**Exhibit 13**

 

2003 ANNUAL REPORT

Merrill MerchantsBancshares, Inc.

 

Contents

 
| Financial  Highlights                     |   |
|-------------------------------------------|--------|
| Letter  to Shareholders                   |   |
| Management’s  Analysis of Operations |   |
| Independent Auditors’  Report        |   |
| Audited  Financial Statements             |   |
| Corporate Directory                       |   |
| Employees                                 |   |
| Corporate  Information                    |   |

 

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**Selected FinancialHighlights**

(Dollars inthousands, except per share data)

 
|                                   |   | **2003** |    | **2002** |   | **2001** |   | **2000** |    | **1999** |   |
|----------------------------------------|--------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
| **For the Year**                       |   |     |    |     |   |     |   |     |    |     |   |
| Net  income                            |   | $        | 4,302   |     | $      | 3,845    |   | $        | 3,254   |     | $      | 2,619 |   | $ | 2,247 |   |
| Net  interest income                   |   | 12,479   |    | 12,463   |   | 11,542   |   | 10,026   |    | 8,885    |   |
| Non-interest  income                   |   | 5,181    |    | 3,963    |   | 3,299    |   | 3,155    |    | 2,602    |   |
| Non-interest  expense                  |   | 10,718   |    | 10,205   |   | 9,468    |   | 8,823    |    | 7,754    |   |
| **Per Common Share**                   |   |     |    |     |   |     |   |     |    |     |   |
| Basic  earnings per share              |   | $        | 1.30    |     | $      | 1.28     |   | $        | 1.13    |     | $      | 0.90 |   | $ | 0.76 |   |
| Diluted  earnings per share            |   | 1.29     |    | 1.14     |   | 0.98     |   | 0.80     |    | 0.66     |   |
| Dividends  per share                   |   | 0.48     |    | 0.39     |   | 0.29     |   | 0.23     |    | 0.19     |   |
| Book  value per share                  |   | 9.19     |    | 8.84     |   | 9.18     |   | 8.24     |    | 7.50     |   |
| Dividend  payout ratio                 |   | 37.16    | %       | 31.27    | %      | 25.87    | %      | 25.52    | %       | 24.71    | %      |
| **Key Ratios**                         |   |     |    |     |   |     |   |     |    |     |   |
| Return  on average equity              |   | 14.74    | %       | 13.93    | %      | 13.18    | %      | 11.94    | %       | 10.58    | %      |
| Return  on average assets              |   | 1.34     |    | 1.33     |   | 1.26     |   | 1.16     |    | 1.11     |   |
| Equity  to assets at year end          |   | 8.93     |    | 9.24     |   | 9.34     |   | 9.45     |    | 9.95     |   |
| Non-performing  assets to total assets |   | 0.18     |    | 0.25     |   | 0.26     |   | 0.25     |    | 0.15     |   |
| Net  charge-offs to average loans      |   | 0.04     |    | 0.07     |   | 0.08     |   | 0.03     |    | 0.07     |   |
| Efficiency  ratio                      |   | 60.51    |    | 62.01    |   | 63.96    |   | 66.63    |    | 67.50    |   |
| **At Year End**                        |   |     |    |     |   |     |   |     |    |     |   |
| Total  assets                          |   | $        | 342,189 |     | $      | 307,316  |   | $        | 278,197 |     | $      | 246,413 |   | $ | 213,747 |   |
| Loans  receivable, net (1)             |   | 242,860  |    | 211,434  |   | 185,094  |   | 163,265  |    | 133,948  |   |
| Investment  securities                 |   | 76,140   |    | 68,867   |   | 71,607   |   | 59,686   |    | 61,475   |   |
| Deposits                               |   | 258,848  |    | 238,857  |   | 219,309  |   | 200,451  |    | 168,578  |   |
| Borrowed  funds                        |   | 49,260   |    | 36,932   |   | 29,792   |   | 20,076   |    | 19,069   |   |
| Shareholders’  equity             |   | 30,553   |    | 28,388   |   | 25,985   |   | 23,292   |    | 21,258   |   |

 

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(1)                                  Excludesloans held for sale

 

1

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Letter to Shareholders

 

Dear Shareholders:

 

Integrity is at the coreof all relationships and fundamental to the success of any enterprise. Thefaithful execution of our corporate mission – to be the very best communitybank in the markets we serve from a customer, employee and investor perspectiveby achieving excellence in all that we do – is something we take veryseriously. Central to that is our commitment to uphold the highest personal andbusiness ethics standards. In the aftermath of the scandals and schemes whichpunctuated the national news in 2003, this is a pledge of significantimportance to you, our shareholders.

 

2

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FINANCIAL PERFORMANCE

 

The Company experiencedrecord earnings performance in 2003 with net income increasing 12% to $4.3million. Earnings per share on a fully diluted basis increased to $1.29 for2003 from $1.14 in 2002. Loan growth of 15% combined with fee income growth of31% translated to a strong return on equity of 14.74%.

 

Net Income Graph

 
| 1999 |   | $ | 2.2 million |   |
|------|--------|---|-------------|--------|
| 2000 |   | $ | 2.6 million |   |
| 2001 |   | $ | 3.3 million |   |
| 2002 |   | $ | 3.8 million |   |
| 2003 |   | $ | 4.3 million |   |

 

LENDING ACTIVITIES

 

The professionalism ofour staff and our quick loan turnaround enabled us to capture market share andgenerate mortgage gains of $1.8 million during a record refinance boom.According to the most recent Registry of Deeds Report for Penobscot County, wewere the leading mortgage originator among all banks in that market area.

 

The loan portfolio iswell-diversified and our lending base now includes Penobscot, Piscataquis,Hancock, Waldo, Washington and Somerset counties. Our lenders aredecision-makers who understand Maine people and the Maine economy and they workdirectly with borrowers throughout the life of a loan, including collection,when necessary.

 

On the commercial side,the bank remained a leading lender in the state for the Small BusinessAdministration (SBA), topping all Maine–based banks in total 7(a) loan typedollars at $3.4 million and 36 loans for fiscal year 2003. This financingprovides customers with attractive loan products which meet their needs andpresent measured risk to the bank. In addition to SBA guaranteed lending, wealso partner with community-based organizations in the area of affordablehousing. This year we were particularly pleased to partner with PenquisCommunity Action Program on a Federal Home Loan Bank grant for an affordablehousing project in Searsport, which is very similar to the successful GrahamSchool Senior Housing Project on which we collaborated in 2001.

 

Loans Receivable Graph

 
| 1999 |   | $ | 133.9 million |   |
|------|--------|---|---------------|--------|
| 2000 |   | $ | 163.3 million |   |
| 2001 |   | $ | 185.1 million |   |
| 2002 |   | $ | 211.4 million |   |
| 2003 |   | $ | 242.9 million |   |

 

RETAIL BANKING

High PerformanceChecking, the retail banking initiative we introduced in late 2002, proved itsreal worth in 2003, as we doubled the number of checking accounts opened yearover year and benefited from additional fee income associated with theaccounts. The program also generated considerable enthusiasm and spirited competitionwithin the Company as branches vied for top honors in marketing and sales.

 

The expansion of oursupermarket branch in Newport was completed in late summer. The additionalspace gained will accommodate present needs and future growth at a busy crossroadsin central Maine.

 

Lucille Zelenkewich, vicepresident, joined Clarence “Chuck” Bickford, Jr., vice president, in ourprivate banking office in Waterville in late November. This addition to staffenables us to complement existing trust and investment services with expandedconsumer and commercial products. Lucille, Chuck and our bank have strong rootsin the Waterville area and we hope to make solid inroads in this market.

 

Deposits Graph

 
| 1999 |   | $ | 168.6 million |   |
|------|--------|---|---------------|--------|
| 2000 |   | $ | 200.5 million |   |
| 2001 |   | $ | 219.3 million |   |
| 2002 |   | $ | 238.9 million |   |
| 2003 |   | $ | 258.9 million |   |

 

3

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TRUST AND INVESTMENTSERVICES

 

The Trust and InvestmentServices Department ended the year with $315.5 million in assets undermanagement. The market recovery over the past year has been most welcome, andwe were pleased to have our investment performance in 2003 rival that ofconventional benchmarks.

 

Our personal servicefocus continues to distinguish us from other investment advisors and we arevery pleased to have added many new client relationships over the past year.

 

Trust Assets Graph

 
| 1999 |   | $ | 189.5 million |   |
|------|--------|---|---------------|--------|
| 2000 |   | $ | 224.8 million |   |
| 2001 |   | $ | 234.8 million |   |
| 2002 |   | $ | 237.2 million |   |
| 2003 |   | $ | 315.5 million |   |

 

COMMUNITY BUILDING

 

An underlying commitmentto improving the quality of life in Maine, both economically and socially, isan integral part of our corporate mission. Toward that end, we have fashioned aphilanthropy program which includes financial support for many state and localinitiatives complemented by both leadership and hands-on community service. Weare very proud of the fact that in 2003 our employees logged in excess of10,000 volunteer service hours, including broad support for the “America’sPromise” and  “Teach Children to Save”programs sponsored by the American and Maine Bankers Associations.

 

After a forty yearbanking career, Beth Carr, vice president, has announced her intended retirementin April 2004. Beth has served as a member of our senior management teamand overseen our risk management and community reinvestment activities for thepast eleven years. We will miss her knowledge and experience and wish her well.

 

STOCK PERFORMANCE

 

Strong earnings led to afavorable performance in the Company’s stock. The market value of your MERBshares increased 43% in 2003 and closed the year at $21.72 per share. Since thecommencement of cash dividends in 1997, we have increased the dividend rate tentimes and, for the eighth consecutive year, paid a stock dividend. In 2003 ourdividend payout ratio increased to 37.1% from 31.3% in 2002.

 

Price Per Share

 
| At  December 31, 1999 |   | $ | 8.98  |   |
|----------------------------|--------|---|-------|--------|
| At  December 31, 2000 |   | $ | 8.75  |   |
| At  December 31, 2001 |   | $ | 11.30 |   |
| At  December 31, 2002 |   | $ | 15.60 |   |
| At  December 31, 2003 |   | $ | 21.72 |   |

 

LOOKING AHEAD

 

An unfinished war in Iraqand the threat of terrorism persist, but there are signs that 2004 will bring amuch anticipated, albeit gradual, economic recovery. The markets arerebounding, housing and productivity are strong and employment figures are improving.Hanging in the balance is the Federal Reserve’s Federal Funds policy. Havingannounced its intent in December to maintain current rates for a “considerableperiod,” we anticipate little change prior to midyear.

 

Our Company is wellpositioned to take advantage of growth opportunities in 2004.  We look forward to increasing shareholdervalue and building on our past success. Thank you for your continued confidence in us.

 

Sincerely,

 
| /s/ Edwin N. Clift                          |                    | /s/ William C. Bullock,  Jr. |   |
|---------------------------------------------|-------------------------|------------------------------|--------|
|                                        |                    |
| Edwin N. Clift                              | William C. Bullock, Jr. |
|                                        |                    |
| ***President and Chief Executive Officer*** | ***Chairman***          |

# ** **

4

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**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**FORWARDLOOKING STATEMENTS**

** **

**Management’sdiscussion and analysis may contain forward-looking statements that areprovided to assist in the understanding of anticipated future financialperformance.  However, such performanceinvolves risk and uncertainties which may cause actual results to differmaterially from those expressed in forward-looking statements.  For a discussion of these risks anduncertainties, see the Company’s Annual Report on Form 10-KSB for the yearended December 31, 2003.  TheCompany disclaims any obligation to publicly announce future events ordevelopments that may affect the forward-looking statements contained herein.**

** **

**GENERAL**

** **

Merrill MerchantsBancshares, Inc. (Company) owns all of the common stock of Merrill MerchantsBank (Bank).  The Bank is a full-servicecommunity bank headquartered in Bangor, Maine, providing a wide range ofconsumer, commercial, and trust and investment services through its elevenlocations in central and eastern Maine. In addition, the Bank provides indirect auto and recreational vehicle lendingthrough its consumer finance division.

 

Merrill Merchants Bank iscommitted to providing outstanding customer service and building long termbanking relationships with customers. Delivery on this commitment through localdecision-making and personal service has helped distinguish Merrill Merchantsfrom its competitors. This will continue to be strategically significant aslarger banks consolidate and their service delivery channels become moredepersonalized.

 

The Company’s goal is tosustain profitable, controlled growth by focusing on increased loan and depositmarket share; managing yields on earning assets and rates on interest-bearingliabilities; increasing non-interest income; and being prepared foracquisitions and expansion opportunities within the financial services industry.

 

**REVIEWOF FINANCIAL STATEMENTS**

** **

**TheCompany declared a 3% stock dividend both in 2003 and 2002.   All financial data included herein has beenrestated to reflect the impact of the stock dividends.**

** **

**Thediscussion and analysis that follows focuses on the factors affecting theCompany’s financial condition at December 31, 2003, and 2002 and financialresults of operations during 2003 and 2002. This discussion should be read in conjunction with the consolidatedfinancial statements and notes included elsewhere in this report.**

** **

**CRITICALACCOUNTING POLICIES**

 

Management’s discussionand analysis of the Company’s financial condition are based on the consolidatedfinancial statements which are prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of suchfinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses andrelated disclosure of contingent assets and liabilities. On an ongoing basis,management evaluates its estimates, including those related to the allowancefor loan losses. Management bases its estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets that are not readily apparent from other sources.Actual results could differ from the amount derived from management’s estimatesand assumptions under different assumptions or conditions.

 

5

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Management believes theallowance for loan losses is a critical accounting policy that requires themost significant estimates and assumptions used in the preparation of theconsolidated financial statements. The allowance for loan losses is based onmanagement’s evaluation of the level of the allowance required in relation tothe estimated loss exposure in the loan portfolio. Management believes theallowance for loan losses is a significant estimate and therefore regularlyevaluates it for adequacy by taking into consideration factors such as priorloan loss experience, the character and size of the loan portfolio, businessand economic conditions and management’s estimation of probable losses. The useof different estimates or assumptions could produce different provisions forloan losses.

 

**RESULTSOF OPERATIONS**

** **

***Overview***

** **

**TheCompany ended 2003 with consolidated assets of $342.2 million representinggrowth of $34.9 million or 11%.  Assetgrowth was attributable to strong real estate loan demand.  The Company reported net income of $4.3million or $1.30 per basic share and $1.29 per diluted share in 2003, comparedto $3.8 million or $1.28 per basic share and $1.14 per diluted share in2002.  This represented earnings growthof $458,000 or 12%.  Return on averageassets increased to 1.34% in 2003 compared to 1.33% in 2002, and return onaverage equity increased to 14.74% in 2003 from 13.93% in 2002.**

** **

***Net Interest Income***

** **

**TheCompany’s primary source of operating income is net interest income.  Net interest income was $12.5 million forboth 2003 and 2002.  Net interest incomeis the difference between the income earned on earning assets and the interestpaid on interest-bearing liabilities. Both net interest income and the net interest margin, which is netinterest income expressed as a percentage of average earning assets, areaffected by the volume and mix of earning assets and interest-bearingliabilities and the interest rates earned or paid on them.**

** **

**Netinterest income increased by $16,000 in 2003 compared to 2002.  The slight increase was due to growth in theloan portfolio which was offset by a decline in the Company’s net interestmargin to 4.12% for 2003 compared to 4.61% for 2002.  The Federal Reserve reduced the Federal Funds rate thirteen timesin the past three years for a total reduction of 5%.   The Federal Funds rate, as set by the Federal Reserve, averaged1.12% in 2003 and 1.67% in 2002.**

** **

**Interestincome was $17.2 million in 2003, a 6% decrease from 2002.  The decrease was driven by a decline in theyield on average earning assets to 5.69% in 2003 from 6.77% in 2002 which wasoffset by growth in the average earning assets of $32.5 million or 12%.**

** **

**Interestexpense decreased to $4.7 million in 2003 from $5.8 million in 2002,representing a 19% decrease.  This decreasewas a result of a decline in the cost of funds to 1.92% in 2003 from 2.64% in2002 which was offset by growth in average interest-bearing liabilities of$24.4 million or 11%.**

** **

**Managementcurrently anticipates that net interest income will continue to increase in2004 due to expected growth in earning assets (primarily loans), although aslight decline in the net interest margin is expected due to industry-widepricing pressure on loans and deposits and the Federal Funds rate remaining athistorically low levels (currently 1.00%).**

** **

**6**

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** **

***AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME***

** **

The following table setsforth, for the years indicated, information regarding (i) the total dollaramount of interest income of the Company from interest-earning assets and theresultant average yields; (ii) the total dollar amount of interest expense oninterest-bearing liabilities and the resultant average costs; (iii) netinterest income; (iv) net interest rate spread; and (v) net interest margin. 

 
|                                                  |   | **2003**             |       | **2002**     |       | **2001**         |       |
|-------------------------------------------------------|--------|----------------------|------------|--------------|------------|------------------|------------|
| **(In Thousands)**                                    |   | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/  Rate** | ** ** |
| Assets:                                               |   |                 |       |         |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                              |   |                 |       |         |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                                             |   | $                    | 234,279    |         | $          | 15,302           |       | 6.53 | % | $ | 202,377 |   | $ | 14,959 |   | 7.39 | % | $ | 175,634 |   | $ | 15,731 |   | 8.96 | % |
| Investment securities                                 |   | 68,387               |       | 1,911        |       | 2.79             | %          | 67,790 |   | 3,347 |   | 4.94 | % | 64,583 |   | 3,748 |   | 5.80 | % |
| Other earning assets                                  |   | 105                  |       | —       |       | —           |       | 90 |   | 1 |   | 1.11 | % | 725 |   | 23 |   | 3.17 | % |
| Total interest-earning assets                         |   | 302,771              |       | 17,213       |       | 5.69             | %          | 270,257 |   | 18,307 |   | 6.77 | % | 240,942 |   | 19,502 |   | 8.09 | % |
| Non-earning assets                                    |   | 17,308               |       |         |       |             |       | 17,812 |   |   |   |   |   | 16,484 |   |   |   |   |   |
| Total assets                                          |   | $                    | 320,079    |         |       |             |       |   | $ | 288,069 |   |   |   |   |   | $ | 257,426 |   |   |   |   |   |
|                                                  |   |                 |       |         |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders’ Equity:            |   |                 |       |         |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                         |   |                 |       |         |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings deposits and interest- bearing checking       |   | $                    | 112,372    |         | 689        |             | 0.61       | % | $ | 103,259 |   | 1,354 |   | 1.31 | % | $ | 86,596 |   | 2,222 |   | 2.57 | % |
| Certificates of deposit                               |   | 91,675               |       | 3,250        |       | 3.55             | %          | 87,393 |   | 3,653 |   | 4.18 | % | 82,160 |   | 4,534 |   | 5.52 | % |
| Securities sold under agreement  to repurchase   |   | 19,797               |       | 162          |       | 0.82             | %          | 17,096 |   | 240 |   | 1.40 | % | 16,453 |   | 529 |   | 3.22 | % |
| Short-term borrowings                                 |   | 9,911                |       | 125          |       | 1.26             | %          | 3,822 |   | 65 |   | 1.70 | % | 4,220 |   | 186 |   | 4.41 | % |
| Long-term borrowings                                  |   | 12,170               |       | 508          |       | 4.17             | %          | 9,933 |   | 532 |   | 5.36 | % | 8,302 |   | 489 |   | 5.89 | % |
| Total interest-bearing  liabilities              |   | 245,925              |       | 4,734        |       | 1.92             | %          | 221,503 |   | 5,844 |   | 2.64 | % | 197,731 |   | 7,960 |   | 4.03 | % |
| Other liabilities                                     |   | 44,962               |       |         |       |             |       | 38,965 |   |   |   |   |   | 35,000 |   |   |   |   |   |
| Shareholders’ equity                             |   | 29,192               |       |         |       |             |       | 27,601 |   |   |   |   |   | 24,695 |   |   |   |   |   |
| Total liabilities and shareholders’  equity |   | $                    | 320,079    |         |       |             |       |   | $ | 288,069 |   |   |   |   |   | $ | 257,426 |   |   |   |   |   |
| Net interest income                                   |   |                 |       | $            | 12,479     |             |       |   |   |   | $ | 12,463 |   |   |   |   |   | $ | 11,542 |   |   |   |
| Net interest rate spread                              |   |                 |       |         |       | 3.77             | %          |   |   |   |   | 4.13 | % |   |   |   |   | 4.06 | % |
| Net interest margin                                   |   |                 |       |         |       | 4.12             | %          |   |   |   |   | 4.61 | % |   |   |   |   | 4.79 | % |

 

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(1) Loans includeportfolio loans, loans held for sale and nonperforming loans, but unpaidinterest on nonperforming loans has not been included for purposes ofdetermining interest income.

 

*ANALYSIS OF CHANGES IN NET INTEREST INCOME*

 

The following tablepresents the changes in interest income and expense attributable to changes ininterest rates, changes in volume and changes in rate/volume forinterest-earning assets and interest-bearing liabilities.

 
| **Year Ended December 31,**                |   | **2003**                         |       | **2002**                         |       |
|-------------------------------------------------|--------|----------------------------------|------------|----------------------------------|------------|
| **(In Thousands)**                              |   | **Increase  (Decrease) Due to:** | ** ** | **Increase  (Decrease) Due to:** | ** ** |
|                                            |   | **Volume**                       |       | **Rate**                         | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total** | ** ** |
| Interest-earning  assets:                       |   |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                           |   | $                                | 2,358      |                             | $          | (1,741 | ) | $ | (274 | ) | $ | 343 |   | $ | 2,395 |   | $ | (2,749 | ) | $ | (418 | ) | $ | (772 | ) |
| Investment  securities                          |   | 29                               |       | (1,453                           | )          | (12 | ) | (1,436 | ) | 186 |   | (559 | ) | (28 | ) | (401 | ) |
| Other  earning assets                           |   | —                           |       | (1                               | )          | — |   | (1 | ) | (20 | ) | (15 | ) | 13 |   | (22 | ) |
| Total  interest income                          |   | 2,387                            |       | (3,195                           | )          | (286 | ) | (1,094 | ) | 2,561 |   | (3,323 | ) | (433 | ) | (1,195 | ) |
|                                            |   |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                  |   |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings  deposits and interest-bearing checking |   | 119                              |       | (721                             | )          | (63 | ) | (665 | ) | 428 |   | (1,086 | ) | (210 | ) | (868 | ) |
| Certificates  of deposit                        |   | 179                              |       | (555                             | )          | (27 | ) | (403 | ) | 289 |   | (1,100 | ) | (70 | ) | (881 | ) |
| Securities  sold under agreement to repurchase  |   | 38                               |       | (100                             | )          | (16 | ) | (78 | ) | 21 |   | (298 | ) | (12 | ) | (289 | ) |
| Short-term  borrowings                          |   | 104                              |       | (17                              | )          | (27 | ) | 60 |   | (18 | ) | (114 | ) | 11 |   | (121 | ) |
| Long-term  borrowings                           |   | 120                              |       | (117                             | )          | (27 | ) | (24 | ) | 96 |   | (44 | ) | (9 | ) | 43 |   |
| Total  interest expense                         |   | 560                              |       | (1,510                           | )          | (160 | ) | (1,110 | ) | 816 |   | (2,642 | ) | (290 | ) | (2,116 | ) |
|                                            |   |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change  in net interest income                  |   | $                                | 1,827      |                             | $          | (1,685 | ) | $ | (126 | ) | $ | 16 |   | $ | 1,745 |   | $ | (681 | ) | $ | (143 | ) | $ | 921 |   |

 

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***Non-Interest Income***

** **

**Non-interestincome was $5.2 million for 2003 compared to $4.0 million for 2002.  The $1.2 million or 31% increase was drivenby the increase in gain on mortgage loan sales of $1.0 million in 2003 andgrowth in most fee income categories.**

** **

**Gainon the sale of mortgage loans increased to $1.8 million for 2003 compared to$796,000 for 2002 due to the record level mortgage refinances resulting fromthe favorable interest rate environment nationally.  The Company’s portfolio of residential mortgages serviced forsecondary market investors at December 31, 2003 of $106.9 millionincreased by $11.8 million, or 12%, from December 31, 2002.**

** **

**HighPerformance Checking, the retail banking initiative we introduced in late 2002,proved its real worth in 2003 as we doubled the number of checking accountsopened year over year and benefited from additional fee income associated withthe accounts.  Overdraft fee incomeincreased to $644,000 in 2003, a 114% increase over 2002 due to new accountactivity combined with a new risk based approach to the overdraft process. **In addition, ATM fees increased 23% in 2003 and merchant processingfees declined $351,000 or 85% as the result of the Company exiting this line ofbusiness.

** **

**Trustfees increased 10% to $1.2 million in 2003. The market value of client assets under administration increased $78.4million to $315.5 million at December 31, 2003 compared with trust assetsof $237.2 million at December 31, 2002. The increase in trust assets wasachieved through new business development combined with market appreciation.**

** **

**Thegeneration of mortgage sale gains and trust fees is dependent on the market andeconomic conditions and, as a result, there can be no assurance that incomelevels reported in prior periods can be achieved in the future.**

** **

***Non-Interest Expense***

** **

**Non-interestexpense was $10.7 million for 2003 compared to $10.2 million in 2002.  The $513,000 or 5% increase was related to increasesin salaries and employee benefits of $435,000, data processing costs of $68,000and other expenses of $103,000 which were offset by a decline in occupancy andequipment costs of $93,000.  The Company’sefficiency ratio (non-interest expense divided by the sum of net interestincome and other income) improved to 60.5% for 2003 compared to 62.0% for 2002.**

** **

**Salariesand employee benefits expense increased 8% to $5.9 million for 2003.  The 2003 increase was a result of normalannual salary increases, additional staffing required as a result of assetgrowth and market expansion and a 31% increase in health insurance costs.  Data processing costs increased 12% for 2003as a result of loan and deposit growth during the year.  Other non-interest expense increased 4% for2003 reflecting an increase inmarketing expenses of $261,000 related to the direct mail advertising campaignfor High Performance Checking and an increase in loan expense of $162,000related to the accelerated amortization of mortgage servicing rights.  Other expenses also reflects a decline inmerchant processing expense of $347,000 related to the Company exiting thisline of business.**

** **

**Annualoperating expenses are also expected to increase in future periods due tofuture branching, product expansion and the retail banking marketing program.**

** **

**BALANCESHEET REVIEW**

** **

***Loans***

** **

**TheBank offers a broad range of personal and business loan products.  Total loans (which excludes loans held forsale) of $246.5 million grew $31.8 million or 15% from December 31,2002.  Real estate lending was strong in2003 with residential and construction mortgages increasing 21% to $65.0million at December 31, 2003 and home equity loans increasing 43% to $28.5million at year- end.  Both thecommercial and consumer portfolios grew at annual rate of 8%.**

** **

**Theaverage yield on loans decreased to 6.53% in 2003 from 7.39% in 2002.  This decrease is the result of lower interestrates in 2003 (the prime rate average was 4.12% for 2003 and 4.67% for2002).  Management anticipates pressureon yields on loans due to sustained lower interest rates in 2004 and increasedcompetition from banks and non-traditional credit providers.**

** **

**8**

----

 

***Investment Securities***

** **

**Theinvestment portfolio provides liquidity, diversification and investment incometo the Company.  The investmentportfolio represents 22% of the Company’s total assets.  The portfolio is comprised primarily of U.S.Government agencies and collateralized mortgage obligations.  Substantially all of the Company’ssecurities are AAA or equivalently rated. Total investment securities increased in 2003 by $7.3 million or 11% to$76.1 million at December 31, 2003. Mortgage-backed securities and collateralized mortgage obligationsrepresent 68% of the investment portfolio while U.S. Government agencysecurities and money market funds represent 19%.  The average yield on the investment portfolio decreased to 2.79%in 2003 compared to 4.94% in 2002 due to maturing investments being reinvestedat lower interest rates and the accelerated premium amortization oncollateralized mortgage obligations resulting from significant prepayments dueto refinancing.**

** **

***Deposits***

** **

Deposits are the majorsource of the Company’s funds for lending, investing and other general businesspurposes.  Deposits are attractedprincipally from within the Company’s primary market area through the offeringof a broad variety of deposit products, including checking accounts, money marketaccounts, savings accounts, certificates of deposit (including jumbocertificates in denominations of $100,000 or more) and retirement savingsplans.  In addition, the Company usesdeposits obtained through investment banking firms which obtain funds fromtheir customers for deposit with the Company (“brokered deposits”).

 

In 2003, total depositsincreased by $20.0 million to $258.8 million, an 8% increase over 2002.  Comparing year-end balances at 2003 to 2002,checking accounts increased 17%, money market accounts grew 23% and savingsaccounts decreased 2%.  Certificate ofdeposit (CD) balances increased $1.1 million due to $5.1 million growth inbrokered CD’s which was offset by a decline in retail CD’s of $4.0 million.

 

Due to the low interestrate environment, the average yield on savings deposits and interest-bearingchecking accounts decreased to .61% in 2003 from 1.31% in 2002 and the averageyield on certificates of deposit decreased to 3.55% in 2003 from 4.18% in 2002.

 

The Company’s focus onquality customer service contributed to the deposit growth in 2003. Inaddition, in October 2002 we launched a new retail banking initiative,High Performance Checking, with the goal of generating significant depositgrowth and associated fee income.  Theprogram includes seven new checking accounts, direct mail advertising,Tell-A-Friend referrals and an attractive selection of premium gifts.  The Company continues to develop consumerand commercial deposit relationships through referrals and additional contactswithin its market area.

 

***Borrowings***

** **

**Borrowingssupplement deposits as a source of liquidity. Borrowed funds consist mainly of securities sold under agreement torepurchase and advances from the Federal Home Loan Bank (FHLB). Totalborrowings were $49.3 million at December 31, 2003 compared to $36.9million at December 31, 2002, an increase of $12.4 million.  Other short-term borrowings include federalfunds purchased, commercial lines of credit, Treasury, tax and loan depositsand interest-bearing demand notes due to the U.S. Treasury.**

** **

**9**

----

** **

**ASSETQUALITY**

** **

Management seeks tomaintain a high quality of assets through prudent underwriting and soundlending practices. Approximately 31% of the Company’s loan portfolio iscollateralized by first liens on primarily owner-occupied residential homeswhich have historically carried a relatively low credit risk.  The Bank also maintains a commercial realestate portfolio comprised primarily of owner-occupied commercial businesses.

 

The Bank participates ingovernment guaranteed loan programs including the Small Business Administration(“SBA”), Rural Development (“RD”) and the Finance Authority of Maine (“FAME”).At December 31, 2003, loans under these programs totaled $14.2 million ofwhich $10.5 million, or 4% of the total loan portfolio outstanding, isguaranteed by the various federal and state government entities.

 

The Bank continues tofocus on asset quality issues and emphasizes loan review and underwritingprocedures.  The Bank utilizes theservices of a consultant, M&M Consulting, LLC (a joint venture owned 50% bythe Bank), to perform periodic loan and documentation review. Management hasestablished a risk rating and review process with the objective of quicklyidentifying, evaluating and initiating necessary corrective action for allcommercial and commercial real estate loans. The goal of the risk ratingprocess is to address the watch list, substandard and non-performing loans, asearly as possible. These components of risk management are integral elements ofthe Bank’s loan program which have contributed to the loan portfolioperformance to date. Nonetheless, management maintains a cautious outlook inattempting to anticipate the potential effects of uncertain economic conditions(both locally and nationally).

 

***Nonperforming Assets***

** **

Nonperforming assetsconsist of non-accrual loans, other loans past due over 90 days and other realestate owned.  Total nonperformingassets as a percentage of total assets was .18% or $617,000 atDecember 31, 2003, compared to .25% or $766,000 at December 31, 2002.

 

Loans are placed onnon-accrual status when, in the judgment of management, principal repayment isdoubtful, whether current or past due. When a loan is placed on non-accrualstatus, previously accrued but unpaid interest is deducted from interestincome. As a matter of policy, interest is generally not accrued on loans pastdue 90 days or more. The Bank does not return a loan to accrual status until itis brought current with respect to both principal and interest, future paymentsare no longer in doubt, and the loan has been performing for at least sixconsecutive months.

 

*** Provision andAllowance for Loan Losses***

** **

**Theprovision for loan losses is a result of management’s periodic analysis of theadequacy of the allowance for loan losses. The provision for loan losses was $444,000 for 2003 and $453,000 for2002, a decrease of $9,000 or 2%.  Theallowance for loan losses represented 1.48% of loans outstanding atDecember 31, 2003, compared to 1.53% at December 31, 2002.  Net charge-offs were $87,000 during 2003 or..04% of average loans outstanding, compared to $144,000 in 2002 or .07%.  The portion of the allowance for loan lossesallocated to commercial and commercial real estate loans increased in 2002 dueto growth in the loan balances combined with an enhancement to the risk ratingsystem.  The risk rating system wasexpanded from seven to eight ratings based on the changing characteristics ofthe loan portfolio and improved classification of loans classified as“watch”  The low level of net loancharge-offs is indicative of the Company’s loan quality and creditadministration standards and the generally stable economic environment existingin the Company’s primary market area.**

** **

**10**

----

** **

**Theallowance for loan losses is maintained at a level determined to be adequate bymanagement to absorb future charge-offs of loans deemed uncollectible.  This allowance is increased by provisionscharged to operating expense and by recoveries on loans previously chargedoff.  A high degree of judgment isnecessary to determine the appropriate level of allowance for loan losses andrequires management’s ongoing evaluation of adequacy.  The adequacy of the loan loss allowance is determined by use of arisk rating system.  The evaluationprocess includes, among other things, industry standards, management’sexperience, the Bank’s historical loan loss experience, evaluation of economicconditions and regular reviews of delinquencies and loan portfolioquality.  Although management believesit uses the best information available to make determinations with respect tothe allowance for loan losses, future adjustments may be necessary if economicconditions differ from the economic conditions in the assumptions used inmaking the final determinations.**

** **

**Futureprovisions for loan losses depend on such factors as asset quality, net loancharge-offs, loan growth and other criteria discussed above.  The appropriate level of the allowance forloan losses and the corresponding provision will continue to be determinedquarterly.  Management anticipates thatthere will be a provision for loan losses in 2004; however, the specific amountcannot be determined at this time. Changes in circumstances affecting the various factors of the Company’smethodology will determine the provision amount in 2004.**

** **

**ASSET/LIABILITYMANAGEMENT**

** **

***Market Risk***

** **

Market risk is the riskof loss in a financial instrument arising from adverse changes in marketrates/prices, such as interest rates, foreign currency exchange rates,commodity prices and equity prices. The Company’s primary market risk exposureis interest rate risk. The ongoing monitoring and management of this risk is animportant component of the Company’s asset/liability management process whichis governed by policies established by the Board of Directors that are reviewedand approved annually.

 

The Board of Directorsdelegates responsibility for carrying out the asset/liability managementpolicies to its Asset/Liability Committee (ALCO).  In this capacity, ALCO develops guidelines and strategiesimpacting the Company’s asset/liability management activities based upon estimatedmarket risk sensitivity, policy limits and overall market interest rate levels/trends.

 

*InterestRate Risk*

 

Interest rate riskrepresents the sensitivity of earnings to changes in market interest rates. Asinterest rates change, the interest income and expense streams associated withthe Company’s financial instruments also change, thereby impacting net interestincome (“NII”), the primary component of the Company’s earnings. ALCO utilizesthe results of a detailed and dynamic simulation model to quantify theestimated exposure of NII to sustained interest rate changes. While ALCOroutinely monitors simulated NII sensitivity over a rolling two-year horizon,it also utilizes additional tools to monitor potential longer-term interestrate risk.

 

The simulation modelcaptures the impact of changing interest rates on the interest income earnedand interest expense incurred on all interest-earning assets andinterest-bearing liabilities reflected in the Company’s statement of financialcondition. This sensitivity analysis is compared to ALCO policy limits whichspecify a maximum tolerance level for NII exposure over a one-year horizon,assuming no asset growth, given a 200 basis point (bp) upward and a 100 bpdownward shift in interest rates. A parallel and pro rata shift in rates over a12-month period is assumed.

 

11

----

 

***Liquidity***

** **

**Liquidityrepresents the ability to meet both asset growth and deposit withdrawals.  Many factors affect a company’s ability tomeet liquidity needs, including changes in the markets served, itsasset-liability mix, its reputation and credit standing in the market andgeneral economic conditions.  Inaddition to traditional in-market deposit sources, the Company has othersources of liquidity, including proceeds from maturing investment securitiesand loans, the sale of investment securities, Federal Funds throughcorrespondent bank relationships, brokered deposits and FHLB borrowings.  Additional liquidity is available in theloan portfolio through sale of residential mortgages and the guaranteed portionof SBA loans.   Management believes thatthe current level of liquidity is sufficient to meet current and future fundingrequirements.**

** **

**CAPITAL**

** **

**AtDecember 31, 2003, shareholders’ equity totaled $30.6 million or 8.9% oftotal assets, as compared to $28.4 million or 9.2% at December 31,2002.  The net increase in shareholders’equity was attributable to: net income of $4.3 million; stock option exercisesand the related tax benefit of $852,000, less share repurchases of $1.2 million;and $1.6 million in cash dividends.**

** **

**Capitalguidelines issued by the Federal Reserve Board require the Company to maintaincertain ratios.  The Company’s riskbased capital ratios for Tier 1 and Tier 2 Capital (as defined by federal bankingagency regulations) at December 31, 2003 of 12.85% and 14.10%,respectively, exceed regulatory guidelines for capital adequacy.  The Company’s Tier 1 and Tier 2 risk basedcapital ratios at December 31, 2002 were 13.10% and 14.35%,respectively.  The Bank is also subjectto federal regulatory capital requirements. At December 31, 2003, the Bank was deemed to be “well capitalized”under the applicable regulations.**

** **

**InOctober 2002, both the mandatory convertible debentures and convertiblecumulative preferred stock were converted to common stock.  These conversions resulted in additionalcapital of $300,000 and the issuance of 305,907 shares of common stock.**

** **

During2003, the Company repurchased 75,031 shares of common stock at anaverage price of $16.23 and in 2002 the Company repurchased 91,949 shares ofcommon stock at an average price of $15.32. In October 2002, the Board of Directors approved a third stockrepurchase program authorizing the Company to repurchase up to 159,493 sharesof the Company’s common stock.  As ofDecember 31, 2003, 86,538 shares had been repurchased under the thirdrepurchase program.  Shares are beingrepurchased into treasury for the purpose of funding the expected exercise ofstock options pursuant to the Company’s stock option plan and for other corporatepurposes.

 

12

----

** **

**IMPACTOF NEW ACCOUNTING STANDARDS**

** **

Financial AccountingStandards Board (FASB) Interpretation Number 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others” (FIN 45), aninterpretation of FASB Statements No. 5, 57, and 107 and rescission of FASBInterpretation No. 34, was issued in November 2002.   The disclosure requirements in thisInterpretation are effective for financial statements of interim or annualperiods ending after December 15, 2002. This Interpretation does not have a material effect on the Company’sconsolidated financial statements.

 

FASB’s Emerging IssuesTask Force Issue No. 03-1 requires new disclosure for investment securitieswith unrealized losses that have not been classified asother-than-temporary.  The new disclosurerequirements, which are effective for years ending after December 15,2003, did not have a material impact on the Company’s consolidated financialstatements.

 

**MARKETFOR COMMON STOCK**

** **

**Marketprices (as quoted by Nasdaq) and cash dividends paid, per share of theCompany’s common stock, by calendar quarter for the past two years are listedbelow.  Per share data information hasbeen adjusted to reflect the 3% stock dividends in both 2003 and 2002,respectively.**

** **
| **2003 Quarters** |   | **Dividends  Declared  Per Share** |   | **Market  Prices** |   |
|-------------------|--------|------------------------------------|--------|--------------------|--------|
| **High**          |   | **Low**                            |
| Fourth            |   | $                                  | 0.13   |               | $      | 21.82 |   | $ | 18.60 |   |
| Third             |   | 0.12                               |   | 19.40              |   | 16.35 |   |
| Second            |   | 0.12                               |   | 16.30              |   | 15.25 |   |
| First             |   | 0.11                               |   | 16.01              |   | 14.82 |   |
|                   |        |                                    |        |                    |        |  |  |  |  |  |

** **
| **2002 Quarters** |   | **Dividends  Declared  Per Share** |       | **Market  Prices** |       |
|-------------------|--------|------------------------------------|------------|--------------------|------------|
| **High**          |   | **Low**                            |       |
| **Fourth**        |   | **$**                              | **0.11**   | ** **         | **$**      | **15.60** | ** ** | **$** | **15.00** | ** ** |
| **Third**         |   | **0.10**                           | ** ** | **15.78**          | ** ** | **14.57** | ** ** |
| **Second**        |   | **0.10**                           | ** ** | **15.67**          | ** ** | **13.83** | ** ** |
| **First**         |   | **0.08**                           | ** ** | **14.27**          | ** ** | **10.65** | ** ** |
|                   |        |                                    |            |                    |            |  |  |  |  |  |

** **

** **

**As ofDecember 31, 2003, the Company had approximately 1,050 shareholders ofrecord and 3,323,797 shares outstanding.**

** **

**Thereare regulatory limitations on the Company’s ability to pay dividends dependingon the dividends it receives from its subsidiary, Merrill Merchants Bank, whichare subject to regulations and the Bank’s continued compliance with allregulatory capital requirements and the overall health of the institution.  See notes 14 and 17 of the notes to theconsolidated financial statements for a discussion of the Company’s capital andthe Bank’s regulatory matters, respectively.**

** **

**13**

----

** **

**INDEPENDENT AUDITORS’ REPORT**

 

To the Board of Directorsand Shareholders

Merrill MerchantsBancshares, Inc.

 

We have audited theaccompanying consolidated statements of financial condition of MerrillMerchants Bancshares, Inc. and Subsidiaries as of December 31, 2003 and2002, and the related consolidated statements of income, changes inshareholders’ equity and cash flows for the years then ended.  These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Merrill MerchantsBancshares, Inc. and Subsidiaries at December  31, 2003 and 2002 and theconsolidated results of their operations and their consolidated cash flows forthe years then ended in conformity with U.S. generally accepted accountingprinciples.

 
| /s/Berry, Dunn, McNeil  & Parker |   |
|--------------------------------------|--------|
| BERRY DUNN MCNEIL &  PARKER      |
| Bangor, Maine                        |
| January 9, 2004                 |

 

14

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### **MERRILL MERCHANTSBANCSHARES, INC. AND SUBSIDIARIES**

### **CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

**(In Thousands, Except Number ofShares and per Share Data)**

 
|                                                                                                           |   | **DECEMBER 31,** |    |
|----------------------------------------------------------------------------------------------------------------|--------|-----------------------|---------|
|                                                                                                           |   | **2003**              |    | **2002** |   |
| ASSETS                                                                                                         |   |                  |    |   |   |
| Cash and due from banks                                                                                        |   | $                     | 10,682  |   | $ | 14,210 |   |
| Interest-bearing  deposits with banks                                                                          |   | 64                    |    | 57 |   |
| Total  cash and cash equivalents                                                                               |   | 10,746                |    | 14,267 |   |
| Investment  securities – available for sale                                                               |   | 76,140                |    | 68,867 |   |
| Loans  held for sale                                                                                           |   | 789                   |    | 1,220 |   |
| Loans  receivable                                                                                              |   | 246,512               |    | 214,729 |   |
| Less  allowance for loan losses                                                                                |   | 3,652                 |    | 3,295 |   |
| Net  loans receivable                                                                                          |   | 242,860               |    | 211,434 |   |
| Other  real estate owned                                                                                       |   | —                |    | 151 |   |
| Properties  and equipment, net                                                                                 |   | 3,335                 |    | 3,537 |   |
| Cash  surrender value of life insurance                                                                        |   | 3,729                 |    | 3,591 |   |
| Deferred  income tax benefit                                                                                   |   | 859                   |    | 646 |   |
| Accrued  income and other assets                                                                               |   | 3,731                 |    | 3,603 |   |
| Total  assets                                                                                                  |   | $                     | 342,189 |   | $ | 307,316 |   |
|                                                                                                           |   |                  |    |   |   |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                     |   |                  |    |   |   |
| Demand  deposits                                                                                               |   | $                     | 47,880  |   | $ | 40,951 |   |
| Savings  and NOW deposits                                                                                      |   | 117,951               |    | 106,021 |   |
| Certificates  of deposit                                                                                       |   | 93,017                |    | 91,885 |   |
| Total  deposits                                                                                                |   | 258,848               |    | 238,857 |   |
| Securities  sold under agreements to repurchase (term and demand)                                              |   | 20,362                |    | 19,236 |   |
| Other  borrowed funds                                                                                          |   | 28,898                |    | 17,696 |   |
| Accrued  expenses and other liabilities                                                                        |   | 3,528                 |    | 3,139 |   |
| Total  liabilities                                                                                             |   | 311,636               |    | 278,928 |   |
| Commitments  (Notes 7, 8, 13, 17 and 18)                                                                       |   |                  |    |   |   |
| Shareholders’  equity                                                                                     |   |                  |    |   |   |
| Common  stock, $1 par value; 4,000,000 shares authorized;                                                      |   |                  |    |   |   |
| shares  issued 3,335,293 and outstanding 3,323,797 in 2003; and                                                |   |                  |    |   |   |
| shares  issued 3,194,497 and outstanding 3,116,263 in 2002                                                     |   | 3,335                 |    | 3,194 |   |
| Capital  surplus                                                                                               |   | 21,762                |    | 20,381 |   |
| Retained  earnings                                                                                             |   | 5,305                 |    | 5,498 |   |
| Accumulated  other comprehensive income                                                                        |   |                  |    |   |   |
| Unrealized  gain on securities available for sale, net of tax of $188 and $276 in 2003  and 2002, respectively |   | 366                   |    | 536 |   |
| Treasury  stock, at cost – 11,496 shares in 2003 and 78,234 shares  in 2002                               |   | (215                  | )       | (1,221 | ) |
| Total  shareholders’ equity                                                                               |   | 30,553                |    | 28,388 |   |
| Total  liabilities and shareholders’ equity                                                               |   | $                     | 342,189 |   | $ | 307,316 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

15

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**MERRILL MERCHANTS BANCSHARES, INC.AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

 
|                                                            |   | **YEARS  ENDED DECEMBER 31,** |   |
|-----------------------------------------------------------------|--------|------------------------------------|--------|
| **(In Thousands, Except Number of  Shares and per Share Data)** |   | **2003**                           |   | **2002** |   |
| Interest  and dividend income                                   |   |                               |   |   |   |
| Interest  and fees on loans                                     |   | $                                  | 15,302 |   | $ | 14,959 |   |
| Interest  on investment securities                              |   | 1,754                              |   | 3,090 |   |
| Dividends  on investment securities                             |   | 157                                |   | 257 |   |
| Interest  on federal funds sold                                 |   | —                             |   | 1 |   |
| Total  interest and dividend income                             |   | 17,213                             |   | 18,307 |   |
| Interest  expense                                               |   |                               |   |   |   |
| Interest  on deposits                                           |   | 3,939                              |   | 5,007 |   |
| Interest  on borrowed funds                                     |   | 795                                |   | 837 |   |
| Total  interest expense                                         |   | 4,734                              |   | 5,844 |   |
| Net  interest income                                            |   | 12,479                             |   | 12,463 |   |
|                                                            |   |                               |   |   |   |
| Provision  for loan losses                                      |   | 444                                |   | 453 |   |
| Net  interest income after provision for loan losses            |   | 12,035                             |   | 12,010 |   |
| Non-interest  income                                            |   |                               |   |   |   |
| Service  charges on deposit accounts                            |   | 1,161                              |   | 858 |   |
| Other  service charges and fees                                 |   | 706                                |   | 944 |   |
| Trust  fees                                                     |   | 1,186                              |   | 1,075 |   |
| Net  gain on sale of mortgage loans                             |   | 1,808                              |   | 796 |   |
| Net  loss on investment securities                              |   | (51                                | )      | (30 | ) |
| Other                                                           |   | 371                                |   | 320 |   |
| Total  other income                                             |   | 5,181                              |   | 3,963 |   |
|                                                            |   |                               |   |   |   |
| Non-interest  expense                                           |   |                               |   |   |   |
| Salaries  and employee benefits                                 |   | 5,887                              |   | 5,452 |   |
| Occupancy  expense                                              |   | 811                                |   | 825 |   |
| Equipment  expense                                              |   | 637                                |   | 716 |   |
| Data  processing                                                |   | 626                                |   | 558 |   |
| Other                                                           |   | 2,757                              |   | 2,654 |   |
|                                                            |   |                               |   |   |   |
| Total  other expense                                            |   | 10,718                             |   | 10,205 |   |
|                                                            |   |                               |   |   |   |
| Income  before income taxes                                     |   | 6,498                              |   | 5,768 |   |
|                                                            |   |                               |   |   |   |
| Income  tax expense                                             |   | 2,196                              |   | 1,923 |   |
|                                                            |   |                               |   |   |   |
| Net  income                                                     |   | $                                  | 4,302  |   | $ | 3,845 |   |
|                                                            |   |                               |   |   |   |
| Per  share data                                                 |   |                               |   |   |   |
| Basic  earnings per common share                                |   | $                                  | 1.30   |   | $ | 1.28 |   |
| Diluted  earnings per common share                              |   | $                                  | 1.29   |   | $ | 1.14 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

16

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY**

 

**(In Thousands, Except Number of Shares and per Share Data)**

 
|                                                                                                    |   | **Convertible  Cumulative  Preferred  Stock** |   | **Common  Stock** |   | **Capital  Surplus** |   | **Retained  Earnings** |   | **Unrealized  Gain  on Securities  Available  for Sale** |   | **Treasury  Stock** |   | **Total  Shareholders’  Equity** |   |
|---------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|-------------------|--------|----------------------|--------|------------------------|--------|----------------------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|
| Balance  at December 31, 2001                                                                      |   | $                                             | 20     |              | $      | 2,741                |   | $                      | 18,794 |                                                     | $      | 4,601               |   | $                                     | 600    |   | $ | (771 | ) | $ | 25,985 |   |
| Net  income                                                                                             |   | —                                        |   | —            |   | —               |   | 3,845                  |   | —                                                   |   | —              |   | 3,845                                 |   |
| Change  in unrealized gain on securities available for sale, net of deferred income  tax benefit of $18 |   | —                                        |   | —            |   | —               |   | —                 |   | (64                                                      | )      | —              |   | (64                                   | )      |
| Total  comprehensive income                                                                             |   | —                                        |   | —            |   | —               |   | 3,845                  |   | (64                                                      | )      | —              |   | 3,781                                 |   |
| Conversion  of cumulative preferred stock and mandatory convertible debentures to common  stock         |   | (20                                           | )      | 306               |   | 14                   |   | —                 |   | —                                                   |   | —              |   | 300                                   |   |
| Common  stock options exercised, 153,424 shares                                                         |   | —                                        |   | 65                |   | 185                  |   | (519                   | )      | —                                                   |   | 959                 |   | 690                                   |   |
| 3%  common stock dividend declared                                                                      |   | —                                        |   | 82                |   | 1,121                |   | (1,205                 | )      | —                                                   |   | —              |   | (2                                    | )      |
| Treasury  stock purchased (91,949 shares at an average price of $15.32)                                 |   | —                                        |   | —            |   | —               |   | —                 |   | —                                                   |   | (1,409              | )      | (1,409                                | )      |
| Tax  benefit related to exercise of stock options                                                       |   | —                                        |   | —            |   | 267                  |   | —                 |   | —                                                   |   | —              |   | 267                                   |   |
| Common  stock cash dividend declared, $.40 per share                                                    |   | —                                        |   | —            |   | —               |   | (1,192                 | )      | —                                                   |   | —              |   | (1,192                                | )      |
| Convertible  cumulative preferred stock dividends declared, $1.63 per share                             |   | —                                        |   | —            |   | —               |   | (32                    | )      | —                                                   |   | —              |   | (32                                   | )      |
|                                                                                                    |   |                                          |   |              |   |                 |   |                   |   |                                                     |   |                |   |                                  |   |
| Balance  at December 31, 2002                                                                      |   | $                                             | — |              | $      | 3,194                |   | $                      | 20,381 |                                                     | $      | 5,498               |   | $                                     | 536    |   | $ | (1,221 | ) | $ | 28,388 |   |
| Net  income                                                                                             |   | —                                        |   | —            |   | —               |   | 4,302                  |   | —                                                   |   | —              |   | 4,302                                 |   |
| Change  in unrealized gain on securities available for sale, net of deferred income  tax benefit of $89 |   | —                                        |   | —            |   | —               |   | —                 |   | (170                                                     | )      | —              |   | (170                                  | )      |
| Total  comprehensive income                                                                             |   | —                                        |   | —            |   | —               |   | 4,302                  |   | (170                                                     | )      | —              |   | 4,132                                 |   |
| Common  stock options exercised, 186,142 shares                                                         |   | —                                        |   | 45                |   | (57                  | )      | (1,458                 | )      | —                                                   |   | 2,224               |   | 754                                   |   |
| 3%  common stock dividend declared                                                                      |   | —                                        |   | 96                |   | 1,340                |   | (1,438                 | )      | —                                                   |   | —              |   | (2                                    | )      |
| Treasury  stock purchased (75,031 shares at an average price of $16.23)                                 |   | —                                        |   | —            |   | —               |   | —                 |   | —                                                   |   | (1,218              | )      | (1,218                                | )      |
| Tax  benefit related to exercise of stock options                                                       |   | —                                        |   | —            |   | 98                   |   | —                 |   | —                                                   |   | —              |   | 98                                    |   |
| Common  stock cash dividend declared, $.48 per share                                                    |   | —                                        |   | —            |   | —               |   | (1,599                 | )      | —                                                   |   | —              |   | (1,599                                | )      |
|                                                                                                    |   |                                          |   |              |   |                 |   |                   |   |                                                     |   |                |   |                                  |   |
| Balance  at December 31, 2003                                                                      |   | $                                             | — |              | $      | 3,335                |   | $                      | 21,762 |                                                     | $      | 5,305               |   | $                                     | 366    |   | $ | (215 | ) | $ | 30,553 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

17

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

### **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
|                                                                                      |   | **YEARS ENDED DECEMBER 31,** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **(In Thousands)**                                                                        |   | **2003**                          |   | **2002** |   |
| Cash  flows from operating activities                                                     |   |                              |   |   |   |
| Net  income                                                                               |   | $                                 | 4,302  |   | $ | 3,845 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities         |   |                              |   |   |   |
| Depreciation                                                                              |   | 457                               |   | 504 |   |
| Amortization                                                                              |   | 650                               |   | 436 |   |
| Net  amortization on investment securities                                                |   | 979                               |   | 44 |   |
| Deferred  income taxes                                                                    |   | (125                              | )      | (113 | ) |
| Provision  for loan losses                                                                |   | 444                               |   | 453 |   |
| Net  gain on sale of mortgage loans, investment securities, and properties and  equipment |   | (788                              | )      | (332 | ) |
| Net  change in:                                                                           |   |                              |   |   |   |
| Loans  held for sale                                                                      |   | 431                               |   | (160 | ) |
| Deferred  loan fees                                                                       |   | 26                                |   | 10 |   |
| Accrued  income and other assets                                                          |   | (31                               | )      | (342 | ) |
| Accrued  expenses and other liabilities                                                   |   | 389                               |   | 328 |   |
| Net  cash provided by operating activities                                                |   | 6,734                             |   | 4,673 |   |
| Cash  flows from investing activities                                                     |   |                              |   |   |   |
| Net  loans made to customers                                                              |   | (31,895                           | )      | (26,944 | ) |
| Acquisition  of properties and equipment and computer software                            |   | (295                              | )      | (420 | ) |
| Purchase  of investment securities available for sale                                     |   | (79,253                           | )      | (111,316 | ) |
| Proceeds  from sales and maturities of investment securities available for sale           |   | 70,691                            |   | 113,902 |   |
| Acquisition  of life insurance policies                                                   |   | —                            |   | (535 | ) |
| Proceeds  from sale of other real estate owned                                            |   | 153                               |   | 217 |   |
| Net  cash used in investing activities                                                    |   | (40,599                           | )      | (25,096 | ) |
| Cash  flows from financing activities                                                     |   |                              |   |   |   |
| Net  increase in demand, savings and NOW deposits                                         |   | 18,859                            |   | 11,314 |   |
| Net  increase in certificates of deposit                                                  |   | 1,132                             |   | 8,234 |   |
| Net  increase in securities sold under agreements to repurchase                           |   | 1,126                             |   | 98 |   |
| Net  increase in other borrowed funds                                                     |   | 1,881                             |   | 8,138 |   |
| Long-term  advances from the Federal Home Loan Bank                                       |   | 10,000                            |   | 3,746 |   |
| Payments  of long-term advances                                                           |   | (679                              | )      | (4,842 | ) |
| Dividends  paid on convertible cumulative preferred stock and common stock                |   | (1,511                            | )      | (1,123 | ) |
| Proceeds  from stock issuance                                                             |   | 754                               |   | 690 |   |
| Purchase  of treasury stock                                                               |   | (1,218                            | )      | (1,409 | ) |
| Net  cash provided by financing activities                                                |   | 30,344                            |   | 24,846 |   |
| Net  increase (decrease) in cash and cash equivalents                                     |   | (3,521                            | )      | 4,423 |   |
| Cash  and cash equivalents, beginning of year                                             |   | 14,267                            |   | 9,844 |   |
| Cash  and cash equivalents, end of year                                                   |   | $                                 | 10,746 |   | $ | 14,267 |   |
|                                                                                      |   |                              |   |   |   |
| Supplemental  disclosures of cash flow information                                        |   |                              |   |   |   |
| Cash  paid for interest                                                                   |   | $                                 | 4,717  |   | $ | 5,823 |   |
| Transfers  to other real estate owned                                                     |   | —                            |   | 141 |   |
| Income  tax paid                                                                          |   | 1,999                             |   | 1,914 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**MERRILLMERCHANTS BANCSHARES, INC. AND SUBSIDIARIES**

**Notesto Consolidated Financial Statements**

**December 31,2003 and 2002**

**(Presentedin Thousands, except Number of Shares and per Share Data)**

 

1.                           Summaryof Significant Accounting Policies

 

Theaccounting and reporting policies conform to U.S. generally accepted accountingprinciples and to general practice within the banking industry.  The following is a summary of thesignificant accounting and reporting policies.

 

Nature of Business

 

MerrillMerchants Bancshares, Inc. (Company) is a financial holding company that ownsall of the common stock of Merrill Merchants Bank (Bank).  The Bank operates branches in Bangor (threeoffices), Brewer, Holden, Milford, Newport, Orono, Orrington, Pittsfield, andWaterville, Maine.

 

TheBank’s lending activities are conducted principally in central Maine.  The Bank grants single family andmulti-family residential loans, commercial real estate loans, commercial loans,and a variety of consumer loans.  Inaddition, the Bank grants loans for the construction of residential homes,multi-family properties and commercial real estate properties.  Most loans granted by the Bank are eithercollateralized by real estate or guaranteed by federal and local governmentalauthorities.  The ability andwillingness of the single family residential and consumer borrowers to honortheir repayment commitments is generally dependent on the level of overalleconomic activity within the borrowers’ geographic areas and real estatevalues.  The ability and willingness ofcommercial real estate, commercial and construction loan borrowers to honortheir repayment commitments is generally dependent on the health of the realestate economic sector in the borrowers’ geographic areas and the generaleconomy.

 

MaineAcceptance Corporation (MAC), formerly a separate subsidiary of the Company,was merged into the Bank effective March 29, 2002.  MAC, located in Bangor, Maine, providesindirect auto and recreational vehicle lending, as well as other types ofloans, including personal unsecured, recreational vehicle, automobile, mobilehome, and home equity loans.

 

TheBank is under the supervision of the Board of Governors of the Federal ReserveSystem and the State of Maine Bureau of Financial Institutions, and itsdeposits are insured by the Federal Deposit Insurance Corporation (FDIC) to thefullest extent permitted by law.

 

Estimates

 

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for loan losses and thevaluation of real estate acquired in connection with foreclosures or in satisfactionof loans.  In connection with thedetermination of the allowance for loan losses and the carrying value of otherreal estate owned, management obtains independent appraisals for significantproperties.

 

FinancialStatement Presentation

 

Theaccompanying consolidated financial statements include the accounts of MerrillMerchants Bancshares, Inc. and its wholly-owned subsidiaries, Merrill MerchantsBank, a state-chartered bank, and Maine Acceptance Corporation. Allintercompany accounts and transactions have been eliminated in the consolidatedfinancial statements.

 

Statementof Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segmentsof an Enterprise and Related Information,” requires a company to disclosecertain income statement and balance sheet information by operating segment.Since the Company’s operations include only its banking and financingactivities, no additional disclosures are required by the Statement.

 

19

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InvestmentSecurities

 

Investmentdebt securities are classified as available for sale and are carried at fairvalue.  Unrealized gains and losses onsecurities available for sale, net of income taxes, are recognized as directincreases or decreases in shareholders’ equity.  Market values of securities are obtained from independent marketsources.  Cost of securities sold isrecognized using the specific identification method.

 

Premiumsare amortized and discounts are accreted using methods approximating theinterest method.

 

Loans Held forSale

 

Residentialmortgage loans originated and intended for sale in the secondary market arecarried at the lower of aggregate cost or estimated market value.  Gains or losses on sales of loans arerecognized at the time of sale and are based upon the difference between theselling price and the carrying amount of loans sold.

 

Other Real EstateOwned

 

Otherreal estate owned (OREO) includes real estate and repossessed personal propertyheld for sale which have been acquired principally through foreclosure or asimilar conveyance of title.  Realestate may be considered to be in-substance foreclosed and included in OREOprior to the conveyance of title when specific criteria are met.  Both foreclosed and in-substance foreclosedreal estate, as well as repossessed personal property, are carried at the lowerof their recorded amounts or fair value less estimated costs of disposal.  Any write-downs at, or prior to, the datesof acquisition are charged to the allowance for loan losses.  Subsequent write-downs are recorded in otherexpense.  Expenses incurred inconnection with holding such assets and gains and losses upon sale are includedin other expense or other income.

 

## **LoansReceivable**

 

Loansreceivable that management has the intent and ability to hold for theforeseeable future or until maturity or pay-off are reported at theiroutstanding principal adjusted for any charge-offs, the allowance for loanlosses, and any deferred fees or costs.

 

Intereston loans is accrued and credited to income based on the principal amountoutstanding.  The accrual of interest onloans is discontinued when, in the opinion of management, there is anindication that the borrower may be unable to meet payments as they become dueor the loan becomes past due 90 days or more unless the credit is well-securedand in process of collection. Upon such discontinuance, all unpaid accruedinterest is reversed.  Interest incomeis subsequently recognized only to the extent cash payments are received.  Loans 30 days or more past due areconsidered delinquent.

 

TheCompany’s provision for loan losses charged to operations is based uponmanagement’s evaluation of the loan portfolio. Loans deemed uncollectible are charged to the allowance.  The allowance for loan losses is maintainedat a level that management believes, to the best of its knowledge, is at alevel at each reporting date to cover known and inherent losses in the loanportfolio that are both probable and reasonably estimable.  The ongoing evaluation process includes aformal analysis of the allowance each quarter, which considers, among otherfactors, the character and size of the loan portfolio, business and economicconditions, loan growth, delinquency trends, charge-off experience and otherasset quality factors.  While managementuses available information to recognize losses on loans, future additions tothe allowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, asan integral part of their examination process, periodically review theCompany’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to theallowance based on their judgments about information available to them at thetime of their examinations.

 

Loansconsidered to be impaired are reduced to the present value of expected futurecash flows or to the fair value of collateral. Management takes into consideration impaired loans in determining theappropriate level of allowance for loan losses.

 

20

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Loan Servicing

 

Thecost of mortgage servicing rights is amortized in proportion to, and over theperiod of, estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fairvalue of those rights.  Fair values areestimated using discounted cash flows based on a current market interestrate.  For purposes of measuringimpairment, the rights are stratified based on loan type, investor type, andinterest rate. The amount of impairment recognized is the amount by which thecapitalized mortgage servicing rights for a stratum exceed their fair value.

 

Properties andEquipment

 

Propertiesand equipment are stated at cost, less accumulated depreciation.  The provision for depreciation is computedon the straight-line method and by accelerated methods over the estimateduseful lives of the assets.

 

Goodwill

 

EffectiveJanuary 1, 2002, the Company discontinued amortization of goodwill inaccordance with SFAS Nos. 142 and 147. Prior to 2002, goodwill was beingamortized using the straight-line method over seven and fifteen years. Inaccordance with SFAS No. 142, goodwill is reviewed for impairment on an annualbasis and if certain conditions occur.

 

Advertising andPromotion

 

Advertisingand promotion costs are expensed when incurred.

 

Loan OriginationFees and Costs

 

Loanorigination fees and certain direct origination costs are capitalized andrecognized as an adjustment of the yield on the related loan.

 

Income Taxes

 

TheCompany records deferred tax assets and liabilities for future tax consequencesattributable to differences between the financial statement carrying amounts ofassets and liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to be recoveredor settled.

 

Off-Balance-SheetFinancial Instruments

 

In theordinary course of business, the Bank has entered into off-balance-sheetfinancial instruments consisting of commitments to extend credit, letters ofcredit and unadvanced commitments under commercial and home equity lines ofcredit, credit cards, and overdraft protection accounts.  Such financial instruments are recorded inthe consolidated financial statements when funded.

 

Cash and CashEquivalents

 

Forthe purpose of presentation in the consolidated statements of cash flows, cashand cash equivalents are defined as cash and due from banks andinterest-bearing deposits with banks.

 

## **EarningsPer Share**

 

Thebasic earnings per share computation is based upon the weighted-average numberof shares of stock outstanding during the period.  Potential common stock is considered in the calculation ofweighted-average shares outstanding for diluted earnings per share.

 

TheCompany declared a 3% stock dividend in 2003 and 2002.  Earnings and cash dividends per share andweighted-average shares outstanding have been retroactively restated to reflectthe stock dividends.

 

21

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Stock Options

 

Underthe Employee and Director Stock Option Plan, the incentive stock option plan(ISO) for officers and employees and the nonstatutory stock option plan(Non-ISO) for directors provide for the issuance of up to 763,314 shares ofcommon stock.  The purchase price of thestock covered by each option shall be its fair market value, which must beequal to at least 100% of the book value of common stock, on the date suchoption is granted.  Options grantedthrough 1997 were subject to an initial vesting period which ended onDecember 31, 1997, after which options become exercisable until May 26,2003.  Options granted after 1997 weregranted subject to an initial vesting period of one, two or three years, afterwhich options become exercisable until ten years from the grant date.

 

TheCompany accounts for these options in accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees.”  As the exercise price of each option equalsthe market price of the Company’s stock on the date of grant, no compensationcost has been recognized for the plan. Had compensation cost for the plan been determined based on the fairvalue of the options at the grant dates consistent with the method described inSFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s 2003 and2002 net income and earnings per share would have been reduced to the pro formaamounts indicated below.

 
|                                                                                                                                            |   |           |   |      |   | **Earnings  per Share** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------|--------|-----------|--------|-------------------------|--------|
|                                                                                                                                            |   | **Net Income** |   | **Basic** |   | **Diluted**             |   |
| **(in thousands, except for per-share data)**                                                                                                   |   | **2003**       |   | **2002**  |   | **2003**                |   | **2002** |   | **2003** |   | **2002** |   |
| Net  income, as reported                                                                                                                        |   | $              | 4,302  |      | $      | 3,845                   |   | $ | 1.30 |   | $ | 1.28 |   | $ | 1.29 |   | $ | 1.14 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of deferred income taxes |   | (28            | )      | (16       | )      | (0.01                   | )      | (0.01 | ) | — |   | (0.01 | ) |
| Pro  forma net income                                                                                                                           |   | $              | 4,274  |      | $      | 3,829                   |   | $ | 1.29 |   | $ | 1.27 |   | $ | 1.29 |   | $ | 1.13 |   |

 

Thefair value of each option is estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions used for all grants in 2003 and 2002: dividend yield of 2.93% in2003 and 2.56% in 2002, risk-free interest rate of 4.4% in 2003 and 2002,expected lives of three years in 2003 and 2002, and expected volatility of 19%in 2003 and 20% in 2002.

 

Impact of Recently Issued Accounting Standards

 

FinancialAccounting Standards Board (FASB) Interpretation Number 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (FIN 45), an interpretation of FASB Statements No. 5, 57, and107 and rescission of FASB Interpretation No. 34, was issued inNovember 2002.   The initialrecognition and initial measurement provisions of this Interpretation areapplicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002, irrespective of the guarantor’s fiscal year-end.  The disclosure requirements in thisInterpretation are effective for financial statements of interim or annualperiods ending after December 15, 2002.

 

Financialand standby letters of credit are included in the scope of FIN 45, whilecommercial letters of credit are not.  Aguarantor of financial and standby letters of credit is required to recognize,at the inception of a guarantee, a liability for the fair value of theobligation undertaken in issuing the guarantee.  This Interpretation contains disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. This Interpretation does not have a material effect on the Company’sconsolidated financial statements.

 

22

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Statement of Financial Accounting Standards(SFAS) No. 142, “Goodwill and Other Intangible Assets,” and SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” are effectiveon January 1, 2002.  SFAS No. 142requires that goodwill no longer be amortized to earnings, but instead bereviewed for impairment. The amortization of goodwill ceased upon adoption ofthe Statement on January 1, 2002. SFAS No. 147, “Acquisitions of Certain Financial Institutions,” amendsSFAS No. 72, “Accounting for Certain Acquisitions of Banking or ThriftInstitutions,” to exclude from its scope most acquisitions of financialinstitutions.  Such transactions shouldbe accounted for in accordance with SFAS No. 141, “Business Combinations.”  The Company adopted SFAS No. 147 during2002, and ceased amortization of goodwill with a carrying value of $422 as ofJanuary 1, 2002. SFAS No. 144 provides guidance concerning the recognitionand measurement of an impairment loss for certain types of long-livedassets.  Adoption of this statement hadno material impact on the Company’s consolidated financial condition andresults of operations.

 

FASB’s Emerging Issues Task Force Issue No.03-1 requires new disclosures for investment securities with unrealized lossesthat have not been classified as other-than-temporary.  Companies are required to discloseseparately investments that have had continual unrealized losses for more thantwelve months, and those that have had continual unrealized losses for lessthan twelve months.  For investments inthe former category, a narrative disclosure is required that would allowfinancial statement users to understand the positive and negative informationmanagement considered in reaching the conclusion that the impairments are notother-than-temporary.  The newdisclosure requirements, which are effective for years ending afterDecember 15, 2003, did not have a material impact on the Company’sconsolidated financial statements.

 

2.                           Cash and Cash Equivalents

 

The Federal Reserve Board requires the Bankto maintain a rolling average compensating balance of $400 in amounts ondeposit. The Company maintains its cash in bank deposit accounts which, attimes, may exceed federally insured limits. The Company has not experienced anylosses in such accounts. The Company believes it is not exposed to anysignificant risk with respect to these accounts.

 

3.                           Investment SecuritiesAvailable for Sale

 

The amortized cost of investment securitiesas shown in the consolidated statements of financial condition and theirapproximate fair values at December 31, 2003, and 2002 were as follows:

 
| **December 31, 2003**                                          |   | **Amortized  Cost** |   | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Fair  Value** |   |
|---------------------------------------------------------------------|--------|---------------------|--------|-----------------------|--------|------------------------|--------|-----------------|--------|
| Mortgage-backed securities and  collateralized mortgage obligations |   | $                   | 51,941 |                  | $      | 140                    |   | $               | (301   | ) | $ | 51,780 |   |
| U.S. Government agencies and corporations                           |   | 12,351              |   | 125                   |   | (3                     | )      | 12,473          |   |
| U.S. Government and agency money market  funds                      |   | 2,105               |   | —                |   | —                 |   | 2,105           |   |
| Certificates of deposit                                             |   | 2,957               |   | —                |   | —                 |   | 2,957           |   |
| State and local government debt securities                          |   | 2,682               |   | —                |   | —                 |   | 2,682           |   |
| Other securities                                                    |   | 3,550               |   | 593                   |   | —                 |   | 4,143           |   |
|                                                                |   | $                   | 75,586 |                  | $      | 858                    |   | $               | (304   | ) | $ | 76,140 |   |

 
| **December 31, 2002**                                          |   | **Amortized  Cost** |   | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------------------------------|--------|---------------------|--------|-----------------------|------------|------------------------|------------|-----------------|------------|
| Mortgage-backed securities and  collateralized mortgage obligations |   | $                   | 33,134 |                  | $          | 533                    |       | $               | (7         | ) | $ | 33,660 |   |
| U.S. Government agencies and corporations                           |   | 11,520              |   | 230                   |       | —                 |       | 11,750          |       |
| U.S. Government and agency money market  funds                      |   | 11,935              |   | —                |       | —                 |       | 11,935          |       |
| Certificates of deposit                                             |   | 4,158               |   | —                |       | —                 |       | 4,158           |       |
| State and local government debt securities                          |   | 2,925               |   | —                |       | —                 |       | 2,925           |       |
| Other securities                                                    |   | 4,382               |   | 93                    |       | (36                    | )          | 4,439           |       |
|                                                                |   | $                   | 68,054 |                  | $          | 856                    |       | $               | (43        | ) | $ | 68,867 |   |

 

At December 31, 2003, gross unrealizedlosses on the investment portfolio totaled $304.  The unrealized losses relate to investment securities purchasedin 2003.

 

23

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At December 31, 2003 and 2002,investment securities with amortized cost of $53,346 and $34,081 and fair valueof $53,315 and $34,652, respectively, were pledged to secure public deposits,Treasury, tax and loan deposits, securities sold under agreements to repurchaseand borrowings and for other purposes required or permitted by law.

 

The amortized cost and fair value of debtsecurities at December 31, 2003 by contractual maturity are shownbelow.  Expected maturities may differfrom contractual maturities because borrowers may have the right to call orprepay obligations with or without call or prepayment penalties.

 
|                       |   | **Amortized  Cost** |   | **Fair  Value** |   |
|----------------------------|--------|---------------------|--------|-----------------|--------|
|                       |   |                |   |            |   |
| Due in one year or less    |   | $                   | 5,776  |            | $      | 5,811 |   |
| Due from one to five years |   | 13,275              |   | 13,420          |   |
| Due from five to ten years |   | 21,012              |   | 20,964          |   |
| Due after ten years        |   | 29,868              |   | 29,697          |   |
|                       |   | $                   | 69,931 |            | $      | 69,892 |   |

 

Mortgage-backed securities and collateralizedmortgage obligations are allocated among the above maturity groupings based ontheir final maturity dates.

 

During 2003 and 2002, the Company soldinvestment securities available for sale for total proceeds of $26,549 and$82,055, respectively. The sales resulted in gross realized losses of $51 for2003 and $30 for 2002.

 

4.                           Loans Receivable

 

The components of loans receivable were asfollows:

 
|                    |   | **2003** |    | **2002** |   |
|-------------------------|--------|----------|---------|----------|--------|
| Commercial              |   | $        | 55,616  |     | $      | 55,024 |   |
| Commercial real estate  |   | 80,212   |    | 70,247   |   |
| Construction            |   | 9,669    |    | 13,379   |   |
| Residential real estate |   | 55,380   |    | 40,362   |   |
| Home equity             |   | 28,496   |    | 19,889   |   |
| Consumer                |   | 17,269   |    | 15,932   |   |
| Less deferred loan fees |   | (130     | )       | (104     | )      |
| Total                   |   | $        | 246,512 |     | $      | 214,729 |   |

 

As of December 31, 2003 and 2002,non-accrual loans were $598 and $432, respectively.  Interest foregone was $24 for 2003 and $36 for 2002.  Accruing loans which are 90 days past due ormore totaled $8 and $169 at December 31, 2003 and 2002, respectively.

 

Impaired loans recorded in conformity withSFAS No. 114, as amended by SFAS No. 118, totaled $299 and $333 atDecember 31, 2003, and 2002, respectively.  The total allowance for loan losses related to these loans was$60 and $33 at December 31, 2003, and 2002, respectively. The averagebalance of outstanding impaired loans was $687 and $272 for 2003 and 2002,respectively.  Interest incomerecognized for cash payments on impaired loans during 2003 and 2002 was notmaterial to the consolidated financial statements.

 

5.                           Allowance for Loan Losses

 

An analysis of the allowance for loan lossesat December 31, 2003, and 2002 is as follows:

 
|                           |                               | **2003** |   | **2002** |   |
|--------------------------------|------------------------------------|----------|--------|----------|--------|
| Balance at beginning of year   |                               | $        | 3,295  |     | $      | 2,986 |   |
| Add:                           | Provision for loan losses          |     | 444    |     | 453    |   |
|                           | Recoveries of previous charge-offs |     | 33     |     | 45     |   |
| Less:   Loans charged off |                               | (120     | )      | (189     | )      |
| Balance at end of year         |                               | $        | 3,652  |     | $      | 3,295 |   |

 

6.                           Mortgage Servicing

 

The Bank services residential mortgage loanssold to investors under non-recourse agreements amounting to $106,864 and$95,095 at December 31, 2003, and 2002, respectively.  Mortgage servicing rights of $792 and $423are capitalized and recorded at their estimated fair value at December 31,2003, and 2002, respectively and are included in other assets.  Mortgage servicing rights of $869 and $361were capitalized in 2003 and 2002, respectively and amortization of mortgageservicing rights was $475 in 2003 and $278 in 2002.

 

24

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7.                           Properties and Equipment

 

Properties and equipment are comprised of thefollowing:

 
|                          |   | **2003** |   | **2002** |   |
|-------------------------------|--------|----------|--------|----------|--------|
| Land and land improvements    |   | $        | 559    |     | $      | 559 |   |
| Bank premises                 |   | 2,370    |   | 2,332    |   |
| Furniture and equipment       |   | 3,079    |   | 2,985    |   |
| Leasehold improvements        |   | 400      |   | 320      |   |
| Total cost                    |   | 6,408    |   | 6,196    |   |
| Less accumulated depreciation |   | 3,073    |   | 2,659    |   |
| Net properties and equipment  |   | $        | 3,335  |     | $      | 3,537 |   |

 

Certain Bank facilities and equipment areleased under various operating leases. Rental expense was approximately $314 for 2003 and $309 for 2002.   Future minimum rental commitments undernon-cancelable leases at December 31, 2003 are:

 

| 2004  |   | $   | 271    |   |
|-------|--------|-----|--------|--------|
| 2005  |   | 157 |   |
| 2006  |   | 140 |   |
| 2007  |   | 75  |   |
| Total |   | $   | 643    |   |

 

8.                           Employee Benefit Plans

 

The Company has established a definedcontribution pension plan under Section 401(k) of the Internal RevenueCode.  Plan participants, who consist ofall employees meeting minimum age and service requirements who elect toparticipate, are permitted to contribute a percentage of their wages to theplan on a pre-tax basis.  The Companymatches a portion of each employee’s contribution, resulting in an expense of$114 and $101 for 2003 and 2002, respectively.

 

In 1997, the Company adopted a nonqualifiedsupplemental executive retirement plan for the benefit of key employees.  The plan was restructured and amended in2000.  Life insurance policies wereacquired to generate income to offset the cost of the plan.  During 2002, additional life insurancepolicies acquired totaled $535.  Theamount of each annual benefit is indexed to the financial performance of eachinsurance policy owned by the Bank over the Bank’s cost of funds expense. Thepresent value of these benefits is being expensed over the employment service periodwhich amounted to $187 for 2003 and $127 for 2002. The cash value of these policieswas $3,729 and $3,591 at December 31, 2003, and 2002, respectively.

 

9.                           Deposits

 

The aggregate amount of certificates ofdeposit with a minimum denomination of $100 was $41,511 and $37,643 atDecember 31, 2003, and 2002, respectively.  Certificates of deposit included brokered deposits in the amountof $25,942 and $20,831 at December 31, 2003, and 2002, respectively.

 

At December 31, 2003, the scheduledmaturities of certificates of deposit are as follows:

 

| 2004       |   | $      | 44,651 |   |
|------------|--------|--------|--------|--------|
| 2005       |   | 17,975 |   |
| 2006       |   | 14,440 |   |
| 2007       |   | 13,359 |   |
| 2008       |   | 2,070  |   |
| Thereafter |   | 522    |   |
| Total      |   | $      | 93,017 |   |

 

10.                     Borrowed Funds

 

Securities sold under agreements torepurchase generally mature within one to four days from the transactiondate.  Other borrowed funds consist ofFederal Home Loan Bank (FHLB) advances, commercial bank line of credit advancesand Treasury, tax and loan deposits. Treasury, tax and loan deposits are repaid upon notification by the U.S.Treasury.

 

Information concerning securities sold underagreements to repurchase is summarized as follows:

 
|                                      |   | **2003** |   | **2002** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|
| Average balance during the year           |   | $        | 19,797 |     | $      | 17,096 |   |
| Maximum month-end balance during the year |   | 23,570   |   | 19,428   |   |
| Average interest rate during the year     |   | 0.82     | %      | 1.40     | %      |
| Average interest rate at end of the year  |   | 0.66     | %      | 1.07     | %      |
|                                           |        |          |        |          |        |  |  |

 

25

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The Bank is required to own stock of the FHLBin order to borrow from the FHLB.  FHLBadvances are collateralized by a pledge of certain mortgage loans and by a lienon the Bank’s FHLB stock of $1,689 at December 31, 2003, which is includedin investment securities available for sale in the consolidated statements offinancial condition.  The Company,through its banking subsidiary, has an available line of credit with the FHLBof $3,509.

 

At December 31, 2003, the Company had a$5,000 commercial bank line of credit that expires in 2004.  The floating rate note is based on the onemonth London Interbank Offer Rate (1.12% at December 31, 2003) plus 1.75%.

 

A summary of the borrowings from the FederalHome Loan Bank follows:

 

December 31, 2003

 

| **Maturity Dates** |   | **Principal  Amounts** |   | **Interest  Rates** |             |
|--------------------|--------|------------------------|--------|---------------------|------------------|
| 2004               |   | $                      | 2,594  |                | 1.14 – 7.34 | % |
| 2005               |   | 2,590                  |   | 1.14 – 7.34    | %                |
| 2006               |   | 5,924                  |   | 1.14 – 6.47    | %                |
| 2007               |   | 4,528                  |   | 2.31 – 6.47    | %                |
| 2008               |   | 738                    |   | 3.38                | %                |
| Thereafter         |   | 1,603                  |   | 3.38                | %                |
|               |   | $                      | 17,977 |                |             |   |

 

December 31, 2002

 

| **Maturity Dates** |   | **Principal  Amounts** |   | **Interest  Rates** |             |
|--------------------|--------|------------------------|--------|---------------------|------------------|
| 2003               |   | $                      | 661    |                | 4.60 – 7.34 | % |
| 2004               |   | 2,002                  |   | 4.60 – 7.34    | %                |
| 2005               |   | 1,943                  |   | 4.60 – 7.34    | %                |
| 2006               |   | 2,235                  |   | 4.60 – 6.47    | %                |
| 2007               |   | 1,815                  |   | 4.60 – 6.47    | %                |
|               |   | $                      | 8,656  |                |             |   |

 

11.                     Income Taxes

 

The current and deferred components of incometax expense are as follows:

 
|             |   | **2003** |   | **2002** |   |
|------------------|--------|----------|--------|----------|--------|
| Current          |   |     |   |     |   |
| Federal          |   | $        | 2,249  |     | $      | 1,974 |   |
| State            |   | 72       |   | 62       |   |
|             |   | 2,321    |   | 2,036    |   |
| Deferred federal |   | (125     | )      | (113     | )      |
|             |   | $        | 2,196  |     | $      | 1,923 |   |

 

The actual tax expense differs from theexpected tax expense computed by applying the applicable U.S. federal corporateincome tax rate to income before income taxes as follows:

 
|                                                        |   | **2003** |   | **2002** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|
| Computed tax expense                                        |   | $        | 2,210  |     | $      | 1,961 |   |
| Increase (reduction) in income tax expense  resulting from: |   |     |   |     |   |
| Income from life insurance                                  |   | (40      | )      | (53      | )      |
| Tax exempt income                                           |   | (47      | )      | (52      | )      |
| State taxes, net of federal benefit                         |   | 48       |   | 41       |   |
| Other                                                       |   | 25       |   | 26       |   |
|                                                        |   | $        | 2,196  |     | $      | 1,923 |   |

 

The tax effects of temporary differences thatgive rise to deferred income tax assets and liabilities are as follows:

 
|                                              |   | **2003**  |   | **2002**      |       |
|---------------------------------------------------|--------|-----------|--------|---------------|------------|
|                                              |   | **Asset** |   | **Liability** | ** ** | **Asset** | ** ** | **Liability** | ** ** |
| Allowance for loan losses                         |   | $         | 1,003  |          | $          | — |   | $ | 852 |   | $ | — |   |
| Unrealized gain on securities available for  sale |   | —    |   | 188           |       | — |   | 276 |   |
| Deferred compensation                             |   | 302       |   | —        |       | 241 |   | — |   |
| Mortgage servicing rights                         |   | —    |   | 269           |       | — |   | 144 |   |
| Depreciation and amortization                     |   | —    |   | 139           |       | — |   | 144 |   |
| Other                                             |   | 150       |   | —        |       | 117 |   | — |   |
|                                              |   | $         | 1,455  |          | $          | 596 |   | $ | 1,210 |   | $ | 564 |   |

 

Management expects the Company will realizeall deferred income tax benefits to offset the income tax liabilities arisingfrom the reversal of taxable temporary differences and taxable income generatedin future years.  Accordingly, theCompany has not established a valuation allowance for deferred income taxbenefits.

 

12.                     Related Parties

 

The Bank has entered into loan transactionswith its directors, executive officers, significant shareholders of the Companyand their affiliates (related parties). Such transactions were made in the ordinary course of business onsubstantially the same terms and conditions, including interest rates andcollateral, as those prevailing at the same time for comparable transactionswith other customers, and did not, in the opinion of management, involve morethan normal risk of collectibility or present other unfavorable features. Loansto related parties which in aggregate exceed $60 were as follows:

 

26

----

 
|                      |   | **2003** |   | **2002** |   |
|---------------------------|--------|----------|--------|----------|--------|
| Balance, January 1   |   | $        | 12,656 |     | $      | 8,964 |   |
| Loans made/advanced       |   | 8,723    |   | 5,698    |   |
| Repayments                |   | (6,879   | )      | (2,006   | )      |
| Balance, December 31 |   | $        | 14,500 |     | $      | 12,656 |   |

 

Commitments, as described in Note 13, torelated parties which in aggregate exceed $60 totaled $1,579 and $1,929 atDecember 31, 2003, and 2002, respectively.

 

13.                     Financial Instruments WithOff-Balance-Sheet Risk

 

The Bank is a party to financial instrumentswith off-balance-sheet risk in the normal course of business to meet thefinancing needs of its customers which involve, to varying degrees, elements ofcredit risk in excess of the amount recognized in the consolidated statementsof financial condition. The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit is represented by the contractual notional amount of thoseinstruments.  The Bank follows the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments, including requiring collateral or othersecurity to support financial instruments with credit risk.

 

The Bank’s commitments at December 31,2003, and 2002 are as follows:

 
|                          |   | **2003** |   | **2002** |   |
|-------------------------------|--------|----------|--------|----------|--------|
| Commitments to extend credit  |   | $        | 14,299 |     | $      | 21,736 |   |
| Letters of credit             |   | 1,496    |   | 831      |   |
| Unadvanced commitments        |   |     |   |     |   |
| Commercial lines of credit    |   | 26,114   |   | 20,550   |   |
| Construction lines of credit  |   | 6,125    |   | 5,512    |   |
| Home equity lines of credit   |   | 16,009   |   | 13,989   |   |
| Overdraft protection accounts |   | 1,325    |   | 1,300    |   |
| Credit card lines             |   | 3,294    |   | 3,191    |   |
|                               |        |          |        |          |        |  |  |

 

14.                     Shareholders’ Equity

 

The Company distributed a 3% stock dividendin both April 2003 and 2002. Earnings per share for 2003 and 2002 have been restated to reflect thesestock dividends.

 

On October 1, 2002, the preferred stockwas converted into 229,433 shares of common stock.  Prior to conversion, each holder of preferred stock was entitledto dividends equal to the total stated value of $46.00 per share multiplied bythe prime rate in effect from time to time as announced by FleetBoston. The preferredstock was non-voting.

 

On October 21, 2002, the mandatoryconvertible debentures were converted into 76,474 shares of common stock andshareholders’ equity increased by $300. Prior to conversion, the mandatory convertible debentures paid quarterlyinterest at 1% per annum in excess of the prime rate of interest of FleetBoston.

 

15.                     Other Expense

 

Other expense amounts are summarized asfollows for 2003 and 2002:

 
|                                                   |   | **2003** |   | **2002** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|
| Advertising and promotion                              |   | $        | 607    |     | $      | 346 |   |
| Professional fees                                      |   | 397      |   | 459      |   |
| Printing, postage, stationery, and supplies            |   | 290      |   | 266      |   |
| Loan expense                                           |   | 266      |   | 104      |   |
| ATM expense                                            |   | 202      |   | 159      |   |
| Telephone                                              |   | 150      |   | 182      |   |
| Travel, meetings, conventions, and employee  education |   | 145      |   | 131      |   |
| Trust expense                                          |   | 136      |   | 137      |   |
| Merchant processing                                    |   | 41       |   | 388      |   |
| Other                                                  |   | 523      |   | 482      |   |
| Total                                                  |   | $        | 2,757  |     | $      | 2,654 |   |

 

27

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16.                     Earnings Per Share

 

The following table sets forth thecomputation of basic and diluted earnings per share (in thousands, except fornumber of shares and per share data):

 
|                                                              |   | **2003**  |   | **2002**  |   |
|-------------------------------------------------------------------|--------|-----------|--------|-----------|--------|
| Basic earnings per share                                          |   |      |   |      |   |
| Net income, as reported                                           |   | $         | 4,302  |      | $      | 3,845 |   |
| Preferred stock dividends declared                                |   | —    |   | (32       | )      |
| Income available to common shareholders                           |   | $         | 4,302  |      | $      | 3,813 |   |
| Weighted-average shares outstanding                               |   | 3,305,701 |   | 2,989,830 |   |
| Basic earnings per share                                          |   | $         | 1.30   |      | $      | 1.28 |   |
|                                                              |   |      |   |      |   |   |   |
| Diluted earnings per share                                        |   |      |   |      |   |
| Net income, as reported                                           |   | $         | 4,302  |      | $      | 3,845 |   |
| Interest on mandatory convertible  debentures, net of tax         |   | —    |   | 9         |   |
| Income available to common shareholders                           |   | $         | 4,302  |      | $      | 3,854 |   |
|                                                              |   |      |   |      |   |   |   |
| Weighted-average shares outstanding                               |   | 3,305,701 |   | 2,989,830 |   |
| Effect of stock options, net of assumed  treasury stock purchases |   | 20,413    |   | 145,233   |   |
| Effect of convertible preferred stock                             |   | —    |   | 176,879   |   |
| Effect of mandatory convertible debentures                        |   | —    |   | 63,277    |   |
| Adjusted weighted-average shares  outstanding                     |   | 3,326,114 |   | 3,375,219 |   |
| Diluted earnings per share                                        |   | $         | 1.29   |      | $      | 1.14 |   |

 

Options to purchase 43,363 shares of commonstock at $15.34 were outstanding at December 31, 2002 but were notincluded in the computation of diluted earnings per share because the options’exercise price was greater than the average market price of the common stock.

 

17.                     Regulatory Matters

 

The Company and Bank are subject to variousregulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory - and possibly additional discretionary -actions by regulators that, if undertaken, could have a direct material effecton the Company and Bank’s consolidated financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and Bank mustmeet specific capital guidelines that involve quantitative measures of the Company’sand Bank’s assets, liabilities and certain off-balance-sheet items ascalculated under regulatory accounting practices.  The Company’s and Bank’s capital amounts and classification arealso subject to qualitative judgments by the regulators about components, riskweightings, and other factors.

 

Quantitative measures established byregulation to ensure capital adequacy require the Company and Bank to maintainminimum amounts and ratios (set forth in the table on the next page) of totaland Tier I capital (as defined in the regulations) to risk-weighted assets (asdefined in the regulations), and of Tier I capital to average assets (asdefined in the regulations).  Managementbelieves as of December 31, 2003, that the Company and Bank meet allcapital adequacy requirements to which they are subject.

 

As of December 31, 2003, the most recentnotification from the Federal Reserve Bank categorized the Bank as wellcapitalized under the regulatory framework for prompt corrective action.  To be categorized “well capitalized,” theBank must maintain minimum total risk-based, Tier I risk-based, and Tier Ileverage ratios as set forth in the table. There are no conditions or events since that notification thatmanagement believes have changed this category.

 

The Company’s and Bank’s actual capitalamounts and ratios are also presented in the table.  No deduction was made from capital for interest-rate risk in 2003and 2002.

 

28

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|                                                   |   | **Actual** |   | **For  capital  adequacy purposes** |   | **To be well  capitalized under prompt  corrective action provisions** |   |
|--------------------------------------------------------|--------|------------|--------|-------------------------------------|--------|------------------------------------------------------------------------|--------|
|                                                   |   | **Amount** |   | **Ratio**                           |   | **Amount**                                                             |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
|                                                   |   |       |   |                                |   |                                                                   |   |   |   |   |   |   |   |
| As of December 31, 2003                           |   |       |   |                                |   |                                                                   |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  Consolidated  |   | $          | 32,584 |                                | 14.10  | %                                                                      | $      | 18,486 |   | 8.00 | % | N/A |   |   |   |
| Bank                                                   |   | 28,991     |   | 12.65                               |   | 18,332                                                                 |   | 8.00 |   | $ | 22,915 |   | 10.00 | % |
| Tier I capital (to risk-weighted assets)  Consolidated |   | 29,686     |   | 12.85                               |   | 9,243                                                                  |   | 4.00 |   | N/A |   |   |   |
| Bank                                                   |   | 26,117     |   | 11.40                               |   | 9,166                                                                  |   | 4.00 |   | 13,749 |   | 6.00 |   |
| Tier I capital (to average assets)  Consolidated       |   | 29,686     |   | 8.83                                |   | 13,451                                                                 |   | 4.00 |   | N/A |   |   |   |
| Bank                                                   |   | 26,117     |   | 7.86                                |   | 9,971                                                                  |   | 3.00 |   | 16,619 |   | 5.00 |   |
|                                                   |   |       |   |                                |   |                                                                   |   |   |   |   |   |   |   |
| As of December 31, 2002                           |   |       |   |                                |   |                                                                   |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  Consolidated  |   | $          | 30,010 |                                | 14.35  | %                                                                      | $      | 16,728 |   | 8.00 | % | N/A |   |   |   |
| Bank                                                   |   | 24,419     |   | 11.80                               |   | 16,552                                                                 |   | 8.00 |   | $ | 20,690 |   | 10.00 | % |
| Tier I capital (to risk-weighted assets)  Consolidated |   | 27,388     |   | 13.10                               |   | 8,364                                                                  |   | 4.00 |   | N/A |   |   |   |
| Bank                                                   |   | 21,824     |   | 10.55                               |   | 8,276                                                                  |   | 4.00 |   | 12,414 |   | 6.00 |   |
| Tier I capital (to average assets)  Consolidated       |   | 27,388     |   | 9.18                                |   | 11,928                                                                 |   | 4.00 |   | N/A |   |   |   |
| Bank                                                   |   | 21,824     |   | 7.49                                |   | 8,740                                                                  |   | 3.00 |   | 14,566 |   | 5.00 |   |

 

18.                     Stock Options

 

A summary of the status of the stock optionplan (Note 1) as of December 31, 2003, and 2002, and changes during theyears then ended, is presented below.

 
|                                                                        |   | **2003**              |   | **2002**                              |   |
|-----------------------------------------------------------------------------|--------|-----------------------|--------|---------------------------------------|--------|
|                                                                        |   | **Number  of Shares** |   | **Weighted  Average  Exercise Price** |   | **Number  of Shares** |   | **Weighted  Average  Exercise Price** |   |
|                                                                        |   |                  |   |                                  |   |   |   |   |   |
| Outstanding at beginning of year                                            |   | 279,333               |   | $                                     | 7.32   |   | 384,682 |   | $ | 5.44 |   |
| Granted during the year                                                     |   | 3,000                 |   | 15.50                                 |   | 50,000 |   | 15.53 |   |
| Exercised during the year                                                   |   | (186,142              | )      | 5.01                                  |   | (153,424 | ) | 4.81 |   |
| Forfeited during the year                                                   |   | (26,654               | )      | 7.92                                  |   | (11,886 | ) | 7.35 |   |
| Additional shares for which options are  exercisable due to stock dividends |   | 5,570                 |   | —                                |   | 9,961 |   | — |   |
| Outstanding at end of year                                                  |   | 75,107                |   | $                                     | 12.60  |   | 279,333 |   | $ | 7.32 |   |
| Exercisable at end of year                                                  |   | 30,028                |   | $                                     | 8.93   |   | 222,298 |   | $ | 5.40 |   |
|                                                                        |   |                  |   |                                  |   |   |   |   |   |
| Weighted-average fair value of options  granted during the year             |   |                  |   | $                                     | 2.13   |   |   |   | $ | 2.27 |   |

 

The following information applies to options outstanding atDecember 31, 2003:

 
|                        |   | **Options  Outstanding** |   | **Options  Exercisable**                    |   |
|-----------------------------|--------|--------------------------|--------|---------------------------------------------|--------|
| **Range of Exercise Price** |   | **Number  of  Shares**   |   | **Wtd. Avg.  Remaining  Contractual  Life** |   | **Wtd. Avg.  Exercise  Price** |   | **Number  of  Shares** |   | **Wtd. Avg.  Exercise  Price** |   |
|   $8.01 - $9.90   |   | 30,028                   |   | 6.4                                         |   | $ | 8.93 |   | 30,028 |   | $ | 8.93 |   |
| $13.27 - $15.34             |   | 45,079                   |   | 8.9                                         |   | 15.04 |   | — |   | — |   |
|                             |        |                          |        |                                             |        |  |  |  |  |  |  |  |  |

 

29

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19.                     Fair Value of FinancialInstruments

 

Fair value estimates, methods and assumptionsare set forth below for the Company’s financial instruments.

 

Cash and Cash Equivalents

 

The fair value of cash and due from banks andinterest-bearing deposits with banks approximates their relative book values atDecember 31, 2003, and 2002, as these financial instruments have shortmaturities.

 

Investment Securities

 

The fair values of investment securities areestimated based on bid prices published in financial newspapers or bidquotations received from securities dealers.

 

Loans Held for Sale

 

The fair values of loans held for sale arebased on quoted market prices from the Federal National Mortgage Association.

 

Loans Receivable

 

Fair values are estimated for portfolios ofloans receivable with similar financial characteristics.  The fair values approximate carrying valuefor all loans with variable interest rates.

 

The fair values of fixed rate loans arecalculated by discounting scheduled cash flows through the estimated maturityusing estimated market discount rates that reflect the risk inherent in theloan. The estimates of maturity are based on the Bank’s historical experiencewith repayments for each loan classification, modified, as required, by anestimate of the effect of current economic and lending conditions, and theeffects of estimated prepayments.

 

Management has made estimates of fair valueusing discount rates that it believes to be reasonable. However, because thereis no market for many of these financial instruments, management has no basisto determine whether the fair value presented below would be indicative of thevalue negotiated in the actual sale.

 

Cash Surrender Value of Life Insurance

 

The fair value is based on the actual cashsurrender value of life insurance policies.

 

Accrued Interest Receivable

 

The fair value approximates the carryingvalue as this financial instrument has a short maturity.  It is the Bank’s policy to stop accruinginterest on loans for which it is probable that the interest is notcollectible.  Therefore, the fair valueof this financial instrument has been adjusted to reflect credit risk.

 

Capitalized Mortgage Servicing Rights

 

The fair value of mortgage servicing rightsis based on the expected present value of future mortgage servicing income, netof estimated servicing costs, considering market consensus loan prepaymentpredictions.

 

Deposits

 

The fair value of deposits with no statedmaturity, such as noninterest-bearing demand deposits, savings, NOW accountsand money market accounts, is equal to the amount payable on demand.  The fair value of certificates of deposit isbased on the discounted value of contractual cash flows.  The discount rate is estimated using therates currently offered for deposits of similar remaining maturities.

 

The fair value estimates do not include thebenefit that results from the low-cost funding provided by the depositscompared to the cost of borrowing funds in the market.  If that value were considered, the fairvalue of the Bank’s net assets could increase.

 

Borrowed Funds

 

The fair value of borrowed funds is based onthe discounted value of contractual cash flows.  The discount rate is estimated using the rates currentlyavailable for borrowings of similar remaining maturities.

 

Accrued Interest Payable

 

The fair value approximates the book value asthis financial instrument has a short maturity.

 

30

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Off-Balance Sheet Instruments

 

The Company’s off-balance sheet instrumentsconsist of loan commitments.  Fairvalues for loan commitments have not been presented as the future revenue derivedfrom such financial instruments is not significant.

 

Limitations

 

Fair value estimates are made at a specificpoint in time, based on relevant market information and information about thefinancial instrument.  These values donot reflect any premium or discount that could result from offering for sale atone time the Company’s entire holdings of a particular financialinstrument.  Because no market existsfor a significant portion of the Company’s financial instruments, fair valueestimates are based on judgments regarding future expected loss experience,current economic conditions, risk characteristics of various financialinstruments, and other factors. These estimates are subjective in nature andinvolve uncertainties and matters of significant judgment and therefore cannotbe determined with precision.  Changesin assumptions could significantly affect the estimates.

 

Fair value estimates are based on existing onand off-balance sheet financial instruments without attempting to estimate thevalue of anticipated future business and the value of assets and liabilitiesthat are not considered financial instruments. Other significant assets and liabilities that are not consideredfinancial instruments include property and equipment and other real estateowned.  In addition, the taxramifications related to the realization of the unrealized gains and losses canhave a significant affect on fair value estimates and have not been consideredin any of the estimates.

 

A summary of the estimated fair values forthe Company’s significant financial instruments at December 31, 2003, and2002 follows:

 
| **December 31, 2003**             |   | **Carrying  Value** |   | **Estimate  of  Fair Value** |   |
|----------------------------------------|--------|---------------------|--------|------------------------------|--------|
| Financial Assets                       |   |                |   |                         |   |
| Cash and cash equivalents              |   | $                   | 10,746 |                         | $      | 10,746 |   |
| Investment securities                  |   | 76,140              |   | 76,140                       |   |
| Loans held for sale                    |   | 789                 |   | 809                          |   |
| Loans receivable, net                  |   | 242,860             |   | 243,444                      |   |
| Cash surrender value of life insurance |   | 3,729               |   | 3,729                        |   |
| Accrued interest receivable            |   | 1,172               |   | 1,172                        |   |
| Capitalized mortgage servicing rights  |   | 792                 |   | 994                          |   |
| Financial Liabilities                  |   |                |   |                         |   |
| Deposits                               |   | 258,848             |   | 260,329                      |   |
| Accrued interest payable               |   | 421                 |   | 421                          |   |
| Borrowed funds                         |   | 49,260              |   | 49,819                       |   |
|                                        |        |                     |        |                              |        |  |  |

 
| **December 31, 2002**             |   | **Carrying  Value** |   | **Estimate  of  Fair Value** |   |
|----------------------------------------|--------|---------------------|--------|------------------------------|--------|
| Financial Assets                       |   |                |   |                         |   |
| Cash and cash equivalents              |   | $                   | 14,267 |                         | $      | 14,267 |   |
| Investment securities                  |   | 68,867              |   | 68,867                       |   |
| Loans held for sale                    |   | 1,220               |   | 1,220                        |   |
| Loans receivable, net                  |   | 211,434             |   | 215,101                      |   |
| Cash surrender value of life insurance |   | 3,591               |   | 3,591                        |   |
| Accrued interest receivable            |   | 1,190               |   | 1,190                        |   |
| Capitalized mortgage servicing rights  |   | 423                 |   | 769                          |   |
| Financial Liabilities                  |   |                |   |                         |   |
| Deposits                               |   | 238,857             |   | 241,170                      |   |
| Accrued interest payable               |   | 404                 |   | 404                          |   |
| Borrowed funds                         |   | 36,932              |   | 37,595                       |   |
|                                        |        |                     |        |                              |        |  |  |

 

31

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20.                     Parent Company FinancialInformation

 

The following is summarized financialstatement information for Merrill Merchants Bancshares, Inc. as ofDecember 31, 2003, and 2002 and for the years then ended:

 

SUMMARIZED BALANCE SHEET INFORMATION

 
|                                              |   | **2003** |       | **2002** |       |
|---------------------------------------------------|--------|----------|------------|----------|------------|
| ASSETS                                            |   |     |       |     |       |
| Cash                                              |   | $        | 8          |     | $          | 4 |   |
| Investment securities at fair value               |   | 4,227    |       | 5,620    |       |
| Investment in subsidiary                          |   | 26,593   |       | 22,787   |       |
| Deferred income tax benefit                       |   | —   |       | 113      |       |
| Other assets                                      |   | 232      |       | 280      |       |
| Total assets                                      |   | $        | 31,060     |     | $          | 28,804 |   |
|                                              |   |     | ** ** |     | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**    |   |     | ** ** |     | ** ** |
| Liabilities                                       |   |     |       |     |       |
| Dividend payable and accrued expenses             |   | $        | 468        |     | $          | 416 |   |
| Deferred income tax liabilities                   |   | 39       |       | —   |       |
| Total liabilities                                 |   | 507      |       | 416      |       |
| Shareholders’ equity                         |   |     |       |     |       |
| Common stock                                      |   | 3,335    |       | 3,194    |       |
| Capital surplus                                   |   | 21,762   |       | 20,381   |       |
| Retained earnings                                 |   | 5,305    |       | 5,498    |       |
| Accumulated other comprehensive income            |   |     |       |     |       |
| Unrealized gain on securities available for  sale |   | 366      |       | 536      |       |
| Treasury stock                                    |   | (215     | )          | (1,221   | )          |
| Total shareholders’ equity                   |   | 30,553   |       | 28,388   |       |
| Total liabilities and shareholders’ equity   |   | $        | 31,060     |     | $          | 28,804 |   |

 

SUMMARIZED STATEMENTS OF INCOME INFORMATION

 
|                                                                     |   | **2003** |   | **2002** |   |
|--------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Dividends from bank subsidiary                                           |   | $        | — |     | $      | 900 |   |
| Interest income on loan from subsidiary                                  |   | —   |   | 64       |   |
| Interest and dividend income on investments                              |   | 90       |   | 164      |   |
| Total income                                                             |   | 90       |   | 1,128    |   |
|                                                                     |   |     |   |     |   |
| Net loss on investment securities                                        |   | (51      | )      | (30      | )      |
|                                                                     |   |     |   |     |   |
| Interest expense on borrowed funds                                       |   | —   |   | 14       |   |
| Operating expenses                                                       |   | 97       |   | 114      |   |
| Total expenses                                                           |   | 97       |   | 128      |   |
|                                                                     |   |     |   |     |   |
| Income (loss) before income tax (benefit)  expense                       |   | (58      | )      | 970      |   |
| Income tax (benefit) expense                                             |   | (29      | )      | 30       |   |
| Income (loss) before equity in  undistributed net income of subsidiaries |   | (29      | )      | 940      |   |
| Equity in undistributed net income of  subsidiaries                      |   | 4,331    |   | 2,905    |   |
| Net income                                                               |   | $        | 4,302  |     | $      | 3,845 |   |

 

SUMMARIZED STATEMENTS OF CASH FLOWSINFORMATION

 
|                                                                              |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Cash flows from operating activities                                              |   |     |   |     |   |
| Net income                                                                        |   | $        | 4,302  |     | $      | 3,845 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities |   |     |   |     |   |
| Deferred income tax benefit                                                       |   | 85       |   | (52      | )      |
| Equity in undistributed net income of  subsidiaries                               |   | (4,331   | )      | (2,905   | )      |
| Net loss on investment securities                                                 |   | 51       |   | 30       |   |
| Decrease (increase) in accrued income and  other assets                           |   | 10       |   | (12      | )      |
| Increase (decrease) in accrued expenses                                           |   | (16      | )      | 17       |   |
| Net cash provided by operating activities                                         |   | 101      |   | 923      |   |
|                                                                              |   |     |   |     |   |
| Cash flows from investing activities                                              |   |     |   |     |   |
| Proceeds from sales and maturities of  investment securities                      |   | 6,248    |   | 8,953    |   |
| Purchase of investment securities                                                 |   | (4,370   | )      | (13,654  | )      |
| Net repayment from subsidiaries                                                   |   | —   |   | 5,569    |   |
| Net cash provided by investing activities                                         |   | 1,878    |   | 868      |   |
|                                                                              |   |     |   |     |   |
| Cash flows from financing activities                                              |   |     |   |     |   |
| Dividends paid on convertible cumulative  preferred stock                         |   | —   |   | (32      | )      |
| Dividends paid on common stock                                                    |   | (1,511   | )      | (1,091   | )      |
| Proceeds from issuance of common stock                                            |   | 754      |   | 690      |   |
| Purchase of treasury stock                                                        |   | (1,218   | )      | (1,409   | )      |
| Net cash used by financing activities                                             |   | (1,975   | )      | (1,842   | )      |
|                                                                              |   |     |   |     |   |
| Net increase (decrease) in cash and cash  equivalents                             |   | 4        |   | (51      | )      |
| Cash and cash equivalents, beginning of  year                                     |   | 4        |   | 55       |   |
| Cash and cash equivalents, end of year                                            |   | $        | 8      |     | $      | 4 |   |

 

32

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**Merrill Merchants Bancshares****, Inc.**

 

# **Board of Directors**

# ** **

William C. Bullock, Jr., Chairman

Merrill Merchants Bank, Bangor, Maine

 

Edwin N. Clift, President & CEO

Merrill Merchants Bank, Bangor, Maine

 

Joseph H. Cyr, President

John T. Cyr & Sons, Inc., Old Town, Maine

 

Perry B. Hansen, Chairman & CEO

THE National Bank, Bettendorf, Iowa

 

Robert E. Knowles, Investor

Unity, Maine

 

Frederick A. Oldenburg, Jr., M.D., Director

Penobscot Respiratory, P.A., Bangor, Maine

 

Lloyd D. Robinson, Investor

Hermon, Maine

 

Dennis L. Shubert, M.D., Ph.D., Investor

Bangor, Maine

 

Susan B. Singer, Investor

Bangor, Maine

 

# **Officers**

# ** **

William C. Bullock, Jr., Chairman

Edwin N. Clift, President & CEO

Deborah A. Jordan, Treasurer, Secretary & Clerk

 

33

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Merrill Merchants Bank

# **Board of Directors**

# ** **

William C. Bullock, Jr., Chairman

Merrill Merchants Bank, Bangor, Maine

 

Edwin N. Clift, President & CEO

Merrill Merchants Bank, Bangor, Maine

 

Joseph H. Cyr, President

John T. Cyr & Sons, Inc., Old Town, Maine

 

John R. Graham III, President

Automatic Distributors, Bangor, Maine

 

Perry B. Hansen, Chairman & CEO

THE National Bank, Bettendorf, Iowa

 

Charles M. Hutchins, Vice President

Alternative Energy, Inc., Bangor, Maine

 

Joseph P. Irish, President

Waldo County Oil, Troy, Maine

 

Robert E. Knowles, Investor

Unity, Maine

 

Frederick A. Oldenburg, Jr., M.D., Director

Penobscot Respiratory, P.A., Bangor, Maine

 

Lloyd D. Robinson, Investor

Hermon, Maine

 

Dennis L. Shubert, M.D., Ph.D., Investor

Bangor, Maine

 

Susan B. Singer, Investor

Bangor, Maine

 

# **MerrillMerchants Bank**

# ** **

# **Honorary Directors**

J. Donald Mackintosh

Leonard E. Minsky

Norman Minsky, Esq.

Joseph Sewall

Harold S. Wright

 

34

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# **Merrill Merchants Bank**

# **Senior Management**

# ** **

William C. Bullock, Jr.

Chairman

 

Edwin N. Clift

President & Chief Executive Officer

 

Charles W. Hart

Executive Vice President, Administration

 

Deborah A. Jordan

Executive Vice President, Chief Financial Officer

 

William P. Lucy

Executive Vice President, Commercial Banking

 

Jane H. Madigan

Senior Vice President, Marketing & Human Resources

 

Lynne A. Spooner

Senior Vice President, Retail Banking

 

Reginald C. Williams, Jr.

Senior Vice President, Operations

 

Sara E. Carr

Vice President, Risk Management

 

Susan L. Rush

Vice President, Systems Administration

 

35

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**MERRILLBANK EMPLOYEES**

 

William W. Abbott

Cindy L. Allen

Matthew E. Arnold

Thomas W. Austin

Alison J. Bailey *

Jill E. Bean

Nancy L. Bellfleur

Scott D. Bennett

Jamie M. Bernard

Clarence E. Bickford, Jr. *

Meris J. Bickford, Esq. *

Abbee L. Bissonnette

Jacqueline A. Bouchey *

Cynthia J. Brawn

Ann M. Brewer

Theresa M. Brooks *

Fred A. Brown *

Linda J. Bryant

William C. Bullock, Jr. *

Angela T. Butler *

Farrah L. Carmichael

Sara E. Carr *

Jessica L. Carver

Eva M. Charity

Edwin N. Clift *

# **Barbara J. Cochran**

# **Julie K. Cote**

Michelle T. Czapiga

George E. Dandaneau *

Carla A. DeVita

Jayne T. Dickey

Marjorie J. Downing *

Melissa M. Eaton

Patricia L. Eldridge

Linda G. England *

Joanne M. Fish

Brent A. Folster *

# **NathanA. Freeman**

Robert J. Gardner *

Juliana H. Graham

Lynne M. Gray

Melissa L. Hamlin

Clarice J. Hannan

Betsy B. Hanscom

Charles W. Hart *

Matthew J. Harvey

Diane M. Hewett

Amelie M. Hichborn

Jody E. Holmes

Jerry C. Jarrell *

Deborah A. Jordan *

Judith D. Kelly

# **GwendolynA. King**

Kim M. Kirchdorfer

Janet L. Kochis

Jonathan S. Lander *

Ronald J. Landry

Janet L. Lane

Darleen M. Lanphere

# **SandraJ. Leavitt**

Cynthia L. Leighton *

Floyd W. Libby *

Linda M. Lizotte

William P. Lucy *

Jane H. Madigan *

Angela R. Madore

Melony R. Maynard

# **EuniceM. McAfee**

Ellen C.H. McBride

Suzanne M. Mercier

Suzanne T. Moffatt *

Michael J. Moody

# **JaimeL. Moore**

Pamela J. Mugnai

Debra L. Murray

Lawrence M. Napoleone *

Roland L. Narofsky

Tasha M. Neal

Deanna L. Ouellette

Lewis H. Payne *

Diane T. Pearson

Sue E. Perkins

Donna M. Poland

Kathleen G. Prescott *

Priscilla A. Pullen

Andrew C. Reed *

Cindy L. Rickman

Carole L. Robinson

Micheline K. Ross

Dianne L. Roy

Susan L. Rush *

Stephanie A. Savard

# **ChristopherR. Sayles**

Stacie A. Severance

Kim L. Shaw

Kelly A. Shorey

# **AlenaJ. Sibley**

Betsy A. Simpson *

Jason D. Simsay

Lori A. Sinclair

Hope J. Smith

Jane F. Smith

Valrie G. Smith

Lynne A. Spooner *

Kathleen Spruce

Linda J. St. Louis

Ginger K. Stalls

Natalie E. Stiles

Veronica E. Sylvia

Susan V. Terrillion *

Lorraine M. Therrien *

Marlene D. Thomas *

Tricia T. Tibbetts

Thomas A. Tilley *

Joyce D. Toman

Holly A. Vetelino *

# **TamiE. Wagstaff**

Judy M. Walls

# **JerinaK. Warner ***

Danelle L. Weston

Jason R. Wilkes

# **KarenH. Willard**

Reginald C. Williams, Jr. *

# **RhondaA. Williams**

# **KathrynE. Wilson**

Christopher R. Winstead 

Judy L. York

Lucille D. Zelenkewich *

Ellen N. Ziobron

 

----

* Officers

 

36

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**CORPORATEINFORMATION**

 

# **Corporate Headquarters**

Merrill Merchants Bancshares, Inc.

201 Main Street

Bangor, Maine 04401

207-942-4800

www.merrillmerchants.com

 

**BRANCH LOCATIONS**
| **Bangor**             |   | **Milford**    |   | **Orrington**  |
|------------------------|--------|----------------|--------|----------------|
| 201 Main Street        |   | 2 Main Street  |   | 191 River Road |
| 920 Stillwater Avenue  |   |           |   |           |
| 992 Union Street       |   | **Newport**    |   | **Pittsfield** |
|                   |   | Newport Plaza  |   | 27 Main Street |
|                   |   |           |   |           |
| **Brewer**             |   |           |   |           |
| **366  Wilson Stree**t |   | **Orono**      |   | **Waterville** |
|                   |   | 69 Main Street |   | 58 Elm Street  |
|                   |   |           |   |           |
| **Holden**             |   |           |   |           |
| Route 1A               |   |           |   |           |

 

# **INQUIRIES AND FINANCIAL INFORMATION**

# ** **

# **Annual Report on Form 10-KSB**

# ** **

The Company’s Annual Report on Form 10-KSB to be filed with theSecurities and Exchange Commission is available online at the Commission’swebsite: www.sec.gov.  Shareholders mayobtain a copy, without charge, upon written request to the address listed atleft.

 

# **Stock Listing**

# ** **

Merrill Merchants Bancshares, Inc. is traded over the counter on theNasdaq National Market system under the symbol MERB.

 

# **Transfer Agent**

# ** **

Shareholder inquiries regarding change of address or title should bedirected to:

 

Registrar and Transfer Company

10 Commerce Drive

Cranford, NJ  07016

1-800-368-5948

 

# **Independent Certified Public Accountants**

Berry Dunn McNeil and Parker

36 Pleasant Street

Bangor, Maine 04401

 

# **Annual Shareholder Meeting**

# ** **

The annual meeting of shareholders will be at 5:00 p.m. on Thursday,April 29, 2004, at the Bangor Conference Center, Hogan Road, Bangor,Maine.

 

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