Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: YES: _____  NO:    X  
                    Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act: YES: _____  NO:     X   
                    Indicate by check mark if 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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. _____
                    Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
                                                                        Large accelerated filer _____        Accelerated filer     X           Non-accelerated filer _____
                    Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2): YES: _____  NO:     X  
                    As of June 30, 2006, the aggregate market value of the 2,989,070 shares of Common Stock of the Registrant issued and outstanding on such date, excluding the approximately 59,770 shares held by all directors and executive officers of the Registrant as a group (which does not include unexercised stock options), was $88,262,471. This aggregate market value is based on the last sale price of $28.95 per share of the Registrant’s Common Stock on June 30, 2006, as reported in The Wall Street Journal on July 3, 2006. Although directors of the Registrant and executive officers of the Registrant and its subsidiaries were assumed to be "affiliates" of the Registrant for purposes of this calculation, the classification is not to be interpreted as an affirmation of such status.
                    Number of shares of Common Stock par value $2.00 outstanding as of March 6, 2007: 3,047,530

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

The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materially adverse effect on its business. Historically, the banking business in the Bank’s market area has been seasonal, with lower deposits in the winter and spring, and higher deposits in the summer and fall. These seasonal swings have been fairly predictable and have historically not had a material adverse impact on the Bank or its liquidity position. Approximately 89% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on all of the deposit account products it offers and does not anticipate any material loss of these deposits.

The Bank emphasizes personal service to the community, with a concentration on retail banking. Customers are primarily individuals and small businesses to which the Bank offers a wide variety of products and services.

Retail Products and Services: The Bank offers a variety of consumer financial products and services designed to satisfy the deposit and borrowing needs of its retail customers. The Bank’s retail deposit products and services include checking accounts, interest bearing NOW accounts, money market accounts, savings accounts, club accounts, short-term and long-term certificates of deposit, and Individual Retirement Accounts. Credit products and services include home mortgages, residential construction loans, home equity loans and lines of credit, student loans, credit cards, installment loans, and overdraft protection services. Secured and unsecured installment loans are provided for new or used automobiles, boats, recreational vehicles, mobile homes and other personal needs. The Bank also offers other customary products and services such as safe deposit box rental, wire transfers, check collection services, foreign currency exchange, money orders, Travelers Checks, and U.S. Savings Bonds.

The Bank staffs a customer service center, providing customers with telephone and e-mail responses to their questions and needs. The Bank also offers free banking-by-mail services.

Retail Brokerage Services: The Bank retains Infinex Investments, Inc, ("Infinex") as a full service third-party broker-dealer, conducting business under the assumed business name "Bar Harbor Financial Services." Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker-dealer offering securities and insurance products that is not affiliated with the Company or its subsidiaries. These products are not deposits, are not insured by the FDIC or any other government agency, are not guaranteed by the Bank or any affiliate, and may be subject to investment risk, including possible loss of value.

Bar Harbor Financial Services principally serves the brokerage needs of individuals, from first-time purchasers, to sophisticated investors. It also offers a line of life insurance, annuity, and retirement products, as well as financial planning services. Infinex was formed by a group of member banks, and is reportedly the current largest provider of third party investment and insurance services to banks and their customers in New England. Through Infinex, the Bank is able to take advantage of the expertise, capabilities, and experience of a well-established third-party broker-dealer in a cost effective manner.

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

Commercial Products and Services: The Bank serves the small business market throughout downeast and midcoast Maine. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, real estate and equipment financing, working capital, real estate development, and a broad range of other business purposes. Business loans are provided primarily to organizations and sole proprietors in the tourist, hospitality, healthcare, blueberry, boatbuilding, and fishing industries, as well as to other small and mid-size businesses associated with coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with other financial institutions, whereby the Bank retains only such portions of those loans that are within its lending limits and credit risk tolerances.

The Bank offers a variety of commercial deposit accounts, most notably business checking and tiered money market accounts. These accounts are typically used as operating accounts or short-term savings vehicles. The Bank’s cash management services provide business customers with short-term investment opportunities through a cash management sweep program, whereby excess operating funds over established thresholds are swept into overnight securities sold under agreements to repurchase. The Bank also offers Business On Line Direct ("BOLD") an Internet banking service for businesses. This service allows business clients to view their account histories, print statements, view check images, order stop payments, transfer funds between accounts, transmit Automated Clearing House (ACH) files, and order both domestic and foreign wire transfers. Other commercial banking services include merchant credit card processing, night depository, and coin and currency handling.

Bar Harbor Trust Services

Trust Services is a Maine chartered, non-depository trust company and a wholly owned subsidiary of the Bank. Trust Services provides a comprehensive array of trust and investment management services to individuals, businesses, not-for-profit organizations, and municipalities of varying asset size.

Trust Services serves as trustee of both living trusts and trusts under wills, including revocable and irrevocable, charitable remainder and testamentary trusts, and in this capacity holds, accounts for and manages financial assets, real estate and special assets. Trust Services offers custody, estate settlement, and fiduciary tax services. Additionally, Trust Services offers employee benefit trust services for which it acts as trustee, custodian, administrator and/or investment advisor, for employee benefit plans and for corporate, self employed, municipal and not-for-profit employers located throughout the Company’s market areas.

The staff includes credentialed investment and trust professionals with extensive experience. At December 31, 2006, Trust Services served 754 client accounts, with assets under management and held in custody amounting to $252 million and $37 million, respectively.

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

According to the Maine State Planning Office, the Maine economy grew moderately in 2006, finding stability despite the potential threats of high energy prices, rising interest rates, and a declining housing market. The housing slowdown in Maine emerged in late summer and continued through the fall. Home sales in the September to November timeframe were down 14% from a year earlier, the same decline experienced by New England as a whole. The State Planning Office also reported that while Maine’s Gross State Product grew by 1.5% in 2006, that growth was less than half the national growth rate of 3.2%.

According to the Maine Department of Revenue Services, taxable sales grew 3% in 2006 compared with 2005. Restaurant/Lodging and Other Retail stores saw the strongest sales growth of 5% and 8%, respectively. The weakest growth was in the automotive and transportation category where taxable sales actually declined 2%. Reflecting recent declines in the housing markets, while building supplies were up 3% in 2006, the November and December numbers were 10% lower than the same period in 2005.

According to the Maine Department of Labor, the 2006 unemployment rate fell to 4.6% compared with 4.8% in 2005. In December, the unemployment rate was 4.7% compared with the national rate of 4.5%. During 2006, job gains were achieved in all sectors except manufacturing.

Changes in the economy are difficult to predict, and the foregoing discussion may or may not be indicative of whether the northern New England economy, including the state of Maine, and particularly downeast and midcoast Maine, is improving or will continue to strengthen. A downturn in the local economies that the Company serves, or material adverse changes in the real estate markets could negatively impact the Company’s business, financial condition, and results of operations.

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

The Company has two principal officers: Joseph M. Murphy, President and Chief Executive Officer, and Gerald Shencavitz, Chief Financial Officer and Treasurer.

The Company maintains comprehensive employee benefit programs, which provide health, dental, long-term and short-term disability, and life insurance. All Company employees are eligible for participation in the Bar Harbor Bankshares 401(k) Plan provided they meet minimum age requirements. Certain officers and employees of the Company and its subsidiaries also participate in the Company’s 2000 Stock Option Plan and/or have incentive bonus compensation plans, deferred compensation arrangements, supplemental executive retirement agreements and change in control, confidentiality and non-compete agreements.

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

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

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

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

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

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

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

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

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

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

Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from Part II, Item 7, section entitled "Capital Resources" and from Part II, Item 8, Notes to Consolidated Financial Statements, Note 12 "Shareholders’ Equity," each in this Annual Report on Form 10-K for the year ended December 31, 2006.

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

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

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

Community Reinvestment: Pursuant to the Community Reinvestment Act ("CRA") and similar provisions of Maine law, regulatory authorities review the performance of the Company and the Bank in meeting the credit needs of the communities served by the Bank. The applicable regulatory authorities consider compliance with this law in connection with the applications for, among other things, approval for branches, branch relocations, and acquisitions of banks and bank holding companies. The Bank received a "satisfactory" rating at its most recent CRA examination, October 3, 2005.

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

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

USA Patriot Act: The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The Patriot Act, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, including the Bank and Trust Services, to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions. It also requires the Federal Reserve Board (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money-laundering activities when considering applications filed under Section 3 of the BHC Act, or under the Bank Merger Act. In 2006, final regulations under the USA Patriot Act were issued requiring financial institutions, including the Bank, to take additional steps to monitor their correspondent banking and private banking relationships as well as their relationships with "shell banks." Management believes the Company is in compliance with all of the requirements prescribed by the Patriot Act and all applicable final implementing regulations.

Insurance of Accounts and FDIC Regulation: The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC. In 2006, the FDIC enacted various rules to implement the provisions of the Federal Deposit Insurance Reform Act of 2005 (the "FDI Reform Act"). Pursuant to the FDI Reform Act, in 2006 the FDIC merged the Bank Insurance Fund with the Savings Association Insurance Fund to create a newly named Deposit Insurance Fund (the "DIF") that covers both banks and savings associations. The FDIC also revised, effective January 1, 2007, the risk-based premium system under which the FDIC classifies institutions based on the factors described below and generally assesses higher rates on those institutions that tend to pose greater risks to the DIF. For most banks and savings associations, including the Bank, FDIC rates will depend upon a combination of CAMELS component ratings and financial ratios. CAMELS ratings reflect the applicable bank regulatory agency’s evaluation of the financial institution’s capital, asset quality, management, earnings, liquidity and sensitivity to risk. For large banks and savings associations that have long-term debt issuer ratings, assessment rates will depend upon such ratings, and CAMELS component ratings. For institutions, such as the Bank, which are the lowest risk category, assessment rates will vary initially from five (5) to seven (7) basis points per $100 of insured deposits. The Federal Deposit Insurance Act ("FDIA") as amended by the FDI Reform Act requires that the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits, the designated reserve ratio (the "DRR") for a particular year within a range of 1.15% to 1.50%. For 2007, the FDIC has set the initial DRR at 1.25%. Under the FDIC’s revised premium assessment program, every FDIC insured institution will pay some level of deposit insurance assessments regardless of the level of the DRR. In 2006 the Bank paid assessments totaling $58,267, or 0.0122 cents per $100 of deposits. The Company cannot predict whether, as a result of an adverse change in economic conditions or other reasons, the FDIC will be required in the future to increase deposit insurance assessments above 2006 levels.

Securities Regulation: The common stock of the Company is registered with the U. S. Securities and Exchange Commission ("SEC") under Section 12(g) of the Securities Exchange Act of 1934, as amended. Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Act.

Financial Information About Industry Segments

The information required under this item is included in the Company’s financial statements, which appear in Part II, Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.

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

In its normal course of business, the Company is subject to many risks and uncertainties inherent with providing banking and financial services. Although the Company continually seeks ways to manage these risks, and has established programs and procedures to ensure controls are in place and operating effectively, the Company ultimately cannot predict the future. Actual results may differ materially from the Company’s expectations due to certain risks and uncertainties. The following discussion sets forth the most significant risk factors that the Company believes could cause its actual future results to differ materially from expected results.

The risks and uncertainties discussed below are not all inclusive. Additional risks and uncertainties that the Company is unaware of, or that it currently deems immaterial, may also become important factors relating to the Company’s future operating results and financial condition.

The Bank’s allowance for loan losses may not be adequate to cover loan losses.

A significant source of risk for the Company arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Bank are secured, but some loans are unsecured based upon management’s evaluation of the creditworthiness of the borrowers. With respect to secured loans, the collateral securing the repayment of these loans principally includes a wide variety of real estate, and to a lesser extent personal property, either of which may be insufficient to cover the obligations owed under such loans.

Collateral values and the financial performance of borrowers may be adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates and debt service levels, changes in oil and gas prices, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events, which are beyond the control of the Bank. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards might create the impression that a loan is adequately collateralized when in fact it is not. Although the Bank may acquire any real estate or other assets that secure defaulted loans through foreclosures or other similar remedies, the amounts owed under the defaulted loans may exceed the value of the assets acquired.

The Bank has adopted underwriting and credit monitoring policies and procedures, including the establishment and ongoing review of the allowance for loan losses and regular review of borrower financial statements and collateral appraisals, that management believes are appropriate to mitigate the risk of loss by assessing the likelihood of borrower non-performance and the value of available collateral. The Bank also manages credit risk by diversifying its 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. However, such policies and procedures have limitations, including judgment errors in management’s risk analysis, and may not prevent unexpected losses that could have a material adverse effect on the Company’s business, financial condition and results of operations.

Interest rate volatility could significantly reduce the Company’s profitability.

The Company regularly assesses the level of operational risk throughout the organization and has established systems of internal controls that provide for timely and accurate information. Testing of the operating effectiveness of these control systems is performed regularly. While not providing absolute assurance, these systems of internal controls have been designed to manage operational risks at appropriate, cost-effective levels. Procedures exist that are designed to ensure policies relating to conduct, ethics, and business practices are followed. From time to time losses from operational risk may occur, including the effects of operational errors. Such losses are recorded as non-interest expense.

The Company's success is dependent to a significant extent upon general economic conditions in the United States and, in particular, the local economies of downeast and midcoast Maine, the primary markets served by the Company. The Company’s success is also dependent on Maine's ability to attract new business, as well as factors that affect tourism, a major source of economic activity in the Company’s immediate market areas. The Company is particularly exposed to real estate and economic factors in the downeast and midcoast areas of Maine, as virtually the entire loan portfolio is concentrated among borrowers in these markets. Furthermore, because a substantial portion of the Bank’s loan portfolio is secured by real estate in these areas, the value of the associated collateral is also subject to regional real estate market conditions. An economic downturn in the markets served by the Company, or the nation as a whole, could negatively impact household and corporate incomes. This impact could lead to decreased demand for both loan and deposit products and increase the number of borrowers who fail to pay the Bank interest or principal on their loans, and accordingly, could have a material adverse effect on the Company’s business, financial condition, results of operations, or liquidity.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on brokered funds and borrowings in the future, which are typically more expensive than deposits.

Changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows. For further information about the Company’s liquidity position, refer to Part II, Item 7, "Liquidity Risk."

The Company depends upon data processing software, communication and information exchange on a variety of computing platforms and networks including the Internet. Despite instituted safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerably to attack or other technological difficulties or failures. The Company also relies on the services of a variety of third party vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be misappropriated, services and operations may be interrupted and the Company could be exposed to claims from customers, suffer loss of business and suffer loss of reputation in its marketplace. Any of these results could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.

No assurance can be given that the Company will continue to be able to compete effectively with other financial institutions in the future. Furthermore, developments increasing the nature or level of competition could have a material adverse affect on the Company’s business, financial condition, results of operations or liquidity. For further information on competition, refer to Part I, Item 1, "Competition" and "Supervision and Regulation."

Non-compliance with the Bank Secrecy Act, the USA Patriot Act and related laws and regulations could result in significant fines or sanctions. These particular laws and regulations have significant implications for all financial institutions, establish new crimes and penalties, and require the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money-laundering and terrorist activities. Even innocent non-compliance and inconsequential failure to follow the regulations may result in significant fines or other penalties, which could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.

In the event the Bank forecloses on a defaulted commercial or residential mortgage loan to recover its investment, it may be subject to environmental liabilities in connection with the underlying real property, which could significantly exceed the value of the real property. Although the Bank exercises due diligence to discover potential environmental liabilities prior to acquiring any property through foreclosure, hazardous substances or wastes, contaminants, pollutants, or their sources may be discovered on properties during its ownership or after a sale to a third party. There can be no assurance that the Bank would not incur full recourse liability for the entire cost of any removal and cleanup on an acquired property, that the cost of removal and cleanup would not exceed the value of the property, or that it could recover any of the costs from any third property. Losses arising from environmental liabilities could have a material adverse impact on the Company’s business, financial condition, results of operations, or liquidity.

None.

ITEM 2. PROPERTIES

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

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

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

3. A retail branch banking office is located at 314 Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975. The branch office was added to, and renovated in 1989, to better meet the Bank’s needs at that location.

4. A retail branch banking office is located at 25 Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the Bank’s needs at that location.

6. A retail branch banking office is located at 2 Bridge Street, Milbridge, Maine. This property consists of a building constructed in 1974, to which a vestibule was added in 1994 to house an ATM that helps to better meet the needs at that location.

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

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

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

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

12. An Operations Center is located in Ellsworth, Maine, that houses the Company’s operations and data processing centers. The building was constructed in 1996 and is currently adequate for the Company’s needs.

13. The Bank and its wholly owned subsidiary, Trust Services, own and occupy a 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. The facility was renovated in 2001.

Additional real estate owned by the Company includes two additional parcels (one improved) contiguous to the Bank’s 135 High Street, Ellsworth location.

The Bank’s Somesville branch banking office located at 1055 Main Street, Somesville, Maine, is a leased property. The Bank and Trust Services also lease office space at One Cumberland Place in Bangor, Maine.

The Company believes that its offices are sufficient for its present operations. Additional information relating to the Company’s properties is provided in Item 8, Note 6 of the Consolidated Financial Statements contained in this Annual Report on Form 10-K and incorporated herein by reference.

The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of the Company’s security holders in the fourth quarter of 2006.

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The following graph illustrates the estimated yearly percentage change in the Company's cumulative total stockholder return on its Common Stock for each of the last five years. Total stockholder return is computed by taking the difference between the ending price of the Common Stock at the end of the previous year and the current year, plus any dividends paid divided by the ending price of the Common Stock at the end of the previous year. For purposes of comparison, the graph also illustrates comparable stockholder return of AMEX listed banks as a group as measured by the AMEX Market Index and the peer group index as defined by AMEX. The graph assumes a $100 investment on December 31, 2001 in the common stock of each of the Company, the AMEX peer group banks and the AMEX Market Index as a group and measures the amount by which the market value of each, assuming reinvestment of dividends, has increased as of December 31 of each calendar year since the base measurement point of December 31, 2001.

(COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN GRAPH)

 Market values are based on information obtained from the American Stock Exchange.

Dividends paid by the Company in 2006 and 2005 are summarized below:

During 2006, the Company declared and distributed cash dividends in the aggregate amount of $2.76 million, compared with $2.58 million in 2005. The Company’s 2006 dividend payout ratio amounted to 40.1%, compared with 40.2% in 2005. The total dividends paid in 2006 amounted to $0.905 per common share of stock, compared with $0.84 in 2005, representing an increase of $0.065, or 7.7%.

In the first quarter of 2007, the Company increased its quarterly cash dividend by $0.005 to $0.235 per common share, representing an increase of $0.015 or 6.8% compared with the dividend paid for the same quarter in 2006. The dividend will be paid March 15, 2007 to shareholders of record as of the close of business on February 16, 2007.

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

The following table sets forth information with respect to any purchase made by or on behalf of the Company or any "affiliated purchaser," as defined in Sec. 240.10b-18(a)(3) under the Exchange Act, of shares of the Company’s common stock during the periods indicated:

On October 3, 2000, the shareholders of the Company approved the Bar Harbor Bankshares and Subsidiaries Incentive Stock Option Plan of 2000, which is described more fully in Part II, Item 8, Notes 1 and 13 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

The following table provides information as of December 31, 2006 with respect to the shares of Common Stock that may be issued under the Company's Incentive Stock Option Plan.

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

The following information should be analyzed in conjunction with Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and with the audited consolidated financial statements included in this Annual Report on Form 10-K.

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

The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the years ended December 31, 2006, 2005 and 2004 should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Annual Report on Form 10-K. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years, and provide supplemental information and analysis.

Amounts in prior period financial statements are reclassified whenever necessary to conform with current period presentation.

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

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.

Bar Harbor Bankshares is a Maine corporation and a registered bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 2006, the Company had consolidated assets of $825 million and was one of the larger independent community banking institutions in Maine.

The Company attracts deposits from the general public in the markets it serves and uses such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage and home equity loans, and a variety of consumer loans. The Company also invests in mortgage-backed securities, obligations of government-sponsored enterprises, obligations of state and political subdivisions, as well as other securities. In addition to community banking, the Company provides a comprehensive array of trust and investment management services through its second tier subsidiary, Bar Harbor Trust Services ("Trust Services") a Maine chartered non-depository trust company.

The principal source of the Company’s revenue is net interest income, representing the difference or spread between interest income from its earning assets and the interest expense paid on deposits and borrowed funds. 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. The Company’s non-interest income is derived from financial services including trust, investment management and third-party brokerage services, as well as service charges on deposit accounts, merchant credit card transaction processing fees, realized gains or losses on the sale of securities, and a variety of other miscellaneous product and service fees.

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

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

Management has numerous policies and control processes in place that provide for the monitoring and mitigation of risks based upon and driven by a variety of assumptions and actions which, if were changed or altered, could impact the Company’s business, financial condition, results of operations or liquidity. The foregoing matters are more fully discussed in Part I, Item 1A, "Risk Factors," and throughout this Annual Report on Form 10-K.

• Loans: Total loans ended the year at $555 million, representing an increase of $40 million, or 7.8%, compared with December 31, 2005. Business lending activity continued at a relatively strong pace during 2006, contributing $26 million or nearly two-thirds of the year-over-year loan growth. At December 31, 2006, consumer loans and commercial loans comprised 56% and 43% of the loan portfolio, compared with 59% and 41% at December 31, 2005, respectively.
  
• Credit Quality: The Bank’s non-performing loans remained at low levels during 2006. At year-end, total non-performing loans amounted to $628 thousand or 0.11% of total loans, compared with $868 thousand or 0.17% at December 31, 2005. The Bank’s loan loss experience continued at low levels during 2006, with net charge-offs amounting to $253 thousand, or net charge-offs to average loans outstanding of 0.05%, compared with $182 thousand, or net charge-offs to average loans outstanding of 0.04% during 2005. The provision for loan losses totaled $131 thousand in 2006, compared with no provision in 2005, principally reflecting growth in the Bank’s loan portfolio.

• Securities: Total securities ended the year at $213 million, representing an increase of $30 million or 16.3% compared with December 31, 2005. During 2006, market yields showed meaningful improvement, with the 5-year U.S. Treasury note climbing to a five year high and the benchmark 10-year U.S. Treasury note reaching a four-year high, presenting opportunities for increasing the Bank’s earning assets and generating higher levels of net interest income.

• Deposits: Total deposits ended the year at $496 million, representing an increase of $51 million or 11.3% compared with December 31, 2005. Deposit growth was supplemented with $22 million in certificates of deposit obtained in the national market, as the Bank’s earning asset growth continued to outpace retail deposit growth. Total retail deposits ended the year at $414 million, representing an increase of $29 million, or 7.4%, compared with December 31, 2005. Money market accounts led the overall growth in retail deposits, which was principally attributed to the introduction of a new variable rate money market account in early 2006.
  
• Borrowings: Borrowed funds principally consist of advances from the Federal Home Loan Bank of Boston. During 2006 the Bank continued to utilize borrowed funds in leveraging its strong capital position and supporting its earning asset portfolios. Total borrowings ended the year at $261 million, representing an increase of $21 million or 8.8% compared with December 31, 2005.
  
• Shareholders’ Equity: Consistent with its long-term strategy of operating a sound and profitable organization, the Company continued to exceed regulatory requirements for "well-capitalized" institutions. At December 31, 2006, the Company’s Tier I Leverage, Tier I Risk-based, and Total Risk-based Capital ratios amounted to 7.34%, 10.82% and 11.65%, respectively. Total shareholders’ equity ended the year at $61 million, representing an increase of $5 million, or 9.0%, compared with December 31, 2005.

Summary Results of Operations

Net income for the year ended December 31, 2006 amounted to $6.9 million, or fully diluted earnings per share of $2.20, compared with $6.4 million or fully diluted earnings per share of $2.03 for the year ended December 31, 2005, representing increases of 7.1% and 8.4%, respectively.

The Company’s return on average equity ("ROE") amounted to 11.95% in 2006, compared with 11.44% in 2005.

• Net Interest Income: Net interest income continued to be the principal component of the Company’s income stream. Net interest income, on a tax equivalent basis, amounted to $22.4 million for the year ended December 31, 2006, representing a decline of $140 thousand or 0.6%, compared with 2005. The decline in net interest income was principally attributed to a 47 basis point decline in the net interest margin, which in 2006 amounted to 2.96%. As is widely the situation throughout the banking industry, the decline in the net interest margin was largely attributed to the seventeen increases in short term interest rates by the Federal Reserve Bank from June 2004 to June 2006 and a flat-to-inverted yield curve throughout 2006, the impact of which has caused the Bank’s funding costs to increase at a faster pace than the yield on its earning asset portfolios.

• Income Tax Expense: The effective income tax rate for 2006 was 29.5%, compared with 28.7% in 2005.

Management believes the primary challenge facing the Company in 2007 is the continuation of a flat-to-inverted U.S. Treasury yield curve, which without substantial change will continue to pressure the Bank’s net interest margin. Management also believes that meaningful increases net interest income will largely depend on the Bank’s ability to grow the loan portfolio and continue gathering core deposits. The Bank’s credit quality has been remarkably strong over the past few years and the continuation of this trend will be a significant determinant of the Company’s future financial performance.

Given the current interest rate posture of the Federal Reserve, declining loan demand in the markets served by the Bank, intensifying competition for loans and deposits, a slowing real estate market, and softening economic conditions overall, management believes the external challenges facing the Company and the banking industry as a whole in 2007 may be among the greatest encountered for many years.

Other factors, which could affect the Company’s financial performance and that of its common stock, are more fully enumerated in the "Forward-Looking Statements" discussion at the beginning of this Annual Report on Form 10-K and the Company’s discussion of certain "Risk Factors" set forth in Part I, Item 1A of this Report.

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 this Annual 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 II, Item 7, Allowance for Loan Losses and Provision, in this Annual Report on Form 10-K, 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 December 31, 2006 and 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, may have an adverse effect the Company's results of operations. Refer to Notes 1 and 7 of the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further details of the Company’s accounting policies and estimates covering goodwill and other intangible assets.

FINANCIAL CONDITION

Asset / Liability Management

In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate, and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets represented 95.9% and 95.2% of total average assets during 2006 and 2005, respectively.

The Company, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit products offered within the markets served, as well as through the prudent use of borrowed and brokered funds.

Total tax-equivalent interest and dividend income during 2006 amounted to $46,850 compared with $37,877 in 2005, representing an increase of $8,973, or 23.7%. The 2006 increase in interest and dividend income was principally attributed to earning asset growth, combined with higher earning asset yields.

At December 31, 2006 the Company’s total assets stood at $824,877 compared with $747,945 at year-end 2005, representing an increase of $76,932, or 10.3%. The increase in total assets was principally attributed to loan growth of $40,233 or 7.8%, followed by an increase in securities amounting to $29,952, or 16.3%.

The securities portfolio represented 26.9% of the Company’s average earning assets during 2006 and generated 22.6% of total tax-equivalent interest and dividend income, compared with 25.0% and 20.4% in 2005 and 2004, respectively.

The 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.

In light of the historically low interest rate environment in prior years, the Bank’s investment strategy had been principally focused on maintaining the majority of the securities portfolio with a relatively short average duration, thereby limiting some of the exposures associated with sustained increases in interest rates. The Bank’s strategy had been to position the majority of the securities portfolio defensively with a steady stream of future cash flows. While this strategy sacrificed 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 risks, and position the portfolio for a rising rate environment. During 2006 cash flows generated from pay-downs on mortgage-backed securities amounted to $27,355, the vast majority of which were reinvested into higher yielding securities.

Total Investment Securities: At December 31, 2006, total investment securities stood at $213,252 compared with $183,300 at December 31, 2005, representing an increase of $29,952, or 16.3%.

During 2006 market yields showed meaningful improvement, with the 5-year U.S. Treasury note climbing to a five year high and the benchmark 10-year U.S. Treasury note reaching a four-year high, presenting opportunities for increasing the Bank’s earning assets and generating higher levels of net interest income.

Trading Securities: Trading securities are securities bought and held principally for the purpose of selling them in the near term with the objective of generating profits on short-term differences in price. During the years ended December 31, 2006 and 2005, the Bank did not own any trading securities.

Securities Held to Maturity: Securities held to maturity are debt securities for which the Bank has the positive intent and ability to hold until maturity. Held to maturity investments are reported at their aggregate cost, adjusted for amortization of premiums and accretion of discounts. During the years ended December 31, 2006 and 2005, the Bank did not own any securities held to maturity. Management does not intend to utilize the held to maturity classification in the foreseeable future.

The following table summarizes the securities available for sale portfolio as of December 31, 2006 and 2005:

Securities Interest Income: The total aggregate tax-equivalent yield on the securities portfolio amounted to 5.21% in 2006, compared with 4.72% in 2005, representing an increase of 49 basis points. The increase was principally attributed to the availability of higher market yields in 2006 compared with prior years. In addition, most of the 2006 cash flows from the securities portfolio were reinvested into securities with higher market yields.

Securities Maturity Distribution and Weighted Average Yields: The following tables summarize the maturity distribution of the amortized cost of the Bank’s securities portfolio and weighted average yields of such securities on a fully tax-equivalent basis as of December 31, 2006 and 2005. The maturity distribution is based upon the final maturity date of the securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or pre-pay certain securities. In the case of mortgage-backed securities, actual maturities may also differ from expected maturities due to the amortizing nature of the underlying mortgage collateral, and the fact that borrowers in most cases have the right to prepay.

Securities Concentrations: At December 31, 2006 and 2005, the Bank did not hold any securities for a single issuer, other than U. S. Government agencies and sponsored enterprises, where the aggregate book value of the securities exceed 10% of the Company’s shareholders’ equity. Management believes U.S. Government-sponsored enterprises have minimal credit risk, as they play a vital role in the nation’s financial markets. At December 31, 2006 and 2005, all securities issued by Government agencies and sponsored enterprises were credit rated "AAA" by Moody’s and Standard and Poor’s.

Impaired Securities: The securities portfolio contains certain securities where amortized cost exceeds fair market value, which at December 31, 2006 amounted to an excess of $2,635, compared with $3,080 at December 31, 2005. Unrealized losses that are considered other-than-temporary are recorded as a loss on the Company’s consolidated statements of income. In evaluating whether impairment is other-than-temporary, management considers a variety of factors including the nature of the investment security, the cause of the impairment, the severity and duration of the impairment, and the Bank’s ability and intent to hold the security to maturity. Other data considered by management includes, for example, sector credit ratings, volatility of the security’s market price, and any other information considered relevant in determining whether other-than-temporary impairment has occurred.

At December 31, 2006 and 2005, management determined there were no unrealized losses in the investment securities portfolio that were other-than-temporary.

Loans to Finance Agricultural Production and Other Loans to Farmers: Agricultural loans amounted to $17,706 at December 31, 2006 compared with $18,962 at December 31, 2005, representing a decline of $1,256 or 6.6%. This category of loans represented 3.2% of the loan portfolio at December 31, 2006, compared with 3.7% at December 31, 2005. The communities served by the Bank generally offer limited opportunities for lending in this industry sector.

Commercial and Industrial Loans: Commercial and industrial loans represented 6.6% of the loan portfolio at December 31, 2006, compared with 8.0% at December 31, 2005. At December 31, 2006, commercial and industrial loans totaled $36,851, compared with $41,291 at the December 31, 2005, representing a decline of $4,440, or 10.8%. The decline was principally attributed to pay-downs on certain commercial and industrial loan balances during 2006. The Bank’s market area demographics have historically limited the growth potential in this particular category of loans.

Loans to Individuals for Household, Family and Other Personal Expenditures: Personal consumer loans, including credit card loans and student loans, totaled $10,684 at December 31, 2006 compared with $10,653 at December 31, 2005, representing an increase of $31, or 0.3%. This category of loans represented 1.9% of the loan portfolio at December 31, 2006, compared with 2.1% at December 31, 2005.

Given strong competition from the financing affiliates of consumer durable goods manufacturers, among other considerations, the Bank has not campaigned aggressively for consumer installment loans over the past several years.

The Bank continues to be one of relatively few community banks with its own credit card loan portfolio, as large credit card processing companies continue to acquire credit card portfolios and associated sources of non-interest income from smaller financial institutions.

All Other Loans: All other loans represented 1.7% of the loan portfolio at December 31, 2006, compared with 0.9% at December 31, 2005. The balance of all other loans at December 31, 2006 totaled $9,387 compared with $4,459 at December 31, 2005, representing an increase of $4,928, or 110.5%.

This category of loans principally includes loans to government municipalities and, to a lesser extent, not-for-profit organizations. Government municipality loans typically have short maturities and low interest rate risk characteristics. Government municipality loans are normally originated through a bid process among local financial institutions and are typically priced aggressively, thus generating narrow net interest income margins.

Loans Secured by Real Estate: At December 31, 2006, consumer and commercial real estate loans comprised 86.5% of the loan portfolio, compared with 85.2% at December 31, 2005. Over the past few years the strength in the local real estate markets, both residential and commercial, led to historically high property values in the Bank’s market area. However, during 2006 this trend began to soften. Recognizing the impact a softening real estate market 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 excessive loan to value ratios or debt service levels. There was no significant deterioration in the performance or risk characteristics of the real estate loan portfolio through the reporting period.

Commercial loans contributed 64.7% to 2006 loan growth, consumer loans contributed 26.6%, followed by an increase of 8.7% in tax-exempt loans to municipalities. In general, loan origination activity benefited from a still-favorable market interest rate environment, a relatively 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 December 31, 2006, consumer loans comprised 55.8% of the total loan portfolio while commercial loans comprised 43.1%, compared with 58.1% and 41.4% at December 31, 2005, respectively.

At December 31, 2006, total commercial loans amounted to $239,166, representing an increase of $26,039, or 12.2%, compared with December 31, 2005. Commercial loan growth was principally driven by commercial real estate loans, which posted an increase of $24,168, or 17.8%. Bank management attributed the overall growth in commercial loans, in part, to an effective business banking team, a variety of new business development initiatives, focused incentive compensation plans and a relatively stable local economy.

Loan Concentrations: At December 31, 2006, approximately $30,210 or 5.4% of the loan portfolio was represented by loans to the lodging industry, compared with $29,857 or $5.8% at December 31, 2005. Loan concentrations continued to reflect the Bank’s business region.

Mortgage Loan Servicing: The Bank from time to time will sell mortgage loans to other institutions, and investors. The sale of loans allows the Bank to make more funds available to customers in its servicing area, while the retention of servicing rights provides an additional source of income. At December 31, 2006, the unpaid balance of mortgage loans serviced for others totaled $6,566 compared with $7,907 at December 31, 2005, representing a decline of $1,341, or 17.0%. The decline in 2006 balances was attributed to serviced mortgage loan principal payments, as well as prepayments resulting from loan refinancing activity. Pursuant to the Bank’s asset and liability management strategy, its need for interest earning assets and its strong capital position, loans originated during 2005 and 2006 were held in the Bank’s loan portfolio.

Loan Maturities and Re-pricing Distribution: The following table summarizes fixed rate loans reported by remaining maturity, and floating rate loans by next re-pricing date, as of December 31, 2006, and 2005. Actual maturity dates may differ from contractual maturity dates due to prepayments or loan re-financings.

The Bank's loan loss experience continued at low levels during 2006, with net charge-offs amounting to $253, or net charge-offs to average loans outstanding of 0.05%, compared with $182, or net charge-offs to average loans outstanding of 0.04% in 2005. While net loan charge-offs were $71 higher in 2006 compared with 2005, management does not consider this increase as significant, or reflective of a deterioration of the overall credit quality of the loan portfolio. In this regard, $193 of the 2006 net charge-offs were attributed to one credit.

General reserves account for the risk and estimated loss inherent in certain pools of industry and geographic loan concentrations within the loan portfolio. There was no major change in loan concentrations during 2006.

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 December 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.

The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Funding sources principally consist of retail deposits and, to a lesser extent, borrowings from the Federal Home Loan Bank of Boston ("FHLB") of which it is a member, and certificates of deposit obtained from the national market.

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

Management believes that the Bank’s future success in growing core funding will be a determinant factor in its ability to grow earning assets and leverage its strong capital position.

Total Deposits: At December 31, 2006 total deposits amounted to $496,319 compared with $445,731 at December 31, 2005, representing an increase of $50,588, or 11.3%. Deposit growth in 2006 was supplemented with $21,975 in certificates of deposit obtained from the national market ("brokered deposits"), as the Bank’s earning asset growth outpaced retail deposit growth.

At December 31, 2006, total retail deposits amounted to $413,958, representing an increase of $28,613 or 7.4% compared with December 31, 2005. Money market accounts led the overall growth in retail deposits, which was principally attributed to the introduction of a new variable rate money market account in early 2006.

Total average deposits amounted to $482,932 in 2006, compared with $417,950 in 2005, representing an increase of $64,982, or 15.5%. Total average retail deposits amounted to $402,042 in 2006, compared with $376,237 in 2005, representing an increase of $25,805, or 6.9%.

The following table summarizes the changes in the average balances of deposits during the periods indicated, including the weighted average interest rates paid for each category of deposits:

The Bank strives to attract demand deposits in connection with its commercial lending activities, on a total relationship basis. The Bank’s business checking account offerings include Small BusinessPlus, BusinessPlus, and Free Small Business, each designed to help business owners manage the varying financial aspects of their business. The Bank also offers its business customers a variety of cash management products including a Cash Management Sweep Account. Customers are able to automatically transfer their excess demand deposit balances, over certain thresholds established with an earnings credit rate, to interest bearing, overnight securities repurchase agreements. Business demand deposits are also generated by way of the Bank’s Merchant Credit Card Processing Program.

NOW Account Deposits: The Bank offers NOW accounts to individuals, not-for-profit organizations and sole proprietor businesses. At December 31, 2006, total NOW accounts stood at $63,588, compared with $66,965 at December 31, 2005, representing a decline of $3,377 or 5.0%. During 2006 total average NOW accounts amounted to $64,785, compared with $66,289 in 2005, representing a decline of $1,504, or 2.3%. NOW accounts represented 15.9% of total average deposits during 2006, compared with 15.9% in 2005.

During 2006, the Bank’s most successful NOW account product continued to be Gold Wave Checking, a relationship product designed for its age 50 and above customers.

Savings and Money Market Deposits: At December 31, 2006, total savings and money market accounts amounted to $164,213, compared with $133,113 at December 31, 2005, representing an increase of $31,110, or 24.3%. Total average savings and money market accounts amounted to $152,095 in 2006, compared with $133,904 in 2005, representing an increase of $18,191, or 13.6%. Savings and money market accounts represented 31.5% of total average deposits during 2006, compared with 32.0% in 2005.

In pricing time deposits, particularly non-relationship time deposits, the Bank will consider other sources of funding which may be offered at more attractive terms and prices, including borrowed funds and time deposits available in the national market.

The following table summarizes the maturity distribution of time deposits of $100 or greater:

Brokered Time Deposits: At December 31, 2006, total brokered time deposits stood at $82,361, compared with $60,386 at December 31, 2005, representing an increase of $21,975, or 36.4%. Total average brokered time deposits amounted to $80,890 during 2006 compared with $41,713 in 2005, representing an increase of $39,177, or 93.9%. Brokered time deposits represented 16.7% of total average deposits during 2006, compared with 10.0% in 2005.

The increase in brokered time deposits was primarily attributed to the funding needs associated with the Bank’s strong earning asset growth, principally loans, which outpaced retail deposit growth during 2006. The rates of interest paid on brokered time deposits were generally comparable with collateralized advances from the Federal Home Loan Bank, the primary source of wholesale funding used by the Bank.

Borrowings From the Federal Home Loan Bank: At December 31, 2006, borrowings from the FHLB totaled $245,785, compared with $223,258 at December 31, 2005, representing an increase of $22,527, or 10.1%. During 2006, borrowings from the FHLB averaged $227,473, compared with $195,124 in 2005, representing an increase of $32,349, or 16.6%.

The increase in borrowings from the FHLB was utilized to fund 2006 earning asset growth, which outpaced the growth in retail deposits.

Total average borrowings from the FHLB expressed as a percentage of total average assets amounted to 28.8% during 2006, compared with 28.3% in 2005.

Borrowing Maturities: Borrowing maturities are managed in concert with the Bank’s asset and liability management strategy, and are closely aligned with the ongoing management of balance sheet interest rate risk.

In prior years, the Bank had utilized higher cost, longer-term borrowings to manage the interest rate risk associated with the growth in longer-term, fixed rate, earning assets generated during periods of historically low interest rates. While this strategy pressured net interest income in the near-term, management believes it lessened the degree of interest rate risk and better positioned the Bank for rising interest rates, similar to the interest rate environment experienced during 2006.

Cash Dividends: The Company has historically paid regular quarterly cash dividends on its common stock. Each quarter the Board of Directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook, the strength of the balance sheet, its need for funds, and other relevant factors. There can be no assurance that dividends on the Company’s common stock will be paid in the future.

The Company’s principal source of funds to pay cash dividends and support its commitments is derived from Bank operations. During 2006, the Company declared and distributed cash dividends in the aggregate amount of $2,761, compared with $2,584 in 2005. The Company’s 2006 dividend payout ratio amounted to 40.1%, compared with 40.2% in 2005. The total dividends paid in 2006 amounted to $0.905 per common share of stock, compared with $0.84 in 2005, representing an increase of $0.065, or 7.7%.

Capital Ratios: 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 adverse effect on the Company's financial statements.

As of December 31, 2006 and 2005, 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 10.0%, a minimum Tier I capital to total risk-weighted assets ratio of at least 6.0%, and a minimum Tier I Leverage ratio of at least 5.0%.

At December 31, 2006, the Company’s total risk-based capital was $63,325 or 11.65% of risk-weighted assets, compared with $59,063, or 12.05% of total risk-weighted assets at December 31, 2005.

At December 31, 2006, the Company’s Tier I capital totaled $58,800 or 10.82% of risk-weighted assets, compared with $54,416, or 11.10% of total risk-weighted assets at December 31, 2005. The ratio of Tier I capital to average assets, or Leverage Ratio, at December 31, 2006 was 7.34%, compared with 7.52% at December 31, 2005.