refer to Part I, Item 2 below, Allowance for Loan Losses, in this report on Form 10-Q for further discussion and analysis regarding the allowance.

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 three months ended March 31, 2006, total non-interest income amounted to $1,604, compared with $1,103 during the same period in 2005, representing an increase of $501, or 45.4%.

Factors contributing to the changes in non-interest income are enumerated in the following discussion and analysis:

Trust and Other Financial Services: Income from trust and financial services is principally derived from fee income based on a percentage of the market value of client assets under management and held in custody and, to a lesser extent, revenue from brokerage services conducted through Bar Harbor Financial Services, an independent third-party broker.

During the first quarter of 2006, income from trust and other financial services amounted to $504 compared with $475 during the same quarter in 2005, representing an increase of $29, or 6.1%.

The increase in fee income was driven by trust and investment management services, as revenue generated from third-party brokerage activities at Bar Harbor Financial Services posted small declines, reflecting lower trading volumes, including sales of mutual funds and annuity products.

At March 31, 2006, total managed assets at Bar Harbor Trust Services, a Maine chartered non-depository trust company and second tier subsidiary of the Company, stood at $226,945 compared with $220,537 and $198,362 at December 31 and March 31, 2005, representing increases of 2.9% and 14.4%, respectively.

Service Charges on Deposits: This income is principally derived from monthly deposit account maintenance and activity fees, overdraft fees, and a variety of other deposit account related fees.

Income generated from service charges on deposit accounts totaled $343 during the three month period ended March 31, 2006, compared with $289 during the same period in 2005, representing an increase of $54 or 18.7%.

While merchant credit card processing profit margins have tightened over the past few years, with competition from large regional processors intensifying, the Bank has been able to generate higher levels of revenue through increased volumes of transactions, competitive pricing strategies, and the local support offered by a community bank.

There is no assurance that the recording of securities gains will continue in future reporting periods at current or historical 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.

Occupancy Expenses: During the three months ended March 31, 2006, total occupancy expenses amounted to $312, compared with $307 during the same period in 2005, representing an increase of $5, or 1.6%. The small increase in occupancy expenses reflect, in part, the favorable impact of relatively mild weather conditions in Down East and Mid Coast, Maine, during the first quarter of 2006 compared with the same period last year.

Furniture and Equipment Expenses

Comparing the three months ended March 31, 2006 with the same period in 2005, the effective tax rates showed increases, principally due to non-taxable income bearing a smaller percentage of income before income taxes than the comparable period in 2005.

The Company’s assets principally consist of loans and investment securities, which at March 31, 2006 represented 67.8% and 25.7% of total assets, respectively.

At March 31, 2006, total assets amounted to $781,207 compared with $748,455 and $664,527 at December 31 and March 31, 2005, representing increases of $32,752 and $116,680, or 4.4% and 17.6%, respectively.

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

The overall objectives of the Bank’s strategy for the investment securities portfolio include maintaining an appropriate level of liquidity, diversifying earning assets, managing interest rate risk, leveraging the Bank’s strong capital position, and generating acceptable levels of net interest income.

At March 31, 2006, total investment securities amounted to $201,129, compared with $183,300 and $163,429 at December 31 and March 31, 2005, representing increases of $17,829 and $37,700, or 9.7% and 23.1%, respectively.

Market yields showed meaningful improvement during the first quarter of 2006, presenting management with opportunities for increasing the Bank’s earning assets and generating higher levels of net interest income.

The loan portfolio is primarily secured by real estate in the counties of Hancock, Washington and Knox, Maine. The following table summarizes the components of the Bank's loan portfolio as of the dates indicated.

Total Loans: At March 31, 2006, total loans amounted to $529,119, compared with $514,866 and $457,766 at December 31, and March 31, 2005, representing increases of $14,253 and $71,353, or 2.8% and 15.6%, respectively.

At March 31, 2006, total commercial loans amounted to $220,913, compared with $213,127 and $171,062 at December 31 and March 31, 2005, representing increases of $7,786 and $49,851, or 3.7% and 29.1%, respectively.

Commercial loans represented 54.6% and 69.9% of the total loan growth when comparing March 31, 2006 with December 31 and March 31, 2005, respectively. Bank management attributes this growth, in part, to a mature commercial lending team, a variety of new business development initiatives, and a relatively stable local economy.

In general, 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.

Non-performing Loans: Non-performing loans include loans on non-accrual status, loans that have been treated as troubled debt restructurings and loans past due 90 days or more and still accruing interest. There were no troubled debt restructurings in the loan portfolio during 2005 and this continued to be the case during the three months ended March 31, 2006. The following table sets forth the details of non-performing loans at the dates indicated:

TOTAL NON-PERFORMING LOANS

During the quarter ended March 31, 2006, non-performing loans remained at relatively low levels. The Bank attributes this success to mature credit administration processes and underwriting standards, aided by a relatively stable local economy. The Bank maintains a centralized loan collection and managed asset department, providing timely and effective collection efforts for problem loans.

At March 31, 2006, total non-performing loans amounted to $896, or 0.17% of total loans, compared with $868 or 0.17% at December 31, 2005, and $527 or 0.12% at March 31, 2005.

While the non-performing loan ratios continued to reflect the favorable quality of the loan portfolio at March 31, 2006, Bank management is cognizant of relatively soft economic conditions overall, and believes it 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, including higher interest rates and debt service levels, oil and gas prices, tourism activity, 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. OREO is classified on the consolidated balance sheet with Other Assets. At March 31, 2006, there was no OREO, unchanged from December 31 and March 31, 2005.

The allowance is maintained at a level that, in management’s judgment, is appropriate for the amount of risk inherent in the current loan portfolio, and adequate to provide for estimated losses.

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 $463 as of March 31, 2006, compared with $593 and $80 as of December 31 and March 31, 2005, respectively. The related allowance for loan losses on these impaired loans amounted to $54 as of March 31, 2006, compared with $238 and $21 at December 31 and March 31, 2005, respectively.

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 loan 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. 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.

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.

For the three months ended March 31, 2006, net charge-offs amounted to $202, or annualized net charge-offs to average loans outstanding of 0.16%, compared with net charge-offs of $30, or annualized net charge-offs to average loans outstanding of 0.03% during the same period in 2005. Of the $202 in first quarter 2006 net charge-offs, $193 was attributed to one borrower, which was 100% provided for in the Bank’s previously recorded allowance.

There were no material changes in loan concentrations during the three months ended March 31, 2006.

The following table details changes in the allowance and summarizes loan loss experience by loan type for the three-month periods ended March 31, 2006 and 2005.

Based upon the process employed and giving recognition to all attendant factors associated with the loan portfolio, management believes the allowance for loan losses at March 31, 2006, to be appropriate for the risks inherent in the loan portfolio and resident in the local and national economy as of that date.

Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring and higher deposits in summer and autumn. These seasonal swings have been fairly predictable and have not had a materially adverse impact on the Bank. Seasonal swings in deposits have been typically absorbed by the Bank’s strong liquidity position, including borrowing lines from the Federal Home Loan Bank of Boston ("FHLB") and cash flows from the securities portfolio. During the first quarter of 2006, the Bank’s net deposit outflows were less than historical norms. Management attributes this to the successful introduction of a new variable rate money market account product, combined with deposit pricing strategies designed to satisfy the changing expectations of its customers, as market interest rates and competitive pricing pressures continued to escalate.

At March 31, 2006, total deposits amounted to $474,752 compared with $445,731 and $384,204 at December 31 and March 31, 2005, representing increases of $29,021 and $90,548, or 6.5% and 23.6%, respectively.

The increases in total deposits were principally attributed to certificates of deposit obtained from the national market ("brokered deposits"), which increased $21,986 and $56,980, or 36.4% and 224.4%, when comparing March 31, 2006 with December 31 and March 31, 2005, respectively. The increase in brokered deposits was utilized to help fund the Bank’s earning asset growth, which outpaced retail deposit growth. Additionally, during 2005 the Bank modified its funding and liquidity strategies, providing more balance between brokered deposits and borrowed funds.  Borrowed funds at March 31, 2006, showed increases of 1.7% and 11.3% compared with December 31, and March 31, 2005, respectively.

At March 31, 2006, retail deposits totaled $392,380 compared with $385,345 and $358,812 at December 31 and March 31, 2005, representing increases of $7,035 and $33,568, or 1.8% and 9.4%, respectively. Comparing March 31, 2006 with the same date in 2005, savings and money market accounts led the overall growth, followed by certificates of deposit and NOW accounts. However, the rate of demand deposit growth lagged historical norms. During the second and third quarters of 2005, the Bank launched several new deposit products, including free business and personal checking products, which it believes are highly competitive. Management believes these products will help increase demand deposits in the foreseeable future.

Management believes that competition from banks and non-banks has intensified, as savers and investors seek higher returns in an atmosphere of rising short-term interest rates, and that financial institutions in particular have been aggressively pricing their deposits in order to fund earning asset growth.

Since short-term rates began rising in June 2004, management has exercised restraint with respect to overly aggressive deposit pricing strategies, and has sought to achieve an appropriate balance between retail deposit growth and wholesale funding levels, while considering the associated impacts on the Bank’s net interest margin and liquidity position.

At March 31, 2006, retail deposits represented 82.6% of total deposits, compared with 86.5% and 93.4% at December 31 and March 31, 2005, respectively.

Borrowed Funds

The Bank utilizes borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk, given the Bank’s ability to select desired amounts, terms and maturities on a daily basis.

At March 31, 2006, total borrowings amounted to $243,703, compared with $239,696 and $219,063 at December 31 and March 31, 2005, representing increases of $4,007 and $24,640, or 1.7% and 11.3%, respectively. The increases in borrowed funds were utilized to help support the Bank’s earning asset growth, which outpaced retail deposit growth.

At March 31, 2006, total borrowings expressed as a percent of total assets amounted to 31.2%, compared with 32.0% and 33.0% at December 31 and March 31, 2005, respectively.

Capital Resources

The Company and the Bank are subject to the risk based capital guidelines administered by the Company’s and the Bank's principal regulators. The risk based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of risk weighted assets and off-balance sheet items. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk based capital to risk weighted assets of 8%, including a minimum ratio of Tier I capital to total risk weighted assets of 4% and a Tier I capital to average assets of 4% ("Leverage Ratio"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on the Company's financial statements.

As of March 31, 2006, the Company and the Bank were considered well capitalized under the regulatory framework for prompt corrective action. Under the capital adequacy guidelines, a well capitalized institution must maintain a minimum total risk based capital to total risk weighted assets ratio of at least 10%, a minimum Tier I capital to total risk weighted assets ratio of at least 6%, and a minimum Tier I leverage ratio of at least 5%.

In March 2004, the Company announced its second stock repurchase plan. The board of directors of the Company authorized open market and privately negotiated purchases of up to 10% of the Company’s outstanding shares of common stock, or 310,000 shares. Purchases began on March 4, 2004 and continued through December 31, 2005. The Company’s board of directors subsequently authorized the continuance of this stock repurchase plan through December 31, 2006. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time, or from time-to-time, without prior notice. As of March 31, 2006, the Company had repurchased 122,457 shares of stock under this plan, or 39.5% of the total authorized, at a total cost of $3,359 and an average price of $27.43 per share. The Company records the repurchased shares as treasury stock.

The Company believes that a stock repurchase plan is a prudent use of capital at this time. Management anticipates the stock repurchase plan will be accretive to the return on average shareholders’ equity and earnings per share.

The Company is a party to certain contractual obligations under which it is obligated to make future payments. These principally include borrowings from the FHLB, consisting of short and long-term fixed rate borrowings, and collateralized by all stock in the FHLB, a blanket lien on qualified collateral consisting primarily of loans with first and second mortgages secured by one-to-four family properties, and certain pledged investment securities. The Company has an obligation to repay all borrowings from the FHLB.

The following table summarizes the Company’s contractual obligations at March 31, 2006. Borrowings are stated at their contractual maturity due dates and do not reflect call features, or principal amortization features, on certain borrowings.

In the normal course of its banking and financial services business, and in connection with providing products and services to its customers, the Company has entered into a variety of traditional third party contracts for support services. Examples of such contractual agreements would include services providing ATM, Visa debit and credit card processing, trust services accounting support, student loan servicing, check printing, and the leasing of T-1 telecommunication lines supporting the Company’s wide area technology network.

The majority of the Company’s core operating systems and software applications are maintained "in-house" with traditional third party maintenance agreements of one year or less.

Off-Balance Sheet Arrangements

The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.

At March 31, 2006, the Company’s off-balance sheet arrangements were limited to standby letters of credit.

Standby Letters of Credit: The Bank guarantees the obligations or performance of certain customers by issuing standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing 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 origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.

At March 31, 2006, commitments under existing standby letters of credit totaled $115, compared with $115 and $1,284 at December 31 and March 31, 2005, respectively. The fair value of the standby letters of credit was not significant as of the foregoing dates.

Off Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and certain financial derivative instruments; namely, interest rate swap agreements and interest rate floor agreements.

Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis using the same credit policies as it does for its balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Bank upon the issuance of commitment, is based on management's credit evaluation of the customer.

The following table summarizes the Bank's commitments to extend credit as of the dates shown: