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**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**







**FORM
      10-K**







**þ******
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**For
      the fiscal year ended December 31, 2005**




**o******
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**For
      the transition period from** **** **to** **** **.**




**Commission
      File Number: 000-24715**




**MERRILL
        MERCHANTS BANCSHARES, INC.**


*(Exact
      name of registrant as specified in its charter)*




**Maine**
            
            **01-0471507***(State
                or other jurisdiction**of
                incorporation or organization)*
            
            *(I.R.S.
                Employer**Identification
                Number)*




**201
                Main Street**
              **Bangor,
                Maine**
            
            **04402-0925***(Address
                of principal executive offices)*
            
            *(Zip
                Code)*


**Registrant’s
      telephone number, including area
      code: (207) 942-4800**


**Securities
      registered pursuant to Section 12(b) of the Act:**  None


**Securities
      registered pursuant to Section 12(g) of the Act:** Common
      Stock, $1.00 par value




Indicate
      by check mark whether the Registrant is a well-known seasoned issuer, as defined
      in Rule 405 of the Securities Act. Yes o No þ




Indicate
      by check mark whether the Registrant is not required to file reports pursuant
      to
      Section 13 or 15(d) of the Act. Yes o No þ




Indicate
      by check mark whether the Registrant (1) has filed all reports required by
      Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
      preceding 12 months and (2) has been subject to such filing
      requirements for the past 90 days. Yes þ No o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the
      best of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this Form 10-K. þ




Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer, as defined in Rule 12b-2 of
      the Exchange Act.  Large accelerated filer o Accelerated
      filer o Non-accelerated
      filer þ




Indicate
      by check mark whether the Registrant is a shell company (as defined in Rule
      12b-2 of the Act). Yes o No þ




The
      aggregate market value of the outstanding common stock, other than shares held
      by persons who may be deemed affiliates of the registrant, as of the last
      business day of the registrant’s most recently completed second fiscal quarter
      was approximately $52,016,000. As of February 28, 2006, there were 3,441,463
      shares of common stock, par value $1.00 per share, of the registrant
      outstanding.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Portions
      of the definitive Proxy Statement for the Annual Meeting of Stockholders to
      be
      held on May 4, 2006 are incorporated by reference into Part III,
      Items 10-14 of this Form 10-K.







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**TABLE
      OF CONTENTS**





**Page****PART
                I**ITEM
                1.
            BUSINESS
            1ITEM
                1A.
            RISK
                FACTORS
            14ITEM
                1B.
            UNRESOLVED
                STAFF COMMENTS
            16ITEM
                2.
            PROPERTIES
            16ITEM
                3.
            LEGAL
                PROCEEDINGS
            17ITEM
                4.
            SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY
                HOLDERS
            17**PART
                II**ITEM
                5.
            MARKET
                FOR THE COMPANY’S COMMON STOCK, RELATED STOCKHOLDER
                MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
            18ITEM
                6.
            SELECTED
                FINANCIAL DATA
            19ITEM
                7.
            MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                AND RESULTS OF OPERATIONS
            19ITEM
                7A.
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK
            36ITEM
                8.
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY
                DATA
            37ITEM
                9.
            CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                AND FINANCIAL DISCLOSURE
            61ITEM
                9A.
            CONTROLS
                AND PROCEDURES
            61ITEM
                9B.
            OTHER
                INFORMATION
            61**PART
                III**ITEM
                10.
            DIRECTORS
                AND EXECUTIVE OFFICERS OF THE
                COMPANY
            61ITEM
                11.
            EXECUTIVE
                COMPENSATION
            61ITEM
                12.
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                MANAGEMENT AND RELATED STOCKHOLDER MATTERS
            62ITEM
                13.
            CERTAIN
                RELATIONSHIPS AND RELATED
                TRANSACTIONS
            62ITEM
                14.
            PRINCIPAL
                ACCOUNTING FEES AND SERVICES
            62**PART
                IV**ITEM
                15.
            EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES
            63SIGNATURES
            64





**Forward
      Looking Statements**


This
      Annual Report on Form 10-K contains certain forward-looking statements. 
These forward-looking statements also may be contained elsewhere in other
      filings with the Securities and Exchange Commission (the “SEC”) and in other
      communications by Merrill Merchants Bancshares, Inc. (the “Company”) and its
      wholly-owned subsidiary, Merrill Merchants Bank (the “Bank”), which are made in
      good faith pursuant to the “safe harbor” provisions of the Private Securities
      Litigation Reform Act of 1995.  The words “may,” “could,” “should,”
“would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and
      similar expressions are intended to identify forward-looking statements. 
In preparing these disclosures, management must make assumptions, including,
      but
      not limited to, the level of future interest rates, prepayments on loans and
      investment securities, required levels of capital, needs for liquidity, and
      the
      adequacy of the allowance for loan losses. These forward-looking statements
      may
      be subject to significant known and unknown risks uncertainties, and other
      factors, including, but not limited to, those matters referred to in the
      preceding sentence.




Although
      we believe that the expectations reflected in such forward-looking statements
      are reasonable, actual results may differ materially from the results discussed
      in these forward-looking statements. You are cautioned not to place undue
      reliance on these forward-looking statements, which speak only as of the date
      hereof. The Company undertakes no obligation to republish revised
      forward-looking statements to reflect events or circumstances after the date
      hereof or to reflect the occurrence of unanticipated events. You are also urged
      to carefully review and consider the various disclosures made by the Company
      which attempt to advise interested parties of the facts which affect the
      Company’s business.




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**PART
      I**





**ITEM
      1.****BUSINESS**





**General**





Merrill
      Merchants Bancshares, Inc. (the “Company”), a Maine corporation organized in
      March 1992, is a registered bank holding company under the Bank Holding Company
      Act of 1956, as amended (“BHCA”). The Company is also a registered financial
      holding company under the BHCA. In October 1992, the Company became the bank
      holding company for Merrill Merchants Bank (the “Bank”) and holds 100% of the
      Bank’s outstanding common stock (the “Bank Stock”). The Company, through its
      ownership of the Bank, is engaged in a general commercial and retail banking
      business, along with trust and investment services. Unless the context otherwise
      requires, references herein to the Company shall include the Company and the
      Bank on a consolidated basis.





The
      Company is an entity legally separate and distinct from the Bank. The Company’s
      sources of income and cash flow are derived from dividends paid on the Bank
      Stock, tax benefits received by the Company and earnings from amounts deposited
      by the Company in interest bearing accounts and investments.





The
      Bank
      was established in 1992 to purchase assets and assume liabilities of certain
      branch banking offices formerly held by a large out of state bank. Merrill
      Merchants Bank is headquartered in Bangor, Maine, which is located 76 miles
      north of Augusta, Maine, the state capital. Presently, the Bank maintains eleven
      banking offices (collectively, the “Branch Banks”) in nine area communities. The
      three Bangor offices provide city-wide convenience and are complemented by:
      (i)
      an office in Brewer, Bangor’s sister city located on the eastern shore of the
      Penobscot River; (ii) a branch in Orono, home of the University of Maine’s
      flagship campus; (iii) a branch in Pittsfield, a small rural town of 4,000
      people located about 30 miles southwest of Bangor; (iv) a convenience store
      branch in Orrington which serves as a satellite office to the Brewer Branch;
      (v)
      a convenience store branch in Milford which serves as a satellite office to
      the
      Orono Branch; (vi) a branch in Holden, a small town located next to Brewer;
      (vii) a banking office located in Waterville; and (viii) a supermarket branch
      in
      Newport, a small town neighboring Pittsfield, approximately 25 miles southwest
      of Bangor. The Newport Branch is located at the juncture of Interstate 95 and
      Route 2, which is the main travel route to the winter and summer tourist area
      of
      the Moosehead Lake Region. In addition to the Branch Banks, the Bank has
      fourteen ATM locations in its primary market area.





The
      Bank
      conducts a general commercial and retail banking business that includes the
      acceptance of deposits from the general public and the application of those
      funds to the origination of a variety of commercial loans, commercial and
      residential real estate loans and consumer loans. As of December 31, 2005,
      the
      Company had total assets of $417.1 million, loans of $319.0 million, deposits
      of
      $331.4 million and shareholders’ equity of $34.4 million. The Bank also
      established a Trust and Investment Services Department, which has grown since
      inception in April 1994 to $366.0 million in assets under management as of
      December 31, 2005.





The
      Bank’s income is derived principally from interest and fees earned in connection
      with its lending activities, interest and dividends on investment securities,
      and service charges and fees on deposit and trust accounts. Its main expenses
      are the interest paid on deposits and operating expenses. The Bank’s customer
      deposits are insured, up to the applicable limits, by the Federal Deposit
      Insurance Corporation (“FDIC”).





**Community
      Banking Strategy**





Having
      identified the need for community banking services in its market area, the
      Bank
      has worked to position itself as a service-oriented community bank. The Bank
      is
      staffed by experienced management personnel, all of whom reside in the area
      and
      who know the Bank’s customers and are able to provide personalized service for
      these customers. This strategy has been deliberately developed and implemented
      at a time when consolidation within the industry has resulted in an increasing
      depersonalization among the larger financial institutions. The Bank has focused
      on fostering banking relationships with customers which include multiple
      financial services that range from basic checking to investment management
      accounts.




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As
      a part
      of this strategy, the Company and the Bank have attracted local business people,
      who actively promote the Bank in the community, to serve on their Boards of
      Directors. In an effort to broaden the community’s awareness of the Bank and
      attract new business, the Company has also obtained additional investments
      in
      and support for the Company from local investors.





The
      Bank
      is active in small business lending and has earned the designation “Preferred
      Lender” by the Small Business Administration (SBA). The Bank is also active in
      residential mortgage lending, and a number of products, including government
      insured loan programs, are available to meet the demands of both the consumer
      and the commercial markets. The Company’s affiliations with third party vendors
      have enabled the Bank to deliver sophisticated products such as Internet
      banking, automated telephone banking, and check imaging while maintaining a
      local, friendly flavor in its Branch Banks. This same strategy has been
      implemented by the Trust and Investment Services Department which is also
      serving many clients who appreciate the personal attention and customer service
      provided locally. The depository custody services and investment advisory
      services provided by the Trust Department are supported through its affiliation
      with The Northern Trust Company.





**Market
      Area and Competition**





The
      Bank’s primary market area, Greater Bangor, is at the center of commercial
      activity for the northeastern and central region of the State of Maine. Nearly
      100,000 people live in the Bank’s primary market area. The Bank is part of a
      strategic link to Canada, as Bangor is the closest U.S. metropolitan area to
      Eastern Quebec and the Canadian Maritime provinces. Many regional and national
      companies site their operations in the Bangor area. Services, trades,
      manufacturing and government are the four largest fields of employment in the
      metropolitan Bangor region. Bangor is also a healthcare center for central,
      eastern and northern Maine. The city is a regional financial center and is
      also
      serviced by several statewide and regional accounting firms, law firms,
      insurance companies and security and investment firms. Bangor is also a hub
      for
      government services, with many local, state and federal offices located within
      the city. Bangor is accessible by multiple exits from Interstate 95, a major
      interstate highway which transits the eastern seaboard of the United States.
      Major routes to all regions of the state bisect Bangor from various directions.
      Bangor International Airport provides domestic and international passenger
      and
      cargo service for a significant portion of the state.





Major
      competitors in our market areas include local branches of large regional and
      national bank affiliates, as well as local independent banks, thrift
      institutions and credit unions. Other competitors for deposits and loans within
      our market area include insurance companies, money market funds, consumer
      finance companies and financing affiliates of consumer durable goods
      manufactures.





The
      Company believes that there will continue to be a need for a bank in the Bank’s
      primary market area with local management having decision-making power and
      emphasizing loans to small and medium sized businesses and to individuals.
      The
      Bank has concentrated on extending business loans to such customers in the
      Bank’s primary market area and to extending trust services to clients with
      accounts of all sizes. The Bank’s management also makes decisions based upon,
      among other things, the knowledge of the Bank’s employees regarding the
      communities and customers in the Bank’s primary market area. The individuals
      employed by the Bank, to a large extent, reside near the Branch Banks and thus
      are generally familiar with the Branch Banks’ communities and customers. This is
      important in local decision-making as it allows the Bank to respond to customer
      questions and concerns on a timely basis and fosters quality customer
      service.




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The
      Trust
      and Investment Services Department of the Bank has taken advantage of
      opportunities created as the larger banks have altered their personal service
      commitment to clients not meeting established account criteria. The Bank is
      able
      to offer a comprehensive array of trust and investment services to individuals,
      businesses, non-profit organizations and municipalities of varying asset size
      and to provide the highest level of personal service. The staff includes an
      attorney as well as investment and employee benefits professionals with trust
      and banking experience.





The
      Bank
      has worked and will continue to work to position itself to be competitive in
      its
      market area. The Bank’s ability to make decisions close to the marketplace,
      management’s commitment to providing quality banking products, the caliber of
      the professional staff, and the community involvement of the Bank’s employees
      are all factors affecting the Bank’s ability to be competitive. If the Company
      and the Bank are unable to compete successfully, however, the business and
      operations could be adversely affected.





**Employees**




The
      Company employs approximately 137 people on a full-time equivalent basis. The
      employees are not represented by a collective bargaining unit, and we believe
      that we enjoy good relations with all personnel.





**Lending
      Activity**





The
      Bank
      has experienced loan growth since it was established in October 1992. 
One of the primary factors contributing to the growth has been an experienced
      local lending group.  Many commercial lending relationships have been
      developed by the Bank as a result of long standing business associations over
      many years.  Many of the Bank’s officers have held lending positions with
      Bangor area banks for in excess of twenty years.  Management believes that
      these relationships have not only been instrumental in loan growth but also
      in
      developing quality customers.





The
      Company strives to provide a full range of financial products and services
      to
      small and medium sized businesses and consumers.  The Bank has an
      established Officer Loan Committee which meets weekly to review and approve
      credits and a Director Loan Committee which meets bi-monthly, or as necessary,
      to approve credits in excess of $500,000.  The Bank’s loan mix is subject
      to the discretion of its Board of Directors and the demands of the local
      marketplace.  Management has established relationships with local area
      legal and accounting professionals to cultivate referrals.  Asset quality
      is a top priority for the Bank and a significant consideration in business
      development efforts.




*Commercial
      and Commercial Real Estate Lending*




Loans
      in
      this category principally include loans to service, retail, medical,
      construction, wholesale and light manufacturing businesses.  Commercial
      loans are made based on the management, financial strength and repayment ability
      of the borrower.  As of December 31, 2005, commercial and commercial
      real estate loans represented the largest class of loans at $178.4 million
      or
      56% of total loans.  The Bank participates in government guaranteed lending
      including programs with the Finance Authority of Maine (FAME) and Rural
      Development (RD).   The Bank is the leading lender in the State of
      Maine for the Small Business Administration.




The
      Bank’s commercial real estate loans are made at variable and fixed rates of
      interest, and amortize up to fifteen years. Loans originated at fixed interest
      rates typically reprice within a three to five year period.  A broad range
      of short-to-medium term commercial loans, both collateralized and
      uncollateralized, are made available to businesses for working capital
      (including inventory and receivables), business expansion (including
      improvements of real estate) and the purchase of equipment and machinery. 
The purpose of a particular loan generally determines its structure.  The
      commercial real estate loans are secured by a variety of properties, including
      buildings occupied by small-to-medium sized businesses, apartment complexes
      and
      non-owner/user office and retail business.




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The
      Bank’s commercial loans primarily are underwritten in the Bank’s primary market
      area on the basis of the borrowers’ ability to service such debt from
      income.  Many of these loans involve lines of credit written at variable
      rates of interest on a demand basis, or for terms not exceeding one year, while
      others are written on a term basis typically for up to five years, generally
      at
      variable rates of interest.  As a general practice, the Bank takes as
      collateral a security interest in any available real estate, equipment or other
      chattel.  As additional security for commercial loans, the Bank normally
      requires the personal guarantee of the principals and may require financial
      performance covenants.




*Residential
      Mortgage Lending*




The
      Bank
      endeavors to meet the needs of its individual customers by making residential
      mortgage loans. Residential loans include the origination of conventional
      mortgages, residential lot loans and residential acquisition, development and
      construction loans for the purchase or construction of single-family housing
      or
      lots. The Bank offers fixed and adjustable rate mortgages (“ARMs”).  With
      these loans, the real estate normally constitutes the primary
      collateral.




Loans
      in
      this category include both portfolio loans which are held by the Bank until
      maturity and loans which are sold on the secondary market.  In the case of
      secondary market loans, all servicing rights are retained by the Bank, which
      maintains the service connection to the customer.  The Bank participates in
      government guaranteed programs and has also helped coordinate several innovative
      programs including a partnership with Penquis Community Action Program in its
      “Own Me” program which assists low income women in the purchase of a home, and
      housing workshops for the hearing impaired.




As
      of
      December 31, 2005, residential loans accounted for a total of $62.6
      million, representing 20% of total loans.  The Bank’s secondary market
      servicing portfolio totaled $141.1 million at December 31, 2005.





*Construction
      Lending*




The
      Company originates construction loans to individuals for the construction of
      one- to four-family residences and to businesses for owner-occupancy.
      Residential and commercial construction loans generally provide for the payment
      of interest only during the construction phase, which is usually between six
      and
      twelve months. At the end of the construction phase, the loan converts to a
      permanent mortgage loan. At December 31, 2005, construction loans totaled
      $15.3 million, representing 5% of total loans.




Construction
      lending generally involves a higher degree of risk than single-family permanent
      mortgage lending or a commercial real estate loan because of the greater
      potential for disagreements between borrowers and builders and the failure
      of
      builders to pay subcontractors. Additional risk often exists because of the
      inherent difficulty in estimating both a property’s value and the estimated cost
      of the property.




*Home
      Equity Lending*




The
      Company originates home equity loans on a fixed and variable interest rate
      basis.  At December 31, 2005, fixed-rate loans totaled $22.2 million
      and variable-rate loans amounted to $19.3 million, representing 13% of total
      loans.  These home equity loans are generally secured by a second mortgage
      on the principal residential property.




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*Consumer
      Lending*





Consumer
      loans made by the Bank include indirect automobile and recreational vehicle
      lending, as well as personal unsecured, boat and recreational vehicle loans,
      mobile home, home improvement and overdraft protection accounts.  The
      Bank’s consumer loan portfolio consists primarily of loans to individuals for
      various consumer purposes.  A majority of these loans are for terms of less
      than 60 months and although generally collateralized by liens on various
      personal assets of the borrower may be made uncollateralized.  Consumer
      loans are made at fixed and variable interest rates. Consumer loans totaled
      $21.2 million and represented 7% of the Company’s loan portfolio at
      December 31, 2005.




**Joint
      Venture**




In
      1996,
      the Bank and MSB Leasing, Inc., a subsidiary of Machias Savings Bank, a state
      chartered mutual savings bank, formed M&M Consulting Limited Liability
      Company (“M&M”), a jointly owned subsidiary.  M&M was established
      to provide a review of various internal bank risk control functions. 
M&M, which has a former FDIC examiner as one of its principals, provides the
      Bank, Machias Savings Bank and over seventy other financial institutions in
      northern New England access to experienced individuals who are highly trained
      in
      loan review, regulatory compliance, training and internal auditing in a
      cost-efficient and timely manner.





**Supervision
      and Regulation**





***General***





The
      Bank
      is a Maine-chartered community bank whose deposit accounts are insured up to
      applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). The
      Bank is also a member of the Federal Reserve System. The Bank is subject to
      extensive regulation, examination and supervision by the Maine Bureau of
      Financial Institutions (the “Bureau”) as its chartering regulator, by the FDIC
      as its deposit insurer and by the Board of Governors of the Federal Reserve
      System (the “FRB”) as its primary federal regulator. The Company, as a financial
      holding company under the Bank Holding Company Act of 1956, as amended (the
      “BHCA”), is subject to the rules and regulations of the FRB. The Company is also
      subject to the rules and regulations of the Securities and Exchange Commission
      (the “SEC”) and the National Association of Security Dealers (“NASD”), to the
      extent that the NASD rules apply to companies quoted on the Nasdaq National
      Market. Both the Company and the Bank are subject to the provisions of the
      Maine
      Revised Statues applicable to financial institutions, and the rules and
      regulations of the Bureau.





The
      following references to the laws and regulations under which the Bank and the
      Company are regulated are brief summaries thereof, do not purport to be
      complete, and are qualified in their entirety by reference to such laws and
      regulations. These laws and regulations have been established primarily for
      the
      protection of depositors and the deposit insurance funds, not Company
      stockholders. Any change in such laws and regulations, whether by the Bureau,
      the FDIC, the FRB or the SEC or through legislation, could have a material
      adverse impact on the Company and the Bank and their operations and
      stockholders.




***Maine
      Banking Laws and Supervision***





The
      Company and the Bank are subject to Maine law and the rules and regulations
      of
      the Bureau. The approval of the Bureau is required to establish or close
      branches, to merge with another bank, to form a bank holding company, to issue
      stock or to undertake many other activities. Any Maine bank that does not
      operate in accordance with the regulations, policies and directives of the
      Bureau is subject to sanctions.





*Loans-to-One-Borrower
      Limitations* .
      With
      certain exceptions, the total obligations of a single borrower to the Bank
      may
      not exceed 20% of the Bank’s total capital. Total loans or other extensions of
      credit in excess of 10% of total capital must be approved by a majority of
      the
      governing body or the executive committee of the Bank. The Bank currently
      complies with applicable loans-to-one-borrower limitations.




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*Dividends.* Under
      Maine law, the Company may declare and pay a dividend on its capital stock
      provided that adequate levels of capital are maintained. The Bureau’s minimum
      capital requirements are set by regulation, and must be at least as stringent
      as
      those set forth by federal banking regulations. See “Federal Regulation of the
      Bank - Capital Requirements.” In addition, federal law also may limit the amount
      of dividends that may be paid by the Bank.




*Examination* .
      The
      Bureau is required to regularly examine each state-chartered bank at least
      once
      every 36 months.




*Enforcement.* The
      Bureau is authorized to issue cease and desist orders to any state-chartered
      bank that is engaging in or has engaged in: an unsafe or unsound practice;
      a
      violation of a law, rule or regulation relating to the supervision of the
      institution; a violation of any condition, imposed in writing, in connection
      with the approval of any application by the superintendent; a violation of
      any
      written agreement entered into with the superintendent; or an anticompetitive
      or
      deceptive practice, or one that is otherwise injurious to the public
      interest.




The
      Bureau may, under certain circumstances, suspend or remove directors or officers
      of a bank if: (1) the directors or officers have violated a law, rule,
      regulation or cease and desist order that has become final; engaged in or
      participated in any unsafe or unsound practice; or committed or engaged in
      any
      act, omission, or practice that constitutes a breach of the fiduciary duty
      of
      the officer or director; (2) by reason of the violation, practice or breach,
      the
      bank has suffered or will probably suffer financial loss or other damage; the
      interests of the bank's depositors or creditors or the public have been or
      could
      be prejudiced; or the officer or director has received financial gain or other
      benefit; and (3) the violation, practice or breach involves personal dishonesty
      or demonstrates willful or continuing disregard for the safety or soundness
      of
      the bank.




***Federal
      Regulation of the Company***





The
      Company is subject to the law of the State of Maine, The Federal law of the
      United States and the regulations of the FRB.





*Capital
      Requirements.* The FRB
      has adopted capital adequacy guidelines pursuant to which it assesses the
      adequacy of capital in examining and supervising a bank holding company and
      in
      analyzing applications to it under the BHCA. The FRB capital adequacy guidelines
      generally require bank holding companies to maintain total capital equal to
      8%
      of total risk-adjusted assets, with at least one-half of that amount consisting
      of Tier 1, or core capital, and up to one-half of that amount consisting of
      Tier
      2, or supplementary capital. Tier 1 capital for bank holding companies generally
      consists of the sum of common stockholders’ equity and perpetual preferred stock
      (subject in the case of the latter to limitations on the kind and amount of
      such
      stocks which may be included as Tier 1 capital), less goodwill and, with certain
      exceptions, intangibles. Tier 2 capital generally consists of hybrid capital
      instruments; perpetual preferred stock which is not eligible to be included
      as
      Tier 1 capital; term subordinated debt and intermediate-term preferred stock;
      and, subject to limitations, general allowances for loan losses. Assets are
      adjusted under the risk-based guidelines to take into account different risk
      characteristics, with the categories ranging from 0% (requiring no additional
      capital) for assets such as cash to 100% for the bulk of assets which are
      typically held by a bank holding company, including multi-family residential
      and
      commercial real estate loans, commercial business loans and consumer loans.
      Single-family residential first mortgage loans which are not past-due (90 days
      or more) or non-performing and which have been made in accordance with prudent
      underwriting standards are assigned a 50% level in the risk-weighing system,
      as
      are certain privately-issued mortgage-backed securities representing indirect
      ownership of such loans. Off-balance sheet items also are adjusted to take
      into
      account certain risk characteristics.




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In
      addition to the risk-based capital requirements, the FRB requires bank holding
      companies to maintain a minimum leverage capital ratio of Tier 1 capital to
      total assets of 3.0%. Total assets for this purpose does not include goodwill
      and any other intangible assets and investments that the FRB determines should
      be deducted from Tier 1 capital. The FRB has announced that the 3.0% Tier 1
      leverage capital ratio requirement is the minimum for the top-rated bank holding
      companies without any supervisory, financial or operational weaknesses or
      deficiencies or those that are not experiencing or anticipating significant
      growth. Other bank holding companies are expected to maintain Tier 1 leverage
      capital ratios of at least 4.0% to 5.0% or more, depending on their overall
      condition.




The
      Company is in compliance with the above-described FRB regulatory capital
      requirements.




*Activities.* The BHCA
      prohibits a bank holding company from acquiring direct or indirect ownership
      or
      control of more than 5% of the voting shares of any bank, or increasing such
      ownership or control of any bank, without prior approval of the FRB. No approval
      under the BHCA is required, however, for a bank holding company already owning
      or controlling 50% of the voting shares of a bank to acquire additional shares
      of such bank.




The
      BHCA
      also prohibits a bank holding company, with certain exceptions, from acquiring
      more than 5% of the voting shares of any company that is not a bank and from
      engaging in any business other than banking or managing or controlling banks.
      Under the BHCA, the FRB is authorized to approve the ownership of shares by
      a
      bank holding company in any company, the activities of which the FRB has
      determined to be so closely related to banking or to managing or controlling
      banks as to be a proper incident thereto. In making such determinations, the
      FRB
      is required to weigh the expected benefit to the public, such as greater
      convenience, increased competition or gains in efficiency, against the possible
      adverse effects, such as undue concentration of resources, decreased or unfair
      competition, conflicts of interest or unsound banking practices.




In
      addition, a bank holding company which does not qualify and elect to be treated
      as a financial holding company under the Gramm-Leach-Bliley Financial Services
      Modernization Act is generally prohibited from engaging in, or acquiring, direct
      or indirect control of any company engaged in non banking activities. One of
      the
      principal exceptions to this prohibition is for activities found by the FRB
      to
      be so closely related to banking or managing or controlling banks as to be
      permissible.




Bank
      holding companies may qualify to become financial holding companies if they
      meet
      certain criteria set forth by the FRB. In 2003, the Company elected to be
      treated as a financial holding company under the BHCA. As a financial holding
      company, the Company may conduct activities that are considered “financial in
      nature” under the BHCA. Such activities include:




§
            Activities
                permissible for bank holding companies prior to the enactment of
                the
                Act;




§
            Lending,
                exchanging, transferring, investing for others, or safeguarding money
                or
                securities;




§
            Underwriting
                and selling insurance;




§
            Providing
                financial, investment, or advisory
                services;




§
            Selling
                pools of assets;




§
            Underwriting,
                dealing in, or making a market in securities;
                and




§
            Merchant
                banking.




In
      order
      to commence a new activity, the Bank must have received a “Satisfactory” on its
      latest Community Reinvestment Act exam. See “Federal Regulation of the Bank -
      Community Reinvestment” below.




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*The
      Sarbanes-Oxley Act.* As a
      public company, the Company is subject to the Sarbanes-Oxley Act, which
      implements a broad range of corporate governance and accounting measures for
      public companies designed to promote honesty and transparency in corporate
      America and better protect investors from the type of corporate wrongdoing.
      The
      Sarbanes-Oxley Act’s principal legislation and the derivative regulation and
      rule making promulgated by the SEC includes:




§
            the
                creation of an independent accounting oversight
                board;




§
            auditor
                independence provisions which restrict non-audit services that accountants
                may provide to their audit clients;




§
            additional
                corporate governance and responsibility measures, including the
                requirement that the chief executive officer and chief financial
                officer
                certify financial statements;




§
            a
                requirement that companies establish and maintain a system of internal
                control over financial reporting and that a company’s management provide
                an annual report regarding its assessment of the effectiveness of
                such
                internal control over financial reporting to the company’s independent
                accountants and that such accountants provide an attestation report
                with
                respect to management’s assessment of the effectiveness of the company’s
                internal control over financial reporting (the Company, as a
                non-accelerated filer, is not subject to this provision until the
                year
                ending December 31, 2007);




§
            the
                forfeiture of bonuses or other incentive-based compensation and profits
                from the sale of an issuer’s securities by directors and senior officers
                in the twelve month period following initial publication of any financial
                statements that later require
                restatement;




§
            an
                increase in the oversight of, and enhancement of certain requirements
                relating to audit committees of public companies and how they interact
                with the Company’s independent
                auditors;




§
            requirement
                that audit committee members must be independent and are absolutely
                barred
                from accepting consulting, advisory or other compensatory fees from
                the
                issuer;




§
            requirement
                that companies disclose whether at least one member of the committee
                is a
                “financial expert” (as such term is defined by the SEC) and if not, why
                not;




§
            expanded
                disclosure requirements for corporate insiders, including accelerated
                reporting of stock transactions by insiders and a prohibition on
                insider
                trading during pension blackout
                periods;




§
            a
                prohibition on personal loans to directors and officers, except certain
                loans made by insured financial
                institutions;




§
            disclosure
                of a code of ethics and filing a Form 8-K for a change or waiver
                of such
                code;




§
            mandatory
                disclosure by analysts of potential conflicts of interest; and




§
            a
                range of enhanced penalties for fraud and other
                violations.




Section
      402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of personal loans
      to directors and executive officers of issuers. The prohibition, however, does
      not apply to loans advanced by an insured depository institution, such as the
      Bank, that are subject to the insider lending restrictions of Section 22(h)
      of
      the Federal Reserve Act (the “FRA”). See “Federal Regulation of the Bank - Loans
      to Insiders” below.




Although
      the Company has and will continue to incur additional expense in complying
      with
      the provisions of the Sarbanes-Oxley Act and the resulting regulations, such
      compliance will not have a material impact on its results of operations or
      financial condition.




*Federal
      Securities Law.* The
      Company’s common stock is registered with the SEC under Section 12(g) of the
      Securities Exchange Act of 1934, as amended (the “Exchange Act”). Thus, the
      Company is subject to information, proxy solicitation, insider trading
      restrictions, and other requirements under the Exchange Act.




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***Federal
      Regulation of the Bank***





The
      Company and the Bank are subject to federal law and regulations of the
      FRB.





*Capital
      Requirements.* Under
      FRB regulations, the Bank is required to maintain minimum levels of capital.
      The
      FRB regulations define two classes of capital known as Tier 1 and Tier 2
      capital. For an institution with a rating of 1 (the highest examination rating
      for banks) under the Uniform Financial Institutions Rating System, the minimum
      capital leverage requirement is a ratio of Tier 1 capital to total assets of
      3%.
      For all other banks, the minimum leverage capital requirement is 4%, unless
      the
      particular circumstances or risk profile of the depository institution warrants
      a higher leverage capital ratio.





The
      FRB
      regulations also require that banks meet a risk-based capital standard. The
      risk-based capital standard requires the maintenance of a ratio of total capital
      (which is defined as the sum of Tier 1 capital and Tier 2 capital, minus certain
      investments or holdings) to risk-weighted assets of at least 8% and a ratio
      of
      Tier 1 capital to risk-weighted assets of at least 4%. In determining the amount
      of risk-weighted assets, all assets, plus certain off balance sheet items,
      are
      multiplied by a risk-weight of 0% to 100%, based on the risks the FRB believes
      are inherent in the type of asset or item.





The
      federal banking agencies, including the FRB, have also adopted regulations
      to
      require an assessment of an institution’s exposure to declines in the economic
      value of a bank’s capital due to changes in interest rates when assessing the
      Bank’s capital adequacy. Under such a risk assessment, examiners will evaluate a
      bank’s capital for interest rate risk on a case-by-case basis, with
      consideration of both quantitative and qualitative factors.





Institutions
      with significant interest rate risk may be required to hold additional capital.
      The agencies also issued a joint policy statement providing guidance on interest
      rate risk management, including a discussion of the critical factors affecting
      the agencies’ evaluation of interest rate risk in connection with capital
      adequacy. The Bank was considered “well capitalized” under FRB guidelines at
      December 31, 2005.





*Activity
      Restrictions on State-Chartered Banks* .
      Section
      24 of the Federal Deposit Insurance Act (“FDIA”), as amended, which was added by
      the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),
      generally limits the activities and investments of state-chartered FDIC insured
      banks and their subsidiaries to those permissible for national banks and their
      subsidiaries, unless such activities and investments are specifically exempted
      by Section 24 or consented to by the FDIC.




Before
      making a new investment or engaging in a new activity not permissible for a
      national bank or not otherwise permissible under Section 24 or the FDIC
      regulations thereunder, an insured bank must seek approval from the FDIC to
      make
      such investment or engage in such activity. The FDIC will not approve the
      activity unless the Bank meets its minimum capital requirements and the FDIC
      determines that the activity does not present a significant risk to the FDIC
      insurance funds.




*Enforcement.* The FRB
      has extensive enforcement authority over state-chartered member banks, including
      the Bank. This enforcement authority includes, among other things, the ability
      to assess civil money penalties, to issue cease and desist orders and to remove
      directors and officers. In general, these enforcement actions may be initiated
      in response to violations of laws and regulations and to unsafe or unsound
      practices.




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*Deposit
      Insurance* .
      Pursuant to FDICIA, the FDIC established a risk-based assessment system for
      determining the deposit insurance assessments to be paid by insured depositary
      institutions. Under the risk-based deposit insurance assessment system, the
      FDIC
      assigns an institution to one of three capital categories based on the
      institution’s history and its financial information as of the quarter ending
      three months before the beginning of the assessment period. The three capital
      categories are: (1) well capitalized, (2) adequately capitalized and (3)
      undercapitalized, using capital ratios that are substantially similar to the
      prompt corrective action capital ratios discussed under “Federal Regulation of
      the Bank- Prompt Corrective Action” below. The FDIC also assigns an institution
      to a supervisory subgroup based on a supervisory evaluation provided to the
      FDIC
      by the institution's primary federal regulator and information that the FDIC
      determines to be relevant to the institution's financial condition and the
      risk
      posed to the deposit insurance funds (which may include, if applicable,
      information provided by the institution's state supervisor). An institution’s
      assessment rate depends on the length of time the institution has been operating
      and the capital category and supervisory category to which it is assigned.
      Under
      the regulation, there are nine assessment risk classifications (i.e.,
      combinations of capital groups and supervisory subgroups) to which different
      assessment rates are applied. Assessment rates currently range from 0.0% of
      deposits for an institution in the highest category (i.e., well capitalized
      and
      financially sound, with no more than a few minor weaknesses) to 0.27% of
      deposits for an institution in the lowest category (i.e., undercapitalized
      and
      substantial supervisory concern). The FDIC is authorized to raise the assessment
      rates as necessary to maintain the required reserve ratio of 1.25%. The Bank’s
      assessment rate at December 31, 2005 was 0.0%. Any increase in insurance
      assessments could have an adverse effect on the earnings of insured
      institutions, including the Bank.





Under
      the
      FDIA, the FDIC may terminate the insurance of an institution’s deposits upon a
      finding that the institution has engaged in unsafe or unsound practices, is
      in
      an unsafe or unsound condition to continue operations or has violated any
      applicable law, regulation, rule, order or condition imposed by the FDIC. The
      management of the Bank does not know of any practice, condition or violation
      that might lead to termination of deposit insurance.





*Transactions
      with Affiliates of the Bank* .
      The
      Bank’s authority to engage in transactions with its affiliates is limited by the
      FRB’s Regulation W and Sections 23A and 23B of the Federal Reserve Act (the
“FRA”). In general, these transactions must be on terms which are as favorable
      to the Bank as comparable transactions with non-affiliates. In addition, certain
      types of these transactions referred to as “covered transactions” are subject to
      quantitative limits based on a percentage of the Bank’s capital, thereby
      restricting the total dollar amount of transactions the Bank may engage in
      with
      each individual affiliate and with all affiliates in the aggregate. The term
      “covered transaction” includes the making of loans, purchase of assets, issuance
      of guarantees and other similar types of transactions. Affiliates must pledge
      qualifying collateral in amounts between 100% and 130% of the covered
      transaction in order to receive loans from the Bank. In addition, applicable
      regulations prohibit the Bank from lending to any of its affiliates that engage
      in activities that are not permissible for bank holding companies and from
      purchasing low-quality (i.e., non-performing) assets from an affiliate or
      purchasing the securities of any affiliate, other than a
      subsidiary.




*Loans
      to Insiders.* The
      Bank’s authority to extend credit to its directors, executive officers and
      principal shareholders, as well as to entities controlled by such persons,
      is
      currently governed by the requirements of Sections 22(g) and 22(h) of the FRA
      and Regulation O of the FRB. Among other things, these provisions require that
      extensions of credit to insiders:




§
            be
                made on terms that are substantially the same as, and follow credit
                underwriting procedures that are not less stringent than, those prevailing
                for comparable transactions with third parties and that do not involve
                more than the normal risk of repayment or present other features
                that are
                unfavorable to the Bank; and




§
            not
                exceed certain limitations on the amount of credit extended to such
                persons, individually and in the aggregate, which limits are based,
                in
                part, on the amount of the Bank’s
                capital.




The
      regulations allow small discounts on fees on residential mortgages for
      directors, officers and employees. In addition, extensions for credit in excess
      of certain limits must be approved by the Bank’s Board of
      Directors.




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*Safety
      and Soundness Standards* .
      Pursuant to the requirements of the FDIA, as amended by the Riegle
      Community Development and Regulatory Improvement Act of 1994 ,
      each
      federal banking agency, including the FRB, has adopted guidelines establishing
      general standards relating to internal controls, information and internal audit
      systems, loan documentation, credit underwriting, interest rate exposure, asset
      growth, asset quality, earnings and compensation, fees and benefits. In general,
      the guidelines require, among other things, appropriate systems and practices
      to
      identify and manage the risks and exposures specified in the guidelines. The
      guidelines prohibit excessive compensation as an unsafe and unsound practice
      and
      describe compensation as excessive when the amounts paid are unreasonable or
      disproportionate to the services performed by an executive officer, employee,
      director, or principal stockholder. In addition, the FRB adopted regulations
      to
      require a bank that is given notice by the FRB that it is not satisfying any
      of
      such safety and soundness standards to submit a compliance plan to the FRB.
      If,
      after being so notified, a bank fails to submit an acceptable compliance plan
      or
      fails in any material respect to implement an accepted compliance plan, the
      FRB
      may issue an order directing corrective and other actions of the types to which
      a significantly undercapitalized institution would be subject under the “prompt
      corrective action” provisions of the FDICIA. If a bank fails to comply with such
      an order, the FRB may seek to enforce such an order in judicial proceedings
      and
      to impose civil monetary penalties.





*Prompt
      Corrective Action* .
      The
      FDIA also established a system of prompt corrective action to resolve the
      problems of undercapitalized institutions. The FRB, as well as the other federal
      banking regulators, adopted regulations governing the supervisory actions that
      may be taken against undercapitalized institutions. The regulations establish
      five categories, consisting of “well capitalized,” “adequately capitalized,”
“undercapitalized,” “significantly undercapitalized” and “critically
      undercapitalized.” The severity of the action authorized or required to be taken
      under the prompt corrective action regulations increases as a bank’s capital
      decreases within the three undercapitalized categories. The Bank is prohibited
      from paying dividends or other capital distributions or paying management fees
      to any controlling person if, following such distribution, the Bank would be
      undercapitalized.





*Community
      Reinvestment* .
      Under
      the Community Reinvestment Act (“CRA”), any insured depository institution,
      including the Bank, has a continuing and affirmative obligation consistent
      with
      its safe and sound operation to help meet the credit needs of its entire
      community, including low and moderate-income neighborhoods. The CRA does not
      establish specific lending requirements or programs for financial institutions
      nor does it limit an institution’s discretion to develop the types of products
      and services that it believes are best suited to its particular community.
      The
      CRA requires the FRB to assess the depository institution’s record of meeting
      the credit needs of its community and to take such record into account in its
      evaluation of certain applications by such institution, including applications
      for additional branches and acquisitions. The CRA requires the FRB to provide
      a
      written evaluation of an institution’s CRA performance utilizing a four-tiered
      descriptive rating system, and the institution is required to publicly disclose
      its CRA rating. The four descriptive ratings are “outstanding,” “satisfactory,”
“needs to improve” and “substantial noncompliance.” The Bank received a
“Satisfactory” rating on its last CRA exam dated September 1, 2005.





CRA
      regulations rate an institution based on its actual performance in meeting
      community needs. In particular, the assessment system focuses on three
      tests:




§
            a
                lending test, to evaluate the institution’s record of making loans in its
                assessment areas;




§
            an
                investment test, to evaluate the institution’s record of investing in
                community development projects, affordable housing, and programs
                benefiting low or moderate income individuals and businesses in its
                assessment area, or a broader area that includes its assessment areas;
                and




§
            a
                service test, to evaluate the institution’s delivery of services through
                its retail banking channels and the extent and innovativeness of
                its
                community development services.





*Federal
      Home Loan Bank System* .
      The
      Bank is a member of the Federal Home Loan Bank (“FHLB”) system, which consists
      of 12 regional FHLB’s. The FHLB provides a central credit facility primarily for
      member institutions. The Bank, as a member of the FHLB of Boston (the
“FHLB-Boston”), is required to acquire and hold shares of capital stock in the
      FHLB-Boston in an amount equal to at least 0.35% of the Bank’s “Membership Stock
      Investment Base,” as defined by the FHLB-Boston, or $10,000, whichever is
      greater. The Bank is also required to own activity based stock, which is based
      on 4.5% of the Bank’s outstanding advances. However, the activity based stock
      investment requirement for overnight advances was reduced to 3%, as of August
      15, 2005. These percentages are subject to change by the FHLB-Boston. The Bank
      was in compliance with this requirement with an investment in FHLB-Boston stock
      at December 31, 2005 of $2.2 million. Any FHLB advances must be secured by
      specified types of collateral, and all long-term advances may be obtained only
      for the purpose of providing funds for residential housing finance. The FHLB’s
      are required to provide funds for certain purposes including contributing funds
      for affordable housing programs. These requirements could reduce the amount
      of
      dividends that the FHLB’s pay to their members and result in the FHLB’s imposing
      a higher rate of interest on advances to their members. If dividends were
      reduced, or interest on future FHLB advances increased, the Bank’s net interest
      income would be affected.




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*Federal
      Reserve System* .
      Under
      FRB regulations, the Bank is required to maintain noninterest-earning reserves
      against its transaction accounts. Current FRB regulations generally require
      a 3%
      reserve for transaction accounts from $7.0 million to $40.6 million, subject
      to
      adjustment by the FRB. The first $7.0 million of otherwise reservable balances,
      subject to adjustments by the FRB, are exempted from the reserve requirements.
      The Bank is in compliance with these requirements. Because required reserves
      must be maintained in the form of either vault cash, a noninterest-bearing
      account at a Federal Reserve Bank or a pass-through account as defined by the
      FRB, the effect of this reserve requirement is to reduce the Bank’s
      interest-earning assets.




*The
      Interstate Banking Act.* Beginning June 1, 1997, the Interstate Banking Act permitted federal banking
      agencies to approve merger transactions between banks located in different
      states, regardless of whether the merger would be prohibited under the law
      of
      the two states. The Interstate Banking Act also permitted a state to "opt in"
      to
      the provisions of the Interstate Banking Act before June 1, 1997, and permitted
      a state to "opt out" of the provisions of the Interstate Banking Act by adopting
      appropriate legislation before that date. Accordingly, beginning June 1, 1997,
      the Interstate Banking Act permitted a bank, such as the Bank, to acquire an
      institution by merger in a state other than Maine unless the other state had
      opted out of the Interstate Banking Act. The Interstate Banking Act also
      authorizes de novo branching into another state if the host state enacts a
      law
      expressly permitting out of state banks to establish such branches within its
      borders.




*The
      Bank Secrecy Act.* The
      Bank, and the Company are subject to the Bank Secrecy Act, as amended by the
      USA
      PATRIOT Act, which gives the federal government powers to address money
      laundering and terrorist threats through enhanced domestic security measures,
      expanded surveillance powers, and mandatory transaction reporting obligations.
      By way of example, the Bank Secrecy Act imposes an affirmative obligation on
      the
      Bank to report currency transactions that exceed certain thresholds and to
      report other transactions determined to be suspicious.




Title
      III
      of the USA PATRIOT Act takes measures intended to encourage information sharing
      among financial institutions, bank regulatory agencies and law enforcement
      bodies. Further, certain provisions of Title III impose affirmative obligations
      on a broad range of financial institutions, including banks, thrifts, brokers,
      dealers, credit unions, money transfer agents and parties registered under
      the
      Commodity Exchange Act. Among other requirements, the USA PATRIOT Act imposes
      the following obligations on financial institutions:




§
            all
                financial institutions must establish anti-money laundering programs
                that
                include, at minimum: (i) internal policies, procedures, and controls;
                (ii)
                specific designation of an anti-money laundering compliance officer;
                (iii)
                ongoing employee training programs; and (iv) an independent audit
                function
                to test the anti-money laundering
                program;




§
            all
                financial institutions must establish and meet minimum standards
                for
                customer due diligence, identification and
                verification;




§
            financial
                institutions that establish, maintain, administer, or manage private
                banking accounts or correspondent accounts in the United States for
                non-United States persons or their representatives (including foreign
                individuals visiting the United States) must establish appropriate,
                specific, and, where necessary, enhanced due diligence policies,
                procedures, and controls designed to detect and report money laundering
                through those accounts (The Company, as a non-accelerated filer,
                is not
                subject to this provision until the year ending December 31,
                2007);




§
            financial
                institutions are prohibited from establishing, maintaining, administering
                or managing correspondent accounts for foreign shell banks (foreign
                banks
                that do not have a physical presence in any country), and are subject
                to
                certain recordkeeping obligations with respect to correspondent accounts
                of foreign banks;




§
            bank
                regulators are directed to consider a bank’s or holding company’s
                effectiveness in combating money laundering when ruling on FRA and
                Bank
                Merger Act applications.







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*Office
      of Foreign Asset Control.* The Bank
      and the Company, like all United States companies and individuals, are
      prohibited from transacting business with certain individuals and entities
      named
      on the Office of Foreign Asset Control’s list of Specially Designated Nationals
      and Blocked Persons. Failure to comply may result in fines and other penalties.
      Recently, the Office of Foreign Asset Control issued guidance directed at
      financial institutions in which it asserted that it may, in its discretion,
      examine institutions determined to be high-risk or to be lacking in their
      efforts to comply with these prohibitions.




*Acquisition
      of the Company or the Bank.* Under
      the federal Change in Bank Control Act, any person (including a company), or
      group acting in concert, seeking to acquire control of the Company or the Bank
      will be required to submit prior notice to the FRB. Under the Change in Bank
      Control Act, the FRB has 60 days within which to act on such notices, taking
      into consideration factors, including the financial and managerial resources
      of
      the acquirer, the convenience and needs of the communities served by the Company
      and the Bank, and the anti-trust effects of the acquisition. The term “control”
is defined generally under the BHCA to mean the ownership or power to vote
      25%
      or more of any class of voting securities of an institution or the ability
      to
      control in any manner the election of a majority of the institution’s directors.
      Additionally under the Bank Merger Act sections of the FDIA, the prior approval
      of an insured institution’s primary federal regulator is required for an insured
      institution to merge with or transfer assets to another insured institution
      or
      an uninsured institution.




**Taxation**





The
      Company is subject to those rules of federal income taxation generally
      applicable to corporations under the Internal Revenue Code. The Company and
      the
      Bank, as members of an affiliated group of corporations within the meaning
      of
      Section 1504 of the Internal Revenue Code, file a consolidated federal income
      tax return, which has the effect of eliminating inter-company distributions,
      including dividends and inter-company interest income and expense, from the
      computation of consolidated taxable income.





The
      Company, on a consolidated basis, is subject to a separate state franchise
      tax
      in lieu of state corporate income tax. The amount of the tax is the sum of
      1% of
      Maine net income and $.08 per $1,000 of Maine assets as defined in Maine law.
      Maine assets are the corporation’s total end of the year assets as reported on
      the federal income tax return. Maine net income is the corporation’s net income
      or loss as reported on the federal income tax return which is apportioned to
      Maine under Maine law.




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**ITEM
      1A.****RISK
      FACTORS**





***Our
      loan portfolio includes loans with a higher risk of loss.*** We
      originate commercial mortgage loans, commercial loans, consumer loans, and
      residential mortgage loans primarily within our market area. Commercial
      mortgage, commercial, and consumer loans may expose a lender to greater credit
      risk than loans secured by residential real estate because the collateral
      securing these loans may not be sold as easily as residential real estate.
      In
      addition, commercial real estate and commercial business loans may also involve
      relatively large loan balances to individual borrowers or groups of borrowers.
      These loans also have greater credit risk than residential real estate for
      the
      following reasons:




·
            *Commercial
                Mortgage Loans.*Repayment is dependent upon income being generated in amounts sufficient
                to cover operating expenses and debt
                service.




·
            *Commercial
                Loans.*****Repayment
                is generally dependent upon the successful operation of the borrower’s
                business.




·
            *Consumer
                Loans.*Consumer
                loans (such as personal lines of credit) may or may not be collateralized
                with assets that provide an adequate source of payment of the loan
                due to
                depreciation, damage, or loss.





Any
      downturn in the real estate market or local economy could adversely affect
      the
      value of the properties securing the loans or revenues from the borrower’s
      business thereby increasing the risk of non-performing loans. At this time,
      however, there is no downturn in the local economy or real estate market and
      we
      are not aware of any adverse effects in property values or business declines
      as
      a result of the local economy.




***If
      our allowance for loan losses is not sufficient to cover actual loan losses,
      our
      earnings could decrease.*** Our loan
      customers may not repay their loans according to their terms and the collateral
      securing the payment of these loans may be insufficient to pay any remaining
      loan balance. We therefore may experience significant loan losses, which could
      have a material adverse effect on our operating results.




Material
      additions to our allowance for loan losses also would materially decrease our
      net income, and the charge-off of loans may cause us to increase the allowance.
      We make various assumptions and judgments about the collectibility of our loan
      portfolio, including the creditworthiness of our borrowers and the value of
      the
      real estate and other assets serving as collateral for the repayment of many
      of
      our loans. We rely on our loan quality reviews, our experience and our
      evaluation of economic conditions, among other factors, in determining the
      amount of the allowance for loan losses. If our assumptions prove to be
      incorrect, our allowance for loan losses may not be sufficient to cover losses
      inherent in our loan portfolio, resulting in additions to our allowance.




***Changes
      in interest rates could adversely affect our results of operations and financial
      condition.*** Our
      profitability, like that of most financial institutions, depends substantially
      on our net interest income, which is the difference between the interest income
      earned on our interest-earning assets and the interest expense paid on our
      interest-bearing liabilities. Increases in interest rates may decrease loan
      demand and make it more difficult for borrowers to repay adjustable rate loans.
      In addition, as market interest rates rise, we will have competitive pressures
      to increase the rates we pay on deposits, which will result in a decrease of
      our
      net interest income.




We
      also
      are subject to reinvestment risk associated with changes in interest rates.
      Changes in interest rates may affect the average life of loans and
      mortgage-related securities. Decreases in interest rates can result in increased
      prepayments of loans and mortgage-related securities as borrowers refinance
      to
      reduce borrowing costs. Under these circumstances, we are subject to
      reinvestment risk to the extent that we are unable to reinvest the cash received
      from such prepayments at rates that are comparable to the rates on existing
      loans and securities.




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Our
      earnings may be adversely impacted by a decrease in interest rates because
      a
      portion of our interest-earning assets are variable rate loans indexed to prime
      rate that will reprice as short-term interest rates decrease while a portion
      of
      our interest-bearing liabilities are expected to remain at fixed interest rates.
      Therefore, in a declining interest rate environment, our yield earned on our
      loan portfolio is expected to decrease more rapidly than our cost of funds.
      A
      declining rate environment is expected to cause a narrowing of our net interest
      rate spread and a decrease in our net interest income.




***Our
      local economy may affect our future growth possibilities.*** Our
      current market area is principally located in Greater Bangor. Our future growth
      opportunities depend on the growth and stability of our regional economy and
      our
      ability to expand our market area. A downturn in our local economy may limit
      funds available for deposit and may negatively affect our borrowers’ ability to
      repay their loans on a timely basis, both of which could have an impact on
      our
      profitability.




***We
      depend on our executive officers and key personnel to continue the
      implementation of our long-term business strategy and could be harmed by the
      loss of their services.*** We
      believe that our continued growth and future success will depend in large part
      upon the skills of our management team. The competition for qualified personnel
      in the financial services industry is intense, and the loss of our key personnel
      or an inability to continue to attract, retain and motivate key personnel could
      adversely affect our business. We cannot assure you that we will be able to
      retain our existing key personnel or attract additional qualified personnel.
      Although we have employment agreements with our Chairman and Chief Executive
      Officer, President and Executive Vice President and Treasurer that each contains
      a non-compete provision, the loss of the services of one or more of our
      executive officers and key personnel could impair our ability to continue to
      develop our business strategy.




***We
      operate in a highly regulated environment, and changes in laws and regulations
      to which we are subject may adversely affect our results of
      operations.*** We are
      subject to extensive regulation, supervision and examination by the Maine Bureau
      of Financial Institutions (the “Bureau”), as our chartering authority, and by
      the Federal Deposit Insurance Corporation (the “FDIC”) as the insurer of our
      deposits up to certain limits. In addition, the Federal Reserve Board (the
      “FRB”) regulates and oversees the Company, as the holding company of the Bank.
      We also belong to the Federal Home Loan Bank System and, as a member of such
      system, we are subject to certain limited regulations promulgated by the Federal
      Home Loan Bank of Boston. This regulation and supervision limits the activities
      in which we may engage. The purpose of regulation and supervision is primarily
      to protect our depositors and borrowers and, in the case of FDIC regulation,
      the
      FDIC’s insurance fund. Regulatory authorities have extensive discretion in the
      exercise of their supervisory and enforcement powers. They may, among other
      things, impose restrictions on the operation of a banking institution, the
      classification of assets by such institution and such institution’s allowance
      for loan losses. Regulatory and law enforcement authorities also have wide
      discretion and extensive enforcement powers under various consumer protection
      and civil rights laws, including the Truth-in-Lending Act, the Equal Credit
      Opportunity Act, the Fair Housing Act, and the Real Estate Settlement Procedures
      Act. Any change in the laws or regulations applicable to us, or in banking
      regulators’ supervisory policies or examination procedures, whether by the
      Bureau, the FDIC, the FRB, other state or federal regulators, the United States
      Congress or the Maine legislature could have a material adverse effect on our
      business, financial condition, results of operations and cash
      flows.




***Competition
      in our primary market area may reduce our ability to attract and retain deposits
      and originate loans.*** We
      operate in a competitive market for both attracting deposits, which is our
      primary source of funds, and originating loans. Historically, our most direct
      competition for savings deposits has come from credit unions, community banks,
      large commercial banks and thrift institutions in our primary market area.
      Particularly in times of extremely low or extremely high interest rates, we
      have
      faced additional significant competition for investors’ funds from brokerage
      firms and other firms’ short-term money market securities and corporate and
      government securities. Our competition for loans comes principally from mortgage
      brokers, commercial banks, other thrift institutions, and insurance companies.
      Such competition for the origination of loans may limit our future growth and
      earnings prospects. Competition for loan originations and deposits may limit
      our
      future growth and earnings prospects.




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***If
      we fail to maintain an effective system of internal control over financial
      reporting, we may not be able to accurately report our financial results or
      prevent fraud, and, as a result, investors and depositors could lose confidence
      in our financial reporting, which could adversely affect our business, the
      trading price of our stock and our ability to attract additional
      deposits.*** Beginning with our annual report for the fiscal year ending December 31, 2007,
      we will have to include in our annual reports filed with the Securities and
      Exchange Commission (the “SEC”) a report of our management regarding internal
      control over financial reporting. As a result, we recently have begun to
      document and evaluate our internal control over financial reporting in order
      to
      satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the
      “Sarbanes-Oxley Act”) and SEC rules and regulations, which require an annual
      management report on our internal control over financial reporting, including,
      among other matters, management’s assessment of the effectiveness of internal
      control over financial reporting and an attestation report by our independent
      auditors addressing these assessments. Accordingly, management has retained
      outside consultants to assist us in (i) assessing and documenting the adequacy
      of our internal control over financial reporting, (ii) improving control
      processes, where appropriate, and (iii) verifying through testing that controls
      are functioning as documented. If we fail to identify and correct any
      significant deficiencies in the design or operating effectiveness of our
      internal control over financial reporting or fail to prevent fraud, current
      and
      potential stockholders and depositors could lose confidence in our financial
      reporting, which could adversely affect our business, financial condition and
      results of operations, the trading price of our stock and our ability to attract
      additional deposits.




***Our
      charter and bylaws may prevent a transaction you may favor or limit our growth
      opportunities, which could cause the market price of our common stock to
      decline.*** Certain
      provisions of our charter and bylaws and applicable provisions of Maine and
      federal law and regulations may delay, inhibit or prevent an organization or
      person from gaining control of the Company though a tender offer, business
      combination, proxy context or some other method, even though you might be in
      favor of the transaction.




***We
      may not be able to pay dividends in the future in accordance with past practice.*** We
      pay a
      quarterly dividend to stockholders. However, we are dependent primarily upon
      the
      Bank for our earnings and funds to pay dividends on our common stock. The
      payment of dividends also is subject to legal and regulatory restrictions.
      Any
      payment of dividends in the future will depend, in large part, on the Bank’s
      earnings, capital requirements, financial condition and other factors considered
      relevant by our Board of Directors.





**ITEM
      1B.****UNRESOLVED
      STAFF COMMENTS**





Not
      applicable.





**ITEM
      2.****PROPERTIES**





At
      December 31, 2005, the Bank conducted its business from the headquarters office
      in Bangor, Maine, its operations center in Bangor, Maine, and its ten branch
      offices in Bangor, Brewer, Holden, Milford, Newport, Orono, Orrington,
      Pittsfield and Waterville, Maine.




In
      July
      2004, the Bank acquired a historic building located at 183 Main Street, Bangor,
      Maine. This property is adjacent to the Bank’s headquarters located at 201 Main
      Street. During 2005, the third floor addition to its headquarters building
      along
      with a three-story connecting corridor to the historic building was completed.
      Construction is in progress to renovate the historic building and the $1.5
      million project is targeted for completion in March 2006.




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The
      following table sets forth certain information regarding the Bank’s properties
      at December 31, 2005.




**Owned**
            
            **Leased**Corporate
                Office
            
            Operations
                Center201
                Main Street
            
            359
                Perry RoadBangor,
                Maine 04401
            
            Bangor,
                Maine 04401183
                Main Street
            
            920
                Stillwater AvenueBangor,
                Maine 04401
            
            Bangor,
                Maine 044011007
                Main Road
            
            992
                Union StreetHolden,
                Maine 04429
            
            Bangor,
                Maine 0440127
                Main Street
            
            366
                Wilson StreetPittsfield,
                Maine 04967
            
            Brewer,
                Maine 044122
                Main StreetMilford,
                Maine 0446144
                Moosehead TrailNewport,
                Maine 0495369
                Main StreetOrono,
                Maine 04473191
                River RoadOrrington,
                Maine 0447458
                Elm StreetWaterville,
                Maine 04901





**ITEM
      3.****LEGAL
      PROCEEDINGS**





Although
      the Bank and the Company, from time to time, are involved in routine litigation
      incidental to the business, there are no material legal proceedings to which
      the
      Bank or the Company are a party or to which any of its property is subject,
      or,
      to the Company’s knowledge, any such proceedings that any governmental authority
      is contemplating, as of the date of this Form 10-K for the fiscal year ended
      December 31, 2005.





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





None.




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**PART
      II**





**ITEM
      5.****MARKET
      FOR THE COMPANY’S COMMON STOCK, RELATED****STOCKHOLDER
      MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**





*Market
      Information and Related Matters*




Our
      common stock is traded on The Nasdaq National Market. The following table sets
      forth the high and low prices of our common stock and the dividends declared
      per
      share of common stock for the periods indicated. Per share data information
      has
      been adjusted to reflect the 3% stock dividends in both 2005 and 2004,
      respectively.








**Market
                Price**
            
            **Dividends
                Declared****2005**
            
            **High**
            
            **Low**
            
            **Per
                Share**First
                Quarter
            
            $
            25.72
            
            $
            20.87
            
            $
            0.150Second
                Quarter
            
            
            23.40
            
            
            20.10
            
            
            0.160Third
                Quarter
            
            
            24.55
            
            
            21.10
            
            
            0.160Fourth
                Quarter
            
            
            25.25
            
            
            23.57
            
            
            0.170**2004**First
                Quarter
            
            $
            24.65
            
            $
            19.52
            
            $
            0.126Second
                Quarter
            
            
            24.90
            
            
            21.36
            
            
            0.136Third
                Quarter
            
            
            23.25
            
            
            19.66
            
            
            0.136Fourth
                Quarter
            
            
            21.94
            
            
            20.15
            
            
            0.146





As
      of
      February 28, 2006, there were 3,441,463 shares of common stock outstanding
      which
      were held by approximately 1,250 holders of record.





We
      have
      historically paid quarterly cash dividends on our common stock and currently
      intend to continue to do so in the foreseeable future. Our ability to pay
      dividends depends on a number of factors, however, including restrictions on
      the
      ability of the Company to pay dividends under federal laws and regulations
      and
      as a result there can be no assurance that dividends will be paid in the
      future.





*Share
      Repurchases*





On
      June
      17, 2004, the Board of Directors approved a fourth stock repurchase program
      authorizing the Company to repurchase up to 169,995 shares of the Company’s
      common stock. The authority may be exercised from time to time and in such
      amounts as market conditions warrant.  Shares are being repurchased for
      other corporate purposes.  The program does not have an expiration date.
      During the year ended December 31, 2005, the Company repurchased 5,500 shares
      at
      an average price per share of $21.70. For the three month period ended December
      31, 2005, the Company did not purchase any shares of common stock.




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**ITEM
      6.****SELECTED
      FINANCIAL DATA**


*(Dollars
                in thousands, except per share data)***For
                the Year**
            
            2005
            
            2004
            
            2003
            
            2002
            
            2001Net
                income
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302
            
            $
            3,845
            
            $
            3,254Net
                interest income
            
            
            15,770
            
            
            13,773
            
            
            12,479
            
            
            12,463
            
            
            11,542Non-interest
                income
            
            
            5,245
            
            
            5,005
            
            
            5,181
            
            
            3,963
            
            
            3,299Non-interest
                expense
            
            
            11,986
            
            
            11,042
            
            
            10,718
            
            
            10,205
            
            
            9,468**Per
                Common Share**(adjusted
                for 3% stock dividend in 2005)Basic
                earnings per share
            
            $
            1.67
            
            $
            1.41
            
            $
            1.23
            
            $
            1.20
            
            $
            1.07Diluted
                earnings per share
            
            
            1.66
            
            
            1.40
            
            
            1.22
            
            
            1.08
            
            
            0.92Dividends
                per share
            
            
            0.64
            
            
            0.54
            
            
            0.45
            
            
            0.37
            
            
            0.28Book
                value per share at year end
            
            
            10.00
            
            
            9.11
            
            
            8.66
            
            
            8.34
            
            
            8.66Stock
                price:High
            
            
            25.72
            
            
            24.90
            
            
            20.57
            
            
            14.87
            
            
            10.22Low
            
            
            20.10
            
            
            19.52
            
            
            13.79
            
            
            10.04
            
            
            8.20Close
            
            
            24.60
            
            
            20.96
            
            
            20.47
            
            
            14.28
            
            
            10.04**Key
                Performance Ratios**Return
                on average equity
            
            
            17.59
            %
            
            16.06
            %
            
            14.74
            %
            
            13.93
            %
            
            13.18
            %Return
                on average assets
            
            
            1.47
            
            
            1.36
            
            
            1.34
            
            
            1.33
            
            
            1.26Equity
                to assets at year end
            
            
            8.24
            
            
            8.50
            
            
            8.93
            
            
            9.24
            
            
            9.34Non-performing
                assets to total assets
            
            
            0.10
            
            
            0.44
            
            
            0.18
            
            
            0.25
            
            
            0.26Net
                charge-offs to average loans
            
            
            0.06
            
            
            0.05
            
            
            0.04
            
            
            0.07
            
            
            0.08Efficiency
                ratio
            
            
            57.37
            
            
            59.29
            
            
            60.51
            
            
            62.01
            
            
            63.96Dividend
                payout ratio
            
            
            38.33
            
            
            38.32
            
            
            37.16
            
            
            31.27
            
            
            25.87**At
                Year End**Total
                assets
            
            $
            417,073
            
            $
            368,690
            
            $
            342,189
            
            $
            307,316
            
            $
            278,197Loans
            
            
            318,965
            
            
            282,988
            
            
            246,512
            
            
            214,729
            
            
            188,080Deposits
            
            
            331,414
            
            
            299,782
            
            
            258,848
            
            
            238,857
            
            
            219,309Borrowed
                funds
            
            
            47,008
            
            
            33,524
            
            
            49,260
            
            
            36,932
            
            
            29,792Shareholders’
                equity
            
            
            34,352
            
            
            31,329
            
            
            30,553
            
            
            28,388
            
            
            25,985





**ITEM
      7.****MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**


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





The
      discussion and analysis that follows focuses on the results of operations of
      the
      Company during 2005, 2004 and 2003 and its financial condition at December
      31,
      2005 and 2004. The Consolidated Financial Statements and related notes should
      be
      read in conjunction with the review.





**General**





The
      Company owns all of the common stock of the Bank. The Bank is a full-service
      community bank headquartered in Bangor, Maine, providing a wide range of
      consumer, commercial, and trust and investment services through its eleven
      locations in central and eastern Maine. In addition, the Bank provides indirect
      auto and recreational vehicle lending through its consumer finance
      division.





The
      Bank
      is committed to providing outstanding customer service and building long term
      banking relationships with customers. Delivery on this commitment through local
      decision-making and personal service has helped distinguish the Company from
      its
      competitors. This will continue to be strategically significant as larger banks
      consolidate and their service delivery channels become more depersonalized.





The
      Company’s goal is to sustain profitable, controlled growth by focusing on
      increased loan and deposit market share; managing yields on earning assets
      and
      rates on interest-bearing liabilities; increasing non-interest income; and
      being
      prepared for acquisitions and expansion opportunities within the financial
      services industry.




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**Executive
      Overview**





The
      Company’s net income increased 17% to $5,738 in 2005 and diluted earnings per
      share was $1.66 in 2005 as compared to $1.40 in 2004, an increase of $0.26
      per
      diluted share or 19%. The following were significant factors related to 2005
      results as compared to 2004:





·
            Total
                loans grew 13% in 2005. Real estate lending was strong with commercial
                real estate increasing 12%, home equity balances growing 22% and
                residential and construction lending up 6%. Loans to businesses grew
                at a
                rate of 16% and consumer loans increased 13% from a year
                ago.





·
            We
                continue to maintain strong asset quality with net charge-offs of
                $177 in
                2005 representing 0.06% of average net loans compared to 0.05% in
                2004.
                Nonperforming assets as a percentage of total assets declined to
                0.10% at
                year-end, down from 0.44% at the close of
                2004.





·
            Deposits
                grew 11% in 2005. The combination of rising short-term interest rates
                and
                special deposit promotions resulted in certificates of deposit growth
                of
                27% and savings account increases of 34%. The direct mail marketing
                campaign to businesses and individuals under the High Performance
                Checking
                program continues to spur core deposit growth with checking account
                balances increasing 4% in 2005.





·
            The
                Company’s net interest margin increased 21 basis points in 2005 to 4.25%.
                The Federal Reserve Bank’s aggressive increase in short-term interest
                rates (a 3% increase in the Federal Funds Rate over an eighteen month
                period) has benefited the Company as -a portion of our commercial
                and home
                equity loans repriced to higher interest rate
                levels.





·
            Non-interest
                income grew 5% in 2005 with increases in trust fees of 13%, other
                fees of
                41% and service fees on deposit accounts of 7%. Gains on loan and
                investment sales declined 23% from a year
                ago.





·
            Our
                efficiency ratio improved to 57.4% compared to 59.3% in 2004. Operating
                expenses increased 9% in 2005 due to increases in salaries and employee
                benefits, occupancy costs, and other expenses. As we have experienced
                growth in loans, deposits and trust assets under management, personnel
                costs have increased due to the additional employees required to
                deliver
                on our promise of “Where Service
                Matters.”





**Critical
      Accounting Policies**





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





*Allowance
      for Loan Losses* .
      Management believes the allowance for loan losses is a critical accounting
      policy that requires the most significant estimates and assumptions used in
      the
      preparation of the consolidated financial statements. The allowance for loan
      losses is based on management’s evaluation of the level of the allowance
      required in relation to the estimated loss exposure in the loan portfolio.
      Management believes the allowance for loan losses is a significant estimate
      and
      therefore regularly evaluates it for adequacy by taking into consideration
      factors such as prior loan loss experience, the character and size of the loan
      portfolio, business and economic conditions and management’s estimation of
      probable losses. The use of different estimates or assumptions could produce
      different provisions for loan losses.




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*Mortgage
      Servicing Rights* .
      Servicing assets are recognized as separate assets when servicing rights are
      acquired through sale of residential mortgage assets. Capitalized servicing
      rights are reported in other assets and are amortized into non-interest expense
      in proportion to, and over the period of, the estimated future net servicing
      income of the underlying financial residential mortgage assets. Servicing assets
      are evaluated for impairment based upon the fair value of the rights as compared
      to amortized costs. Fair value is determined based upon discounted cash flows
      using market-based assumptions. When the book value exceeds its fair value,
      an
      impairment allowance is recognized so that mortgage servicing rights are carried
      at the lower of amortized book value or fair value. In periods of falling market
      interest rates, accelerated loan prepayment speeds can adversely impact the
      fair
      value of these mortgage servicing rights relative to their book value. In the
      event that the fair value of these assets were to increase in the future, the
      Company can recognize the increased fair value to the extent of the impairment
      allowance but cannot recognize an asset in excess of its amortized book value.
      Future changes in management’s assessment of the impairment of these servicing
      assets, as a result of changes in observable market data relating to market
      interest rates, loan prepayment speeds, and other factors, could impact the
      Company’s financial condition and results of operations either positively or
      adversely. On a quarterly basis, an independent third party determines the
      valuation of the Company’s mortgage servicing rights asset.





**Review
      of Financial Statements**





The
      Company declared a 3% stock dividend both in 2005 and 2004. All financial data
      included herein has been restated to reflect the impact of the stock
      dividends.





**Results
      of Operations**





*Comparison
      of 2005 and 2004*





*Summary*





The
      Company ended 2005 with consolidated assets of $417,073, representing growth
      of
      $48,383 or 13%.  Asset growth was attributable to strong loan demand. 
The Company reported net income of $5,738 or $1.67 per basic share and $1.66
      per
      diluted share in 2005, compared to $4,907 or $1.41 per basic share and $1.40
      diluted share in 2004.  This represented earnings growth of $831 or
      17%.  Return on average assets increased to 1.47% in 2005 compared to 1.36%
      in 2004, and return on average equity increased to 17.59% in 2005 from 16.06%
      in
      2004.




*Net
      Interest Income*





The
      Company’s primary source of operating income is net interest income.  Net
      interest income was $15,770 for 2005 and $13,773 for 2004.  Net interest
      income is the difference between the income earned on earning assets and the
      interest paid on interest-bearing liabilities.  Both net interest income
      and the net interest margin, which is net interest income expressed as a
      percentage of average earning assets, are affected by the volume and mix of
      earning assets and interest-bearing liabilities and the interest rates earned
      or
      paid on them.




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**Table
      1 - Three-Year Average Balance Sheets**





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





**2005**
            
            **2004**
            
            **2003****Average
                Balance**
            
            **Interest**
            
            **Yield/**
              **Rate**
            
            **Average
                Balance**
            
            **Interest**
            
            **Yield/**
              **Rate**
            
            **Average
                Balance**
            
            **Interest**
            
            **Yield/**
              **Rate**Assets:Interest-earning
                assets:Loans
                (1)
            
            $
            299,353
            
            $
            20,368
            
            
            6.80
            %
            $
            269,091
            
            $
            16,609
            
            
            6.17
            %
            $
            234,279
            
            $
            15,302
            
            
            6.53
            %Investment
                securities
            
            
            67,741
            
            
            2,338
            
            
            3.45
            %
            
            70,259
            
            
            2,071
            
            
            2.95
            %
            
            68,387
            
            
            1,911
            
            
            2.79
            %Other
                earning assets
            
            
            3,620
            
            
            118
            
            
            3.26
            %
            
            1,595
            
            
            28
            
            
            1.76
            %
            
            105
            
            
            —
            
            
            —Total
                interest-earning assets
            
            
            370,714
            
            
            22,824
            
            
            6.16
            %
            
            340,945
            
            
            18,708
            
            
            5.49
            %
            
            302,771
            
            
            17,213
            
            
            5.69
            %Non-earning
                assets
            
            
            19,886
            
            
            
            
            
            
            
            
            18,727
            
            
            
            
            
            
            
            
            17,308Total
                assets
            
            $
            390,600
            
            
            
            
            
            
            
            $
            359,672
            
            
            
            
            
            
            
            $
            320,079Liabilities
                and shareholders' equity:Interest-bearing
                liabilities:Savings
                deposits and interest-bearing
                checking
            
            $
            146,732
            
            
            2,076
            
            
            1.41
            %
            $
            129,774
            
            
            818
            
            
            0.63
            %
            $
            112,372
            
            
            689
            
            
            0.61
            %Certificates
                of deposit
            
            
            111,612
            
            
            3,719
            
            
            3.33
            %
            
            103,881
            
            
            3,223
            
            
            3.10
            %
            
            91,675
            
            
            3,250
            
            
            3.55
            %Borrowings
            
            
            42,664
            
            
            1,259
            
            
            2.95
            %
            
            41,588
            
            
            894
            
            
            2.15
            %
            
            41,878
            
            
            795
            
            
            1.90
            %Total
                interest-bearing liabilities
            
            
            301,008
            
            
            7,054
            
            
            2.34
            %
            
            275,243
            
            
            4,935
            
            
            1.79
            %
            
            245,925
            
            
            4,734
            
            
            1.92
            %Other
                liabilities
            
            
            56,973
            
            
            
            
            
            
            
            
            53,881
            
            
            
            
            
            
            
            
            44,962Shareholders'
                equity
            
            
            32,619
            
            
            
            
            
            
            
            
            30,548
            
            
            
            
            
            
            
            
            29,192Total
                liabilities and shareholders'equity
            
            $
            390,600
            
            
            
            
            
            
            
            $
            359,672
            
            
            
            
            
            
            
            $
            320,079Net
                interest income
            
            
            
            
            $
            15,770
            
            
            
            
            
            
            
            $
            13,773
            
            
            
            
            
            
            
            $
            12,479Net
                interest rate spread
            
            
            
            
            
            
            
            
            3.82
            %
            
            
            
            
            
            
            
            3.70
            %
            
            
            
            
            
            
            
            3.77
            %Net
                interest margin
            
            
            
            
            
            
            
            
            4.25
            %
            
            
            
            
            
            
            
            4.04
            %
            
            
            
            
            
            
            
            4.12
            %





(1)
            Loans
                include portfolio loans, loans held for sale and nonperforming loans,
                but
                unpaid interest on nonperforming loans has not been included for
                purposes
                of determining interest income.





**Table
      2 - Changes in Net Interest Income**





The
      following table presents the changes in interest income and expense attributable
      to changes in interest rates (change in rate multiplied by prior year volume),
      changes in volume (change in volume multiplied by prior year rate) and changes
      in rate/volume (change in rate multiplied by change in volume) for
      interest-earning assets and interest-bearing liabilities.





**December
                31, 2005 vs. 2004**
            
            **December
                31, 2004 vs. 2003****Increase
                (Decreased) Due to Change in:**
            
            **Increase
                (Decreased) Due to Change in:****Rate/**
            
            
            
            
            
            
            
            **Rate/****Volume**
            
            **Rate**
            
            **Volume**
            
            **Total**
            
            **Volume**
            
            **Rate**
            
            **Volume**
            
            **Total**Interest-earning
                assets:Loans
            
            $
            1,868
            
            $
            1,700
            
            $
            191
            
            $
            3,759
            
            $
            2,274
            
            $
            (842
            )
            $
            (125
            )
            $
            1,307Investment
                securities
            
            
            (74
            )
            
            354
            
            
            (13
            )
            
            267
            
            
            52
            
            
            105
            
            
            3
            
            
            160Other
                earning assets
            
            
            36
            
            
            24
            
            
            30
            
            
            90
            
            
            —
            
            
            2
            
            
            26
            
            
            28Total
                interest income
            
            
            1,830
            
            
            2,078
            
            
            208
            
            
            4,116
            
            
            2,326
            
            
            (735
            )
            
            (96
            )
            
            1,495Interest-bearing
                liabilities:Savings
                deposits and interest- bearing checking
            
            
            107
            
            
            1,018
            
            
            133
            
            
            1,258
            
            
            107
            
            
            19
            
            
            3
            
            
            129Certificates
                of deposit
            
            
            240
            
            
            238
            
            
            18
            
            
            496
            
            
            433
            
            
            (406
            )
            
            (54
            )
            
            (27
            )Borrowings
            
            
            23
            
            
            333
            
            
            9
            
            
            365
            
            
            199
            
            
            (75
            )
            
            (25
            )
            
            99Total
                interest expense
            
            
            370
            
            
            1,589
            
            
            160
            
            
            2,119
            
            
            739
            
            
            (462
            )
            
            (76
            )
            
            201Net
                interest income
            
            $
            1,460
            
            $
            489
            
            $
            48
            
            $
            1,997
            
            $
            1,587
            
            $
            (273
            )
            $
            (20
            )
            $
            1,294






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          to Table of Contents**




Net
      interest income increased by $1,997 in 2005 compared to 2004.  The increase
      was due to growth in the loan portfolio combined with an increase in the
      Company’s net interest margin to 4.25% for 2005 compared to 4.04% for
      2004.  The Federal Reserve Bank increased short-term interest rates with a
      3% increase in the Federal Funds Rate over an eighteen month period. The Federal
      Funds rate, as set by the Federal Reserve, averaged 3.19% in 2005 and 1.34%
      in
      2004.




Interest
      income was $22,824 in 2005, a 22% increase from 2004.  The increase was
      driven by growth in the average earning assets of $29,769 or 9% and an increase
      in the yield on average earning assets to 6.16% in 2005 from 5.49% in 2004.




Interest
      expense increased to $7,054 in 2005 from $4,935 in 2004, representing a 43%
      increase.  This increase was a result of growth in average interest-bearing
      liabilities of $25,765 or 9% and an increase in the cost of funds to 2.34%
      in
      2005 from 1.79% in 2004.




Management
      currently anticipates that net interest income will continue to increase in
      2006
      due to expected growth in earning assets (primarily loans) combined with the
      benefit of the increase in the Federal Funds rate.





*Provision
      and Allowance for Loan Losses*




The
      provision for loan losses is a result of management’s periodic analysis of the
      adequacy of the allowance for loan losses. The provision for loan losses was
      $397 for 2005 and $348 for 2004, an increase of $49 or 14%. The allowance for
      loan losses represented 1.28% of loans outstanding at December 31, 2005,
      compared to 1.37% at December 31, 2004. Net charge-offs were $177 during 2005
      or
      .06% of average loans outstanding, compared to $134 in 2004 or .05%. The low
      level of net loan charge-offs is indicative of the Company’s loan quality and
      credit administration standards and the generally stable economic environment
      existing in the Company’s primary market area.





The
      allowance for loan losses is maintained at a level determined to be adequate
      by
      management to absorb future charge-offs of loans deemed uncollectible. This
      allowance is increased by provisions charged to operating expense and by
      recoveries on loans previously charged off. A high degree of judgment is
      necessary to determine the appropriate level of allowance for loan losses and
      requires management’s ongoing evaluation of adequacy. The adequacy of the loan
      loss allowance is determined by use of a risk rating system. The evaluation
      process includes, among other things, industry standards, management's
      experience, the Bank's historical loan loss experience, evaluation of economic
      conditions and regular reviews of delinquencies and loan portfolio quality.
      Although management believes it uses the best information available to make
      determinations with respect to the allowance for loan losses, future adjustments
      may be necessary if economic conditions differ from the economic conditions
      in
      the assumptions used in making the final determinations.





Future
      provisions for loan losses depend on such factors as asset quality, net loan
      charge-offs, loan growth and other criteria discussed above. The appropriate
      level of the allowance for loan losses and the corresponding provision will
      continue to be determined quarterly. Management anticipates that there will
      be a
      provision for loan losses in 2006; however, the specific amount cannot be
      determined at this time. Changes in circumstances affecting the various factors
      of the Company’s methodology will determine the provision amount in
      2006.





*Non-Interest
      Income*





Non-interest
      income was $5,245 for 2005 compared to $5,005 for 2004, an increase of $240.
      We
      experienced growth in most fee categories with service fees on deposit accounts
      increasing 7%, trust fees growing 13% and other fees increasing 41%. Gains
      on
      investment securities declined $136 and gains on mortgage and credit card loan
      sales declined $107 from a year ago.




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          to Table of Contents**





Mortgage
      refinance activity has slowed considerably in 2005 resulting in a decline in
      mortgage gains to $684 in 2005 from $897 in 2004. The Company’s portfolio of
      residential mortgages serviced for secondary market investors at December 31,
      2005 of $141,125 increased by $19,000, or 16%, from December 31,
      2004.





Service
      fees on deposit accounts increased 7% to $1,496 in 2005. Overdraft fee income
      increased to $1,088 in 2005, a 15% increase over 2004 due to new account
      activity combined with a centralized approach to the overdraft process. Other
      fees increased $155 due to increases in financial service income of $62, income
      on cash surrender value of life insurance of $38 and income from M&M of $30.





Trust
      fees increased 13% to $1,567 in 2005. The market value of client assets under
      administration increased $9,514 to $365,950 at December 31, 2005 compared with
      trust assets of $356,436 at December 31, 2004. The increase in trust assets
      was
      achieved through new business development combined with market
      appreciation.





The
      generation of mortgage sale gains and trust fees is dependent on the market
      and
      economic conditions and, as a result, there can be no assurance that income
      levels reported in prior periods can be achieved in the future.





*Non-Interest
      Expense*





Non-interest
      expense was $11,986 for 2005 compared to $11,042 in 2004. The $944 or 9%
      increase was related to the increase in salaries and employee benefits of $525,
      occupancy expense of $101 and other expenses of $344. The Company’s efficiency
      ratio (non-interest expense divided by the sum of net interest income and other
      income) improved to 57.4% for 2005 compared to 59.3% for 2004.





Salaries
      and employee benefits expense increased 8% to $6,835 for 2005. The 2005 increase
      was a result of normal annual salary increases and additional staffing required
      as a result of loan and deposit growth. Occupancy expense increased 12% as
      maintenance and repairs increased 45% and heat and utilities costs grew 23%
      between years. Professional fees increased $125 or 33% due to an increase in
      directors fees and the use of consultants for technology, compliance and
      collection projects.





Annual
      operating expenses are also expected to increase in future periods due to future
      branching, and product expansion.





*Comparison
      of 2004 and 2003*





*Summary*





The
      Company ended 2004 with consolidated assets of $368,690 representing growth
      of
      $26,501 or 8%.  Asset growth was attributable to strong real estate loan
      demand.  The Company reported net income of $4,907 or $1.41 per basic share
      and $1.40 per diluted share in 2004, compared to $4,302 or $1.23 per basic
      share
      and $1.22 per diluted share in 2003.  This represented earnings growth of
      $605 or 14%.  Return on average assets increased to 1.36% in 2004 compared
      to 1.34% in 2003, and return on average equity increased to 16.06% in 2004
      from
      14.74% in 2003.





*Net
      Interest Income*





Net
      interest income totaled $13,773 for 2004 and $12,479 for 2003. The $1,294
      increase was due to growth in the loan portfolio which was slightly offset
      by a
      decline in the Company’s net interest margin to 4.04% for 2004 compared to 4.12%
      for 2003.




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          to Table of Contents**





*Non-Interest
      Income*





Non-interest
      income was $5,005 for 2004 compared to $5,181 for 2003, a decrease of $176.
      Non-interest income declined 3% in 2004 due to the substantial drop in mortgage
      refinance activity which resulted in a decline in the gain on loan sales of
      $911. We experienced growth in all other fee categories with service fees on
      deposit accounts increasing 20%, trust fees growing 17% and gains on investment
      securities increasing $206 from a year ago.





Mortgage
      refinance activity slowed considerably in 2004 resulting in a decline in
      mortgage gains to $897 in 2004 from $1,808 in 2003. The Company’s portfolio of
      residential mortgages serviced for secondary market investors at December 31,
      2004 of $122,125 increased by $15,261, or 14%, from December 31,
      2003.





Service
      fees on deposit accounts increased 20% to $1,399 in 2004. Overdraft fee income
      increased to $947 in 2004, a 47% increase over 2003 due to new account activity
      combined with a risk based approach to the overdraft process that was
      implemented during 2003. In addition, ATM fees increased 20% in
      2004.





Trust
      fees increased 17% to $1,382 in 2004. The market value of client assets under
      administration increased $40,894 to $356,436 at December 31, 2004 compared
      with
      trust assets of $315,542 at December 31, 2003. The increase in trust assets
      was
      achieved through new business development combined with market
      appreciation.





*Non-Interest
      Expense*





Non-interest
      expense was $11,042 for 2004 compared to $10,718 in 2003. The $324 or 3%
      increase was related to the increase in salaries and employee benefits of $423,
      data processing costs of $60 and occupancy expense of $47 which were offset
      by a
      decline in equipment expense of $31 and other expenses of $175. The Company’s
      efficiency ratio (non-interest expense divided by the sum of net interest income
      and other income) improved to 59.3% for 2004 compared to 60.5% for
      2003.





Salaries
      and employee benefits expense increased 7% to $6,310 for 2004. The 2004 increase
      was a result of normal annual salary increases and additional staffing required
      as a result of loan and deposit growth. Data processing costs increased 10%
      for
      2004 as a result of increased volume of item processing transactions. Other
      non-interest expense decreased 6% for 2004 due to a decrease in amortization
      of
      mortgage servicing rights of $121 and a decrease in merchant processing expense
      of $48 related to the Company exiting this line of business.





**Financial
      Condition**





The
      Company’s consolidated total assets at December 31, 2005 were $417,073, an
      increase of $48,383, or 13% from December 31, 2004. The change in assets
      consisted primarily of an increase in net loans of $35,757, a $6,390 increase
      in
      investment securities, a $3,608 increase in cash and cash equivalents and a
      $1,013 increase in net premises and equipment. The asset growth was funded
      by an
      increase in total deposits of $31,632 and a $13,484 increase in borrowed funds.
      Deposit growth was driven by an increase in certificates of deposit of $18,189
      and a $9,184 increase in savings, money market and interest checking balances.
      In addition, total shareholders’ equity increased $3,023 as a result of current
      year earnings less common stock repurchases and shareholder dividends
      paid.





*Investment
      Securities*





The
      Company’s investment portfolio is utilized for several purposes. It serves as a
      vehicle to manage interest rate and prepayment risk, generates interest and
      dividend income from the investment of excess funds, provides liquidity to
      meet
      liquidity requirements and is used as collateral for public deposits and other
      borrowing sources.




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The
      average balance of the securities portfolio, which consists of securities
      available for sale, was $67,741 in 2005 and $70,259 in 2004, a decrease of
      $2,518. The securities portfolio consists primarily of collateralized mortgage
      obligations and U.S. Government and agency securities. The majority of
      securities are rated AAA or equivalently rated. Collateralized mortgage
      obligations and mortgage-backed securities comprised 60% of the securities
      portfolio at December 31, 2005 compared to 72% at December 31, 2004. The average
      yield on securities was 3.45% during 2005, compared to 2.95% during 2004, which
      is due to the increase in market rates.





**Table
      3 - Investment Securities**





The
      following table sets forth the Company’s investment securities at the dates
      indicated:





**December
                31,****2005**
            
            **2004**
            
            **2003****%
                of**
            
            
            
            **%
                of**
            
            
            
            **%
                of****Amount**
            
            **Total**
            
            **Amount**
            
            **Total**
            
            **Amount**
            
            **Total**Collateralized
                mortgage obligations
            
            $
            39,386
            
            
            54
            %
            $
            43,553
            
            
            66
            %
            $
            46,441
            
            
            61
            %U.S.
                Government agencies and corporations
            
            
            16,417
            
            
            23
            %
            
            10,297
            
            
            16
            %
            
            12,351
            
            
            16
            %Mortgage-backed
                securities
            
            
            4,354
            
            
            6
            %
            
            3,982
            
            
            6
            %
            
            5,500
            
            
            7
            %U.S.
                Government and agency money market funds
            
            
            1,050
            
            
            1
            %
            
            480
            
            
            1
            %
            
            2,105
            
            
            3
            %Certificates
                of deposit
            
            
            4,827
            
            
            7
            %
            
            1,346
            
            
            2
            %
            
            2,957
            
            
            4
            %State
                and local government debt securities
            
            
            2,933
            
            
            4
            %
            
            2,311
            
            
            3
            %
            
            2,682
            
            
            4
            %Total
                debt securities
            
            
            68,967
            
            
            95
            %
            
            61,969
            
            
            94
            %
            
            72,036
            
            
            95
            %Equity
                securities
            
            
            3,774
            
            
            5
            %
            
            3,825
            
            
            6
            %
            
            3,550
            
            
            5
            %Total
                securities available for sale
            
            
            72,741
            
            
            100
            %
            
            65,794
            
            
            100
            %
            
            75,586
            
            
            100
            %Net
                unrealized (losses) gains
            
            
            (252
            )
            
            
            
            
            305
            
            
            
            
            
            554Fair
                value of securities available for sale
            
            $
            72,489
            
            
            
            
            $
            66,099
            
            
            
            
            $
            76,140





**Table
      4 - Maturities of Debt Securities**





The
      following table sets forth the contractual maturities and the weighted average
      yields (based on amortized cost) of the Company’s debt securities at December
      31, 2005. Actual maturities will differ from contractual maturities because
      borrowers may have the right to call or prepay obligations with or without
      call
      or prepayment penalties.





**Amortized
                Cost Maturing in****Less
                than**
              **One
                year**
            
            **1
                to 5 years**
            
            **More
                than 5 to**
              **10
                years**
            
            **More
                than**
              **Over
                10 years**
            
            **Total****Amount**
            
            **Yield**
            
            **Amount**
            
            **Yield**
            
            **Amount**
            
            **Yield**
            
            **Amount**
            
            **Yield**
            
            **Amount**
            
            **Yield**Collateralized
                mortgageobligations
            
            $
            —
            
            
            —
            
            $
            1,365
            
            
            3.78
            %
            $
            17,122
            
            
            3.70
            %
            $
            20,899
            
            
            4.04
            %
            $
            39,386
            
            
            3.88
            %U.S.
                Government agencies andcorporations
            
            
            5,058
            
            
            2.76
            %
            
            11,359
            
            
            4.15
            %
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            16,417
            
            
            3.72
            %Mortgage-backed
                securities
            
            
            15
            
            
            6.83
            %
            
            1,342
            
            
            4.13
            %
            
            2,997
            
            
            4.10
            %
            
            —
            
            
            —
            
            
            4,354
            
            
            4.12
            %U.S.
                Government and agencymoney
                market funds
            
            
            1,050
            
            
            4.03
            %
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,050
            
            
            4.03
            %Certificates
                of deposit
            
            
            4,752
            
            
            4.36
            %
            
            75
            
            
            3.10
            %
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            4,827
            
            
            4.34
            %State
                and local government debtsecurities
            
            
            377
            
            
            2.96
            %
            
            1,454
            
            
            4.12
            %
            
            962
            
            
            4.11
            %
            
            140
            
            
            4.74
            %
            
            2,933
            
            
            4.00
            %Total
            
            $
            11,252
            
            
            3.56
            %
            $
            15,595
            
            
            4.11
            %
            $
            21,081
            
            
            3.77
            %
            $
            21,039
            
            
            4.05
            %
            $
            68,967
            
            
            3.90
            %






-26-
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          to Table of Contents**


*Loans*





The
      Bank
      offers a broad range of personal and business loan products. Total loans (which
      includes loans held for sale) averaged $299,353 during 2005 compared to $269,091
      during 2004, an increase of $30,262, or 11%. Total loans grew 13% in 2005 to
      $318,965 at December 31, 2005. Real estate lending was strong with commercial
      real estate increasing 12%, home equity balances growing 22% and residential
      and
      construction lending up 6%. Loans to businesses grew at a rate of 16% and
      consumer loans increased 13% from a year ago.





The
      average yield on loans increased to 6.80% in 2005 from 6.17% in 2004. The prime
      rate average was 6.19% for 2005 and 4.34% for 2004. Management anticipates
      an
      increase on loan yields due to the increase in the prime rate however strong
      competition from banks and non-traditional credit providers will limit the
      level
      of the increase.





**Table
      5 - Composition of Loan Portfolio**





The
      following table summarizes the composition of the Bank’s loan portfolio by type
      of loan at the dates indicated:




**At
                December 31,****2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001****Amount**
            ****
            **%**
            ****
            **Amount**
            ****
            **%**
            ****
            **Amount**
            ****
            **%**
            ****
            **Amount**
            ****
            **%**
            ****
            **Amount**
            ****
            **%**Real
              EstateCommercial
            
            $
            108,553
            
            
            34
            %
            $
            96,956
            
            
            34
            %
            $
            80,212
            
            
            32
            %
            $
            70,247
            
            
            33
            %
            $
            69,209
            
            
            37
            %Construction
            
            
            15,345
            
            
            5
            %
            
            12,854
            
            
            5
            %
            
            9,669
            
            
            4
            %
            
            13,379
            
            
            6
            %
            
            6,678
            
            
            4
            %Residential
            
            
            62,568
            
            
            19
            %
            
            60,314
            
            
            21
            %
            
            55,380
            
            
            22
            %
            
            40,362
            
            
            19
            %
            
            35,040
            
            
            19
            %Home
                equity
            
            
            41,469
            
            
            13
            %
            
            34,139
            
            
            12
            %
            
            28,496
            
            
            12
            %
            
            19,889
            
            
            9
            %
            
            17,675
            
            
            9
            %Total
                real estate
            
            
            227,935
            
            
            71
            %
            
            204,263
            
            
            72
            %
            
            173,757
            
            
            70
            %
            
            143,877
            
            
            67
            %
            
            128,602
            
            
            69
            %Commercial
            
            
            69,799
            
            
            22
            %
            
            60,010
            
            
            21
            %
            
            55,486
            
            
            23
            %
            
            54,920
            
            
            26
            %
            
            43,533
            
            
            23
            %Consumer
            
            
            21,231
            
            
            7
            %
            
            18,715
            
            
            7
            %
            
            17,269
            
            
            7
            %
            
            15,932
            
            
            7
            %
            
            15,945
            
            
            8
            %Total
                loans
            
            $
            318,965
            
            
            100
            %
            $
            282,988
            
            
            100
            %
            $
            246,512
            
            
            100
            %
            $
            214,729
            
            
            100
            %
            $
            188,080
            
            
            100
            %Less
              allowance for loan losses
            
            
            (4,086
            )
            
            
            
            
            (3,866
            )
            
            
            
            
            (3,652
            )
            
            
            
            
            (3,295
            )
            
            
            
            
            (2,986
            )Total
            
            $
            314,879
            
            
            
            
            $
            279,122
            
            
            
            
            $
            242,860
            
            
            
            
            $
            211,434
            
            
            
            
            $
            185,094


**Table
      6 - Scheduled Contractual Amortization of Certain Loans at December 31,
      2005**





The
      following table sets forth the scheduled contractual amortization of
      construction loans and commercial business loans at December 31, 2005, as well
      as the amount of such loans which are scheduled to mature after one year which
      have fixed or adjustable interest rates.





**Commercial**
            
            **Construction****Business
                Loans**
            
            **Loans**
            
            **Total**Amounts
                due:Within
                one year
            
            $
            33,117
            
            $
            15,345
            
            $
            48,462After
                one year through five years
            
            
            23,036
            
            
            —
            
            
            23,036Beyond
                five years
            
            
            13,646
            
            
            —
            
            
            13,646Total
            
            $
            69,799
            
            $
            15,345
            
            $
            85,144Interest
                rate terms on amounts due after one year:Fixed
            
            $
            7,228
            
            $
            —
            
            $
            7,228Adjustable
            
            
            29,454
            
            
            —
            
            
            29,454





Management
      seeks to maintain a high quality of assets through prudent underwriting and
      sound lending practices. Approximately 28% of the Company's loan portfolio
      is
      collateralized by first liens on primarily owner-occupied residential homes
      which have historically carried a relatively low credit risk. The Bank also
      maintains a commercial real estate portfolio comprised primarily of
      owner-occupied commercial businesses.




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          to Table of Contents**





The
      Bank
      participates in government guaranteed loan programs including the Small Business
      Administration ("SBA"), Rural Development ("RD") and the Finance Authority
      of
      Maine ("FAME"). At December 31, 2005, loans under these programs totaled $18,807
      of which $13,825, or 4% of the total loan portfolio outstanding, is guaranteed
      by the various federal and state government entities.





The
      Bank
      continues to focus on asset quality issues and emphasizes loan review and
      underwriting procedures. The Bank utilizes the services of M&M to perform
      periodic loan and documentation review. Management has established a risk rating
      and review process with the objective of quickly identifying, evaluating and
      initiating necessary corrective action for all commercial and commercial real
      estate loans. The goal of the risk rating process is to address the watch list,
      substandard and non-performing loans, as early as possible. These components
      of
      risk management are integral elements of the Bank's loan program which have
      contributed to the loan portfolio performance to date. Nonetheless, management
      maintains a cautious outlook in attempting to anticipate the potential effects
      of uncertain economic conditions (both locally and nationally).





*Non-Performing
      Assets*





Non-performing
      assets consist of non-accrual loans, other loans past due over 90 days,
      foreclosed assets and other real estate owned. Total non-performing assets
      as a
      percentage of total assets decreased to .10% or $420 at December 31, 2005,
      compared to .44% or $1,609 at December 31, 2004.




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





**Table
      7- Five-Year Schedule of Non-Performing Assets**




The
      following table presents a summary of non-performing assets at the dates
      indicated.





**At
                December 31,****2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001**Loans:Non-accrual
                loans
            
            $
            378
            
            $
            1,571
            
            $
            598
            
            $
            432
            
            $
            432Loans
                90 days or more past due but still accruing
            
            
            —
            
            
            4
            
            
            8
            
            
            37
            
            
            75Restructured
                loans
            
            
            —
            
            
            4
            
            
            8
            
            
            132
            
            
            —Non-performing
                loans
            
            
            378
            
            
            1,579
            
            
            614
            
            
            601
            
            
            507OREO
                and repossessed assets
            
            
            42
            
            
            30
            
            
            3
            
            
            165
            
            
            221Non-performing
                assets
            
            $
            420
            
            $
            1,609
            
            $
            617
            
            $
            766
            
            $
            728Non-performing
                loans as a percentage of total loans
            
            
            0.12
            %
            
            0.56
            %
            
            0.25
            %
            
            0.28
            %
            
            0.27
            %Non-performing
                assets as a percentage of total assets
            
            
            0.10
            %
            
            0.44
            %
            
            0.18
            %
            
            0.25
            %
            
            0.26
            %Non-performing
                assets as a percentage of total loans and OREO/repossessed
                assets
            
            
            0.13
            %
            
            0.57
            %
            
            0.25
            %
            
            0.36
            %
            
            0.39
            %






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At
      December 31, 2005, loans on non-accrual status totaled $378. Interest income
      not
      recognized on non-accrual loans was $11 in 2005. There was no interest income
      recognized on non-accrual loans in 2005.





*Adversely
      Classified Assets*





The
      Bank’s management adversely classifies certain assets as “substandard,”
“doubtful” or “loss” based on criteria established under banking regulations. An
      asset is considered substandard if inadequately protected by the current net
      worth and paying capacity of the obligor or of the collateral pledged, if any.
      Substandard assets include those characterized by the “distinct possibility”
that the insured institution will sustain “some loss” if existing deficiencies
      are not corrected. Assets classified as doubtful have all the weaknesses
      inherent in those classified substandard with the added characteristic that
      the
      weaknesses present make “collection or liquidation in full,” on the basis of
      currently existing facts, conditions, and values, “highly questionable and
      improbable.” Assets classified as loss are those considered “uncollectible” and
      of such little value that their continuance as assets without the establishment
      of a specific loss reserve is not warranted.





At
      December 31, 2005 and 2004, loans classified as substandard amounted to $11,252
      and $8,417, respectively, and loans classified as doubtful totaled $397 and
      $36,
      respectively. Performing loans represent 79% and 83% of the adversely classified
      balances as of December 31, 2005 and 2004, respectively. The Bank had no loans
      which were classified as loss at either date. Total classified loans as a
      percentage of total loans increased to 3.7% at December 31, 2005 from 2.9%
      at
      December 31, 2004. Classified loans represent loans that, in the opinion of
      management, could potentially migrate to non-performing or loss status.
      Delinquent loans may or may not be adversely classified depending upon
      management’s judgment with respect to each individual loan. As of December 31,
      2005 and 2004, the portion of loans guaranteed by either the SBA, RD or FAME
      for
      each year amounted to 10% and 15%, respectively, of the total loan balances
      adversely classified. At December 31, 2005, related party loans totaling $1,942
      were classified as substandard and over 30 days past due.




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          to Table of Contents**





**Table
      8 - Five-Year Table of Activity in the Allowance for Loan Losses and Net
      Charge-offs as a Percent of Average Loans Outstanding**





The
      following table presents net charge-offs by loan type and the activity in the
      allowance for loan losses during the periods indicated.




**Year
                Ended December 31,****2005**
            
            
            **2004**
            
            
            **2003**
            
            
            **2002**
            
            
            **2001**Allowance
                at beginning of year
            
            $
            3,866
            
            $
            3,652
            
            $
            3,295
            
            $
            2,986
            
            $
            2,658Charge-offs:Commercial
                real estate
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Residential
                real estate
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Home
                equity loans
            
            
            —
            
            
            (10
            )
            
            —
            
            
            —
            
            
            (20
            )Commercial
                business loans
            
            
            (72
            )
            
            (24
            )
            
            (7
            )
            
            (28
            )
            
            (65
            )Overdrafts
                on deposit accounts
            
            
            (58
            )
            
            —
            
            
            —
            
            
            —
            
            
            —Consumer
            
            
            (
                96
            )
            
            (144
            )
            
            (113
            )
            
            (161
            )
            
            (99
            )Total
                loans charged-off
            
            
            (226
            )
            
            (178
            )
            
            (120
            )
            
            (189
            )
            
            (184
            )Recoveries:Commercial
                real estate
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Residential
                real estate
            
            
            —
            
            
            —
            
            
            —
            
            
            27
            
            
            22Home
                equity loans
            
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            —Commercial
                business loans
            
            
            —
            
            
            12
            
            
            4
            
            
            5
            
            
            1Overdrafts
                on deposit accounts
            
            
            18
            
            
            —
            
            
            —
            
            
            —
            
            
            —Consumer
            
            
            30
            
            
            32
            
            
            29
            
            
            13
            
            
            15Total
                loans recovered
            
            
            49
            
            
            44
            
            
            33
            
            
            45
            
            
            38Net
                charge-offs
            
            
            (177
            )
            
            (134
            )
            
            (87
            )
            
            (144
            )
            
            (146
            )Provisions
                for loan losses
            
            
            397
            
            
            348
            
            
            444
            
            
            453
            
            
            474Allowance
                at end of year
            
            $
            4,086
            
            $
            3,866
            
            $
            3,652
            
            $
            3,295
            
            $
            2,986Total
                net loans outstanding at the end of year (1)
            
            $
            314,879
            
            $
            279,122
            
            $
            242,860
            
            $
            211,434
            
            $
            185,094Average
                net loans outstanding during the year (1)
            
            $
            294,571
            
            $
            264,616
            
            $
            229,392
            
            $
            198,120
            
            $
            171,692Ratios:Net
                charge-offs to average loans outstanding
            
            
            0.06
            %
            
            0.05
            %
            
            0.04
            %
            
            0.07
            %
            
            0.08
            %Net
                charge-offs to loans, end of period
            
            
            0.06
            %
            
            0.05
            %
            
            0.04
            %
            
            0.07
            %
            
            0.08
            %Allowance
                for loan losses to average loans outstanding
            
            
            1.37
            %
            
            1.44
            %
            
            1.57
            %
            
            1.64
            %
            
            1.71
            %Allowance
                for loan losses to loans, end of year
            
            
            1.28
            %
            
            1.37
            %
            
            1.48
            %
            
            1.53
            %
            
            1.59
            %Allowance
                for loan losses to non-performing loans
            
            
            1080.95
            %
            
            244.84
            %
            
            594.79
            %
            
            548.25
            %
            
            588.95
            %





(1)
            Excludes
                loans held for sale.





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          to Table of Contents**




**Table
      9 - Allocation of the Allowance for Loan Losses - Five-Year
      Schedule**





The
      following table sets forth the breakdown of the allowance for loan losses by
      loan category for the periods indicated. Management believes that the allowance
      can be allocated by category only on an approximate basis. The allocation of
      an
      allowance to each category is not necessarily indicative of future losses and
      does not restrict the use of the allowance to absorb losses in any other
      category.





**At
                December 31,****2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001****Amount**
            
            **%
                of**
              **Loans
                to**
              **Total**
              **Loans**
            
            **Amount**
            
            **%
                of**
              **Loans
                to**
              **Total**
              **Loans**
            
            **Amount**
            
            **%
                of**
              **Loans
                to**
              **Total**
              **Loans**
            
            **Amount**
            
            **%
                of**
              **Loans
                to**
              **Total**
              **Loans**
            
            **Amount**
            
            **%
                of**
              **Loans
                to**
              **Total**
              **Loans**Commercial
                and
              Commercial
                Real Estate (1)
            
            $
            3,115
            
            
            56
            %
            $
            2,818
            
            
            56
            %
            $
            2,774
            
            
            55
            %
            $
            1,881
            
            
            58
            %
            $
            1,574
            
            
            60
            %Construction
            
            
            77
            
            
            5
            %
            
            64
            
            
            4
            %
            
            48
            
            
            4
            %
            
            67
            
            
            6
            %
            
            33
            
            
            4
            %Residential
            
            
            198
            
            
            20
            %
            
            214
            
            
            21
            %
            
            181
            
            
            22
            %
            
            361
            
            
            19
            %
            
            285
            
            
            19
            %Home
                equity
            
            
            114
            
            
            12
            %
            
            91
            
            
            12
            %
            
            74
            
            
            12
            %
            
            248
            
            
            9
            %
            
            220
            
            
            9
            %Consumer
            
            
            340
            
            
            7
            %
            
            354
            
            
            7
            %
            
            277
            
            
            7
            %
            
            460
            
            
            8
            %
            
            424
            
            
            8
            %Off-Balance
                Sheet
            
            
            242
            
            
            —
            
            
            212
            
            
            —
            
            
            125
            
            
            —
            
            
            278
            
            
            —
            
            
            212
            
            
            —Unallocated
            
            
            —
            
            
            —
            
            
            113
            
            
            —
            
            
            173
            
            
            —
            
            
            —
            
            
            —
            
            
            238
            
            
            —Total
                allowance for loan losses
            
            $
            4,086
            
            
            100
            %
            $
            3,866
            
            
            100
            %
            $
            3,652
            
            
            100
            %
            $
            3,295
            
            
            100
            %
            $
            2,986
            
            
            100
            %





(1)
            Commercial
                and commercial real estate loans have been combined in allocating
                the
                allowance for loan losses as the Company utilizes an internal risk
                rating
                system for these loans on a consolidated
                basis.





The
      allowance for loan losses represents the amount available for credit losses
      inherent in the Company's loan portfolio. Loans are charged off when they are
      deemed uncollectible, after giving consideration to factors such as the
      customer's financial condition, underlying collateral and guarantees, as well
      as
      general and industry economic conditions.




In
      general, the Company determines the appropriate overall allowance for loan
      losses based upon periodic, systematic reviews of its portfolio to identify
      inherent losses based on management's judgment about various qualitative
      factors. These reviews result in the identification and quantification of loss
      factors, which are used in determining the amount of the allowance for loan
      losses. The Company periodically evaluates prevailing economic and business
      conditions, industry concentrations, changes in the size and characteristics
      of
      the portfolio and other pertinent factors. Portions of the allowance for loan
      losses are quantified to cover the estimated losses inherent in each loan
      category based on the results of this detailed review process.





Commercial
      loans are individually reviewed and assigned a credit risk rating from "1"
      (low
      risk of loss) to "8" (high risk of loss). For non-impaired loans with a credit
      risk rating of "1" to "6", estimated loss factors based on historical loss
      experience (ranging from two to five years) are used to calculate a loan loss
      reserve for each credit risk rating classification. Qualitative adjustments
      are
      also made based upon management's assessment of prevailing economic conditions,
      trends in volumes and terms of loans, levels and trends in delinquencies and
      non-accruals, and the effect of changes in lending policies. A specific
      allocation is made for impaired loans, or loans no longer accruing interest
      as a
      result of the deemed uncollectibility of interest due, which are measured at
      the
      net present value of future cash flows, discounted at the loan's effective
      interest rate, or at fair market value of collateral if the loan is collateral
      dependent. The combination of these analyses is the basis for the determination
      of the commercial loan portion of the allowance for loan losses.





Consumer
      loans, which include residential mortgages, home equity loans, and
      direct/indirect loans, are generally evaluated as a group based on product
      type.
      The determination of the consumer loan portion of the allowance for loan losses
      is based on a five-year average of annual historical losses, adjusted for the
      qualitative factors noted above.




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          to Table of Contents**





At
      December 31, 2005, the reserve allocated to the commercial and commercial real
      estate category constitutes 76% of the total allowance for loan losses compared
      to 73% at December 31, 2004. The change is due to an increase in adversely
      classified loans. The allocation of the allowance for loan losses for
      construction, residential, home equity, consumer and off-balance sheet remains
      consistent between years.





The
      results of all analyses are reviewed and discussed by the Board of Directors
      on
      a quarterly basis. An integral component of the Company's risk management
      process is to ensure the proper quantification of the reserve for loan losses
      based upon an analysis of risk characteristics, demonstrated losses, loan
      segmentations, and other factors. Reserve methodology is reviewed on a periodic
      basis and modified as appropriate. Based on this analysis, including the
      aforementioned assumptions, the Company believes that the allowance for loan
      losses is appropriate as of December 31, 2005. Although management utilizes
      its
      best judgment in providing for possible losses, there can be no assurance the
      Bank will not have to increase its provision for possible losses in the future
      due to increases in non-performing assets or otherwise, which would adversely
      affect the results of operations.





*Funding
      and Liquidity*





The
      Company’s principal sources of funding are deposits and borrowed funds. The
      Company has a comprehensive liquidity management program in place. It maintains
      adequate funding for its assets by monitoring anticipated sources and uses
      of
      funding. Deposits are attracted principally from within the Company's primary
      market area through the offering of a broad variety of deposit products,
      including checking accounts, money market accounts, savings accounts,
      certificates of deposit (including jumbo certificates in denominations of $100
      or more) and retirement savings plans. In addition to traditional in-market
      deposit sources, the Company has other sources of liquidity, including proceeds
      from maturing investment securities and loans, the sale of investment
      securities, Federal Funds through correspondent bank relationships, brokered
      deposits and Federal Home Loan Bank (FHLB) borrowings. Additional liquidity
      is
      available in the loan portfolio through sale of residential mortgages and the
      guaranteed portion of SBA loans. The Company also maintains a $5,000 credit
      line
      with a correspondent bank. Management believes that the current level of
      liquidity is sufficient to meet current and future funding
      requirements.





*Deposits*





In
      2005,
      total deposits increased by $31,632 to $331,414, an 11% increase over 2004.
      The
      combination of rising short-term interest rates and special deposit promotions
      resulted in certificates of deposit growth of 27% and savings account increases
      of 34%. The direct mail marketing campaign to businesses and individuals under
      the High Performance Checking program continues to spur core deposit growth
      with
      checking account balances increasing 4% in 2005.





The
      Company’s focus on quality customer service combined with the marketing of the
      High Performance Checking program contributed to the deposit growth in 2005.
      The
      program includes free checking accounts for businesses and individuals, direct
      mail advertising, Tell-A-Friend referrals and an attractive selection of premium
      gifts. The Company continues to develop consumer and commercial deposit
      relationships through referrals and additional contacts within its market
      area.





The
      Bank’s average cost of deposits (including non-interest checking) was 1.86% for
      the year 2005, compared to 1.42% during 2004. The increase was due to rising
      short-term interest rates.




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**Table
      10 - Average Deposit Balances and Rates**





The
      following table sets forth the average balances and weighted average rates
      for
      the Bank’s categories of deposits for the periods indicated:


**Year
                  Ended December 31,****2005**
              
              **2004**
              
              **2003****Average**
                **Balance**
              
              **Average**
                **Rate**
              
              **%
                  of**
                **Total**
                **Deposits**
              
              **Average**
                **Balance**
              
              **Average**
                **Rate**
              
              **%
                  of**
                **Total**
                **Deposits**
              
              **Average**
                **Balance**
              
              **Average**
                **Rate**
              
              **%
                  of**
                **Total**
                **Deposits**Non-interest
                  checking
              
              $
              52,869
              
              
              —
              
              
              17
              %
              $
              50,331
              
              
              —
              
              
              18
              %
              $
              41,740
              
              
              —
              
              
              17
              %Interest
                  checking
              
              
              42,886
              
              
              0.69
              %
              
              14
              %
              
              40,693
              
              
              0.36
              %
              
              14
              %
              
              34,188
              
              
              0.28
              %
              
              14
              %Money
                  market
              
              
              53,087
              
              
              2.26
              %
              
              17
              %
              
              45,852
              
              
              1.12
              %
              
              16
              %
              
              36,943
              
              
              0.95
              %
              
              15
              %Savings
              
              
              50,759
              
              
              1.14
              %
              
              16
              %
              
              43,229
              
              
              0.37
              %
              
              15
              %
              
              41,241
              
              
              0.58
              %
              
              17
              %Brokered
                  deposits
              
              
              39,702
              
              
              3.97
              %
              
              13
              %
              
              37,937
              
              
              3.88
              %
              
              14
              %
              
              22,727
              
              
              4.69
              %
              
              9
              %Certificates
                  of deposit
              
              
              71,910
              
              
              2.98
              %
              
              23
              %
              
              65,944
              
              
              2.65
              %
              
              23
              %
              
              68,948
              
              
              3.17
              %
              
              28
              %Total
              
              $
              311,213
              
              
              1.86
              %
              
              100
              %
              $
              283,986
              
              
              1.42
              %
              
              100
              %
              $
              245,787
              
              
              1.60
              %
              
              100
              %




The
      Bank
      does not have a concentration of deposits from any one source, the loss of
      which
      would have a material adverse effect on the business of the Bank. Management
      believes that substantially all the Bank’s depositors are residents in its
      primary market area except for $47,762 in brokered deposits at December 31,
      2005.





The
      following table summarizes at December 31, 2005 the Bank’s certificates of
      deposit (CD) of $100 or more and by time remaining until maturity:




Maturity
                Period:Less
                than three months
            
            $
            5,165Over
                three months through six months
            
            
            6,547Over
                six months through twelve months
            
            
            12,191Over
                twelve months
            
            
            38,407Total
            
            $
            62,310





*Borrowings*





Borrowings
      supplement deposits as a source of liquidity. Borrowed funds consist mainly
      of
      securities sold under agreement to repurchase and advances from the FHLB. Total
      borrowings were $47,008 at December 31, 2005 compared to $33,524 at December
      31,
      2004, an increase of $13,484. Short-term borrowings include federal funds
      purchased, commercial lines of credit, FHLB overnight, Treasury, tax and loan
      deposits and interest-bearing demand notes due to the U.S. Treasury. The
      following table sets forth certain information regarding short-term borrowed
      funds for the years ended December 31, 2005, 2004 and 2003.





**2005**
            
            **2004**
            
            **2003**Balance
                outstanding at end of year
            
            $
            24,074
            
            $
            17,854
            
            $
            31,283Average
                balance during the year
            
            
            19,851
            
            
            22,820
            
            
            29,698Maximum
                outstanding at any month-end during the year
            
            
            24,074
            
            
            35,932
            
            
            44,377Average
                interest rate during the year
            
            
            1.87
            %
            
            0.89
            %
            
            0.97
            %Average
                interest rate at end of the year
            
            
            2.49
            %
            
            1.12
            %
            
            0.83
            %







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          to Table of Contents**


*Off-Balance
      Sheet Financial Instruments*





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





*Contractual
      Obligations and Commitments*





**Table
      11 - Contractual Obligations and Commitments**





The
      following tables summarize the Company’s contractual cash obligations and other
      commitments at December 31, 2005.


Payments
                Due by Period:**Contractual
                Obligations**
            
            Total
                Amount of Obligation
            
            Less
                than 1 Year
            
            1
                - 3 years
            
            4
                - 5 years
            
            After
                5 yearsOperating
                leases
            
            $
            913
            
            $
            288
            
            $
            404
            
            $
            208
            
            $
            13Long-term
                debt (FHLB borrowings)
            
            
            22,934
            
            
            3,181
            
            
            11,013
            
            
            7,151
            
            
            1,589Total
                contractual obligations
            
            $
            23,847
            
            $
            3,469
            
            $
            11,417
            
            $
            7,359
            
            $
            1,602








Commitment
                Expires in:**Other
                Commitments**
            
            Total
                Amount Committed
            
            Less
                than 1 Year
            
            1
                - 3 years
            
            4
                - 5 years
            
            After
                5 yearsLetters
                of credit
            
            $
            1,392
            
            $
            1,138
            
            $
            —
            
            $
            254
            
            $
            —Other
                commitments to extend credit
            
            
            73,156
            
            
            45,464
            
            
            2,632
            
            
            1,102
            
            
            23,958Total
                commitments
            
            $
            74,548
            
            $
            46,602
            
            $
            2,632
            
            $
            1,356
            
            $
            23,958





At
      December 31, 2005, the Company had interest rate swap agreements with notional
      amounts of $10,000. The following table summarizes the Company’s obligations
      under the interest rate swap agreements.





Payments
                Due by Period:Less
                than 1 Year
            
            1
                - 3 Years
            
            4
                - 5 Years
            
            After
                5 YearsFixed
                payments from counterparty
            
            $
            279
            
            $
            —
            
            $
            —
            
            $
            —Payments
                based on prime rate
            
            
            318
            
            
            —
            
            
            —
            
            
            —Net
                cash outflow
            
            $
            39
            
            $
            —
            
            $
            —
            
            $
            —





See
      Note
      4 to the Consolidated Financial Statements for more information regarding the
      nature and business purpose of derivative financial instruments.





**Asset/Liability
      Management**





*Market
      Risk*





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




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          to Table of Contents**





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




*Interest
      Rate Risk*





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




The
      simulation model captures the impact of changing interest rates on the interest
      income earned and interest expense incurred on all interest-earning assets
      and
      interest-bearing liabilities reflected in the Company’s statement of financial
      condition. This sensitivity analysis is compared to ALCO policy limits which
      specify a maximum tolerance level for NII exposure over a one-year horizon,
      assuming no asset growth, given a 200 basis point (bp) upward and downward
      shift
      in interest rates. A parallel and pro rata shift in rates over a 12-month period
      is assumed. The following reflects the Company’s NII sensitivity analysis as
      measured during the 4th quarter of 2005.




EstimatedRate
                Change
            
            Change
                in NII+200bp
            
            
            1.28
            %-200bp
            
            
            (3.26
            )%




The
      preceding sensitivity analysis does not represent a Company forecast and should
      not be relied upon as being indicative of expected operating results. These
      hypothetical estimates are based upon numerous assumptions including, among
      others, the nature and timing of interest rate levels, yield curve shape,
      prepayments on loans and securities, deposit decay rates, pricing decisions
      on
      loans and deposits, and reinvestment/replacement of asset and liability cash
      flows. While assumptions are developed based upon current economic and local
      market conditions, the Company cannot make any assurances as to the predictive
      nature of these assumptions, including how customer preferences or competitor
      influences might change.





When
      appropriate, the Company may utilize derivative financial instruments, such
      as
      interest rate floors, caps and swaps to hedge its interest rate risk position.
      The Board of Directors’ approved hedging policy statements govern the use of
      these instruments. As of December 31, 2005, the Company had a notional principal
      of $10,000 in interest rate swap agreements. ALCO monitors derivative activities
      relative to its expectation and the Company’s hedging policy. These instruments
      are more fully described in Note 4 - Derivative Financial Instruments within
      the
“Notes to Consolidated Financial Statements” section.





In
      2004,
      the Company acquired interest rate swap agreements to convert a portion of
      the
      loan portfolio from a variable rate based upon the prime rate to a fixed rate.
      The $10,000 of interest rate swap agreements mature in 2006. In a purchased
      interest rate swap agreement, cash interest payments are exchanged between
      the
      Company and counterparty. The estimated effects of these derivative financial
      instruments on the Company’s earnings are included in the sensitivity analysis
      presented above. The risks
      associated with entering into this transaction are the risk of default by the
      counterparty with whom the Company has entered into the agreement and poor
      correlation between the rate being swapped and the yield on the hedged assets.
      The Company’s risk from default of a counterparty is limited to the expected
      cash flow anticipated from the counterparty, not the notional
      value.




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          to Table of Contents**





*Capital
      Resources*





At
      December 31, 2005, shareholders’ equity totaled $34,352 or 8.2% of total assets,
      as compared to $31,329 or 8.5% at December 31, 2004. The net increase in
      shareholders’ equity was attributable to: net income of $5,738 less share
      repurchases of $19; $408 in unrealized losses on securities available for sale
      and derivative instruments; and $2,203 in cash dividends to the Company’s
      shareholders.





During
      2005, the Company repurchased 5,500 shares of common stock at an average price
      of $21.70 and in 2004 the Company repurchased 89,592 shares of common stock
      at
      an average price of $23.36. Upon completion of the third stock repurchase
      program, the Board of Directors approved a fourth stock repurchase program
      in
      June 2004 authorizing the Company to repurchase up to 169,995, or 5%, of its
      outstanding shares of common stock. As of December 31, 2005, 22,137 shares
      had
      been repurchased under this program. No shares were repurchased during the
      fourth quarter of 2005. Future repurchases will be made from time to time at
      the
      discretion of Company management.





Capital
      guidelines issued by the Federal Reserve Board require the Company to maintain
      certain ratios. The Company’s risk-based capital ratios for Tier 1 and Tier 2
      Capital (as defined by federal banking agency regulations) at December 31,
      2005
      of 11.06% and 12.40%, respectively, exceed regulatory guidelines for capital
      adequacy. The Company’s Tier 1 and Tier 2 risk-based capital ratios at December
      31, 2004 were 11.83% and 13.09%, respectively. The Bank is also subject to
      federal regulatory capital requirements. At December 31, 2005, the Bank was
      deemed to be “well capitalized” under the applicable regulations. See Note 17 to
      the Consolidated Financial Statements.




*Equity
      Ratios*





**Table
      12 - Equity Ratios**





The
      following tables summarize the Company’s key equity ratios at December 31,
      2005, 2004 and 2003.


**2005**
            
            **2004**
            
            **2003**Return
                on average assets
            
            
            1.47
            %
            
            1.36
            %
            
            1.34
            %Return
                on average equity
            
            
            17.59
            %
            
            16.06
            %
            
            14.74
            %Dividend
                payout ratio
            
            
            38.33
            %
            
            38.32
            %
            
            37.16
            %Average
                equity to average assets
            
            
            8.35
            %
            
            8.49
            %
            
            9.12
            %





*Impact
      of New Accounting Standards*





For
      information on the impact of new accounting standards, see Note 1 to the
      Consolidated Financial Statements.





**ITEM
      7A.****QUANTITATIVE
      AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**





The
      information contained in the section captioned “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations - Asset/Liability
      Management” in Item 7 hereof is incorporated herein by reference.




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**ITEM
      8.****FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA**





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


**Consolidated
      Statements of Financial Condition**


December
                31,2005
            
            2004(In
                thousands, except number of shares and per share data)**ASSETS**Cash
                and due from banks
            
            $
            13,785
            
            $
            10,092Interest-bearing
                deposits with banks
            
            
            43
            
            
            128Total
                cash and cash equivalents
            
            
            13,828
            
            
            10,220Investment
                securities - available for sale
            
            
            72,489
            
            
            66,099Loans
                held for sale
            
            
            925
            
            
            617Loans
                receivable
            
            
            318,965
            
            
            282,988Less
                allowance for loan losses
            
            
            4,086
            
            
            3,866Net
                loans receivable
            
            
            314,879
            
            
            279,122Properties
                and equipment, net
            
            
            4,863
            
            
            3,850Cash
                surrender value of life insurance
            
            
            4,018
            
            
            3,854Deferred
                income tax benefit
            
            
            1,372
            
            
            1,079Accrued
                income and other assets
            
            
            4,699
            
            
            3,849Total
                assets
            
            $
            417,073
            
            $
            368,690**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Demand
                deposits
            
            $
            56,204
            
            $
            51,945Savings,
                money market and interest checking deposits
            
            
            151,798
            
            
            142,614Certificates
                of deposit
            
            
            123,412
            
            
            105,223Total
                deposits
            
            
            331,414
            
            
            299,782Securities
                sold under agreements to repurchase (term and demand)
            
            
            18,534
            
            
            16,486Other
                borrowed funds
            
            
            28,474
            
            
            17,038Accrued
                expenses and other liabilities
            
            
            4,299
            
            
            4,055Total
                liabilities
            
            
            382,721
            
            
            337,361Commitments
                (Notes 4, 8, 10, 14, 17 and 18)Shareholders’
                equityCommon
                stock, par value $1; authorized 4,000,000 shares, issued and outstanding
                3,435,851 shares in 2005 and 3,340,310 shares in 2004
            
            
            3,436
            
            
            3,340Capital
                surplus
            
            
            24,188
            
            
            22,037Retained
                earnings
            
            
            6,947
            
            
            5,763Accumulated
                other comprehensive (loss) incomeUnrealized
                (loss) gain on securities available for sale, net of tax
            
            
            (167
            )
            
            203Net
                unrealized depreciation on derivative instruments marked to market,
                net of
                tax
            
            
            (52
            )
            
            (14
            )Total
                shareholders’ equity
            
            
            34,352
            
            
            31,329Total
                liabilities and shareholders’ equity
            
            $
            417,073
            
            $
            368,690


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




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          to Table of Contents**


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


**Consolidated
      Statements of Income**


Years
                Ended December 31,(In
                thousands, except number of shares and per share data)
            
            2005
            
            2004
            
            2003Interest
                and dividend incomeInterest
                and fees on loans
            
            $
            20,368
            
            $
            16,609
            
            $
            15,302Interest
                on investment securities
            
            
            2,192
            
            
            1,953
            
            
            1,754Dividends
                on investment securities
            
            
            146
            
            
            118
            
            
            157Interest
                on federal funds sold
            
            
            118
            
            
            28
            
            
            -Total
                interest and dividend income
            
            
            22,824
            
            
            18,708
            
            
            17,213Interest
                expenseInterest
                on deposits
            
            
            5,795
            
            
            4,041
            
            
            3,939Interest
                on borrowed funds
            
            
            1,259
            
            
            894
            
            
            795Total
                interest expense
            
            
            7,054
            
            
            4,935
            
            
            4,734Net
                interest income
            
            
            15,770
            
            
            13,773
            
            
            12,479Provision
                for loan losses
            
            
            397
            
            
            348
            
            
            444Net
                interest income after provision for loan losses
            
            
            15,373
            
            
            13,425
            
            
            12,035Non-interest
                incomeService
                charges on deposit accounts
            
            
            1,496
            
            
            1,399
            
            
            1,161Other
                service charges and fees
            
            
            836
            
            
            790
            
            
            706Trust
                fees
            
            
            1,567
            
            
            1,382
            
            
            1,186Net
                gain on sale of mortgage and credit card loans
            
            
            790
            
            
            897
            
            
            1,808Net
                gain (loss) on investment securities
            
            
            19
            
            
            155
            
            
            (51
            )Other
            
            
            537
            
            
            382
            
            
            371Total
                non-interest income
            
            
            5,245
            
            
            5,005
            
            
            5,181Non-interest
                expenseSalaries
                and employee benefits
            
            
            6,835
            
            
            6,310
            
            
            5,887Occupancy
                expense
            
            
            959
            
            
            858
            
            
            811Equipment
                expense
            
            
            655
            
            
            606
            
            
            637Advertising
                and promotion
            
            
            634
            
            
            578
            
            
            607Data
                processing
            
            
            611
            
            
            686
            
            
            626Professional
                fees
            
            
            500
            
            
            375
            
            
            397Other
            
            
            1,792
            
            
            1,629
            
            
            1,753Total
                non-interest expense
            
            
            11,986
            
            
            11,042
            
            
            10,718Income
                before income taxes
            
            
            8,632
            
            
            7,388
            
            
            6,498Income
                tax expense
            
            
            2,894
            
            
            2,481
            
            
            2,196Net
                income
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Per
                share dataBasic
                earnings per common share
            
            $
            1.67
            
            $
            1.41
            
            $
            1.23Diluted
                earnings per common share
            
            $
            1.66
            
            $
            1.40
            
            $
            1.22


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




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          to Table of Contents**


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


**Consolidated
      Statements of Changes in Shareholders’
Equity**





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


AccumulatedOtherCommon
            
            Capital
            
            Retained
            
            Comprehensive
            
            TreasuryStock
            
            Surplus
            
            Earnings
            
            Income
                (Loss)
            
            Stock
            
            TotalBalance
                at December 31, 2002
            
            $
            3,194
            
            $
            20,381
            
            $
            5,498
            
            $
            536
            
            $
            (1,221
            )
            $
            28,388Net
                income
            
            
            —
            
            
            —
            
            
            4,302
            
            
            —
            
            
            —
            
            
            4,302Change
                in unrealized gain on securities available for sale, net of deferred
                income taxes of $89
            
            
            —
            
            
            —
            
            
            —
            
            
            (170
            )
            
            —
            
            
            (170
            )Comprehensive
                income
            
            
            —
            
            
            —
            
            
            4,302
            
            
            (170
            )
            
            —
            
            
            4,132Common
                stock options exercised, 184,142 shares
            
            
            45
            
            
            (57
            )
            
            (1,458
            )
            
            —
            
            
            2,224
            
            
            754Tax
                benefit related to exercise of stock options
            
            
            -
            
            
            98
            
            
            —
            
            
            —
            
            
            —
            
            
            983%
                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
            )Common
                stock cash dividends declared, $.48 per share
            
            
            —
            
            
            —
            
            
            (1,599
            )
            
            —
            
            
            —
            
            
            (1,599
            )Balance
                at December 31, 2003
            
            $
            3,335
            
            $
            21,762
            
            $
            5,305
            
            $
            366
            
            $
            (215
            )
            $
            30,553Net
                income
            
            
            —
            
            
            —
            
            
            4,907
            
            
            —
            
            
            —
            
            
            4,907Unrealized
                loss on derivative instruments, net of deferred taxes of
                $7
            
            
            —
            
            
            —
            
            
            —
            
            
            (13
            )
            
            —
            
            
            (13
            )Change
                in unrealized gain on securities available for sale, net of deferred
                income taxes of $85
            
            
            —
            
            
            —
            
            
            —
            
            
            (164
            )
            
            —
            
            
            (164
            )Comprehensive
                income
            
            
            —
            
            
            —
            
            
            4,907
            
            
            (177
            )
            
            —
            
            
            4,730Common
                stock options exercised, 7,628 shares
            
            
            2
            
            
            9
            
            
            (42
            )
            
            —
            
            
            97
            
            
            66Tax
                benefit related to exercise of stock options
            
            
            —
            
            
            21
            
            
            —
            
            
            —
            
            
            —
            
            
            213%
                common stock dividend declared
            
            
            100
            
            
            2,422
            
            
            (2,526
            )
            
            —
            
            
            —
            
            
            (4
            )Treasury
                stock purchased (72,592 shares at an average price of
                $24.80)
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,801
            )
            
            (1,801
            )Treasury
                stock retirement
            
            
            (80
            )
            
            (1,839
            )
            
            —
            
            
            —
            
            
            1,919
            
            
            —Common
                stock repurchased (17,000 shares at an average price of
                $20.88)
            
            
            (17
            )
            
            (338
            )
            
            —
            
            
            —
            
            
            —
            
            
            (355
            )Common
                stock cash dividends declared, $.56 per share
            
            
            —
            
            
            —
            
            
            (1,881
            )
            
            —
            
            
            —
            
            
            (1,881
            )Balance
                at December 31, 2004
            
            $
            3,340
            
            $
            22,037
            
            $
            5,763
            
            $
            189
            
            $
            —
            
            $
            31,329Net
                income
            
            
            —
            
            
            —
            
            
            5,738
            
            
            —
            
            
            —
            
            
            5,738Unrealized
                loss on derivative instruments, net of deferred taxes of
                $20
            
            
            —
            
            
            —
            
            
            —
            
            
            (38
            )
            
            —
            
            
            (38
            )Change
                in unrealized gain on securities available for sale, net of deferred
                income taxes of $189
            
            
            —
            
            
            —
            
            
            —
            
            
            (370
            )
            
            —
            
            
            (370
            )Comprehensive
                income
            
            
            —
            
            
            —
            
            
            5,738
            
            
            (408
            )
            
            —
            
            
            5,330Common
                stock options exercised, 7,628 shares
            
            
            1
            
            
            11
            
            
            —
            
            
            —
            
            
            —
            
            
            12Tax
                benefit related to exercise of stock options
            
            
            -
            
            
            2
            
            
            —
            
            
            —
            
            
            —
            
            
            23%
                common stock dividend declared
            
            
            100
            
            
            2,251
            
            
            (2,355
            )
            
            —
            
            
            —
            
            
            (4
            )Common
                stock repurchased (5,500 shares at an average price of
                $21.70)
            
            
            (5
            )
            
            (113
            )
            
            —
            
            
            —
            
            
            —
            
            
            (118
            )Common
                stock cash dividends declared, $.64 per share
            
            
            —
            
            
            —
            
            
            (2,199
            )
            
            —
            
            
            —
            
            
            (2,199
            )Balance
                at December 31, 2005
            
            $
            3,436
            
            $
            24,188
            
            $
            6,947
            
            $
            (219
            )
            $
            —
            
            $
            34,352


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




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


**Consolidated
      Statements of Cash Flows**


Years
                Ended December 31,(In
                thousands)
            
            2005
            
            2004
            
            2003Cash
                flows from operating activitiesNet
                income
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Adjustments
                to reconcile net income to net cash provided by operating
                activitiesDepreciation
            
            
            388
            
            
            392
            
            
            457Amortization
            
            
            256
            
            
            523
            
            
            650Net
                amortization on investment securities
            
            
            423
            
            
            800
            
            
            979Deferred
                income taxes
            
            
            (83
            )
            
            (129
            )
            
            (125
            )Provision
                for loan losses
            
            
            397
            
            
            348
            
            
            444Net
                (gain) loss on sale of credit card portfolio, investment securities
                and
                property and equipment
            
            
            (124
            )
            
            (150
            )
            
            57Net
                change in:Loans
                held for sale
            
            
            (308
            )
            
            172
            
            
            431Deferred
                loan fees, net
            
            
            (103
            )
            
            (29
            )
            
            26Accrued
                income and other assets
            
            
            (1,341
            )
            
            (712
            )
            
            (876
            )Accrued
                expenses and other liabilities
            
            
            244
            
            
            527
            
            
            389Net
                cash provided by operating activities
            
            
            5,487
            
            
            6,649
            
            
            6,734Cash
                flows from investing activitiesNet
                loans made to customers
            
            
            (36,808
            )
            
            (36,581
            )
            
            (31,895
            )Proceeds
                from sale of credit card portfolio
            
            
            863
            
            
            —
            
            
            —Acquisition
                of premises and equipment and computer software
            
            
            (1,478
            )
            
            (1,033
            )
            
            (295
            )Purchase
                of investment securities available for sale
            
            
            (53,993
            )
            
            (56,511
            )
            
            (79,253
            )Proceeds
                from sales and maturities of investment securities available for
                sale
            
            
            46,642
            
            
            65,658
            
            
            70,691Proceeds
                from sale of other real estate owned
            
            
            —
            
            
            —
            
            
            153Net
                cash used by investing activities
            
            
            (44,774
            )
            
            (28,467
            )
            
            (40,599
            )Cash
                flows from financing activitiesNet
                increase in demand, savings and NOW deposits
            
            
            13,443
            
            
            28,728
            
            
            18,859Net
                increase in certificates of deposit
            
            
            18,189
            
            
            12,206
            
            
            1,132Net
                increase (decrease) in securities sold under agreements to
                repurchase
            
            
            2,048
            
            
            (3,876
            )
            
            1,126Net
                increase (decrease) in other borrowed funds
            
            
            4,172
            
            
            (9,553
            )
            
            1,881Long-term
                advances from the Federal Home Loan Bank
            
            
            10,000
            
            
            3,290
            
            
            10,000Payments
                on long-term advances
            
            
            (2,736
            )
            
            (5,597
            )
            
            (679
            )Dividends
                paid on common stock
            
            
            (2,115
            )
            
            (1,816
            )
            
            (1,511
            )Repurchase
                of common stock
            
            
            (118
            )
            
            (2,156
            )
            
            (1,218
            )Proceeds
                from stock issuance
            
            
            12
            
            
            66
            
            
            754Net
                cash provided by financing activities
            
            
            42,895
            
            
            21,292
            
            
            30,344Net
                increase (decrease) in cash and cash equivalents
            
            
            3,608
            
            
            (526
            )
            
            (3,521
            )Cash
                and cash equivalents, beginning of year
            
            
            10,220
            
            
            10,746
            
            
            14,267Cash
                and cash equivalents, end of year
            
            $
            13,828
            
            $
            10,220
            
            $
            10,746Supplemental
                disclosures of cash flow informationCash
                paid for interest
            
            $
            6,935
            
            $
            4,710
            
            $
            4,717Income
                tax paid
            
            
            3,028
            
            
            2,668
            
            
            1,999


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




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


**Notes
      to Consolidated Financial Statements**


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





**1.**
            **Summary
                of Significant Accounting
                Policies**





The
      accounting and reporting policies conform with U.S. generally accepted
      accounting principles and to general practice within the banking industry.
      Merrill Merchants Bancshares, Inc. (the “Company”) is a financial holding
      company that owns all of the common stock of Merrill Merchants Bank (the
“Bank”). The Company’s principal business activity is retail and commercial
      banking and trust and investment services which are provided through its eleven
      branch locations in eastern and central Maine. The Bank is under the supervision
      of the Board of Governors of the Federal Reserve System and the State of Maine
      Bureau of Financial Institutions, and its deposits are insured by the Federal
      Deposit Insurance Corporation (FDIC) to the fullest extent permitted by law.
      The
      following is a description of the more significant accounting and reporting
      policies.





***Estimates***





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





Material
      estimates that are particularly susceptible to significant change in the near
      term relate to the determination of the allowance for loan losses, mortgage
      servicing rights and the valuation of real estate acquired in connection with
      foreclosures or in satisfaction of loans. In connection with the determination
      of the allowance for loan losses and the carrying value of other real estate
      owned, management obtains independent appraisals for significant properties.
      In
      connection with the valuation of mortgage servicing rights, management obtains
      an independent third party valuation.





***Financial
      Statement Presentation***





The
      accompanying consolidated financial statements include the accounts of Merrill
      Merchants Bancshares, Inc. and its wholly-owned subsidiary, Merrill Merchants
      Bank, a state-chartered bank. All intercompany accounts and transactions have
      been eliminated in the consolidated financial statements. The Company accounts
      for its unconsolidated partially-owned entity on the equity method of
      accounting.





Statement
      of Financial Accounting Standards (SFAS) No. 131, “Disclosures about Segments of
      an Enterprise and Related Information,” requires a company to disclose certain
      income statement and balance sheet information by operating segment. Since
      the
      Company’s operations include only its banking and financing activities, no
      additional disclosure standards are required by the Statement.





***Investment
      Securities***





Investment
      debt securities are classified as available for sale and are carried at fair
      value. Unrealized gains and losses on securities available for sale, net of
      income taxes, are recognized as direct increases or decreases in shareholders'
      equity. Market values of securities are obtained from independent market
      sources. Cost of securities sold is recognized using the specific identification
      method.





Premiums
      are amortized and discounts are accreted using methods approximating the
      interest method.




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***Loans
      Held for Sale***





Residential
      mortgage loans originated and intended for sale in the secondary market are
      carried at the lower of aggregate cost or estimated market value. Gains or
      losses on sales of loans are recognized at the time of sale and are based upon
      the difference between the selling price and the carrying amount of loans
      sold.





***Other
      Real Estate Owned***





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





***Loans
      Receivable***





Loans
      receivable that management has the intent and ability to hold for the
      foreseeable future or until maturity or pay-off are reported at their
      outstanding principal adjusted for any charge-offs, the allowance for loan
      losses, and any deferred fees or costs.




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





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




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




Commercial
      real estate and commercial business loans are considered impaired when it is
      probable that the Company will not be able to collect all amounts due according
      to the contractual terms of the loan agreement. Factors considered by management
      in determining impairment include payment status and collateral value. Loans
      considered to be impaired are reduced to the present value of expected future
      cash flows or to the fair value of collateral.  Management takes into
      consideration impaired loans in determining the appropriate level of allowance
      for loan losses.




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***Loan
      Servicing***





The
      cost
      of mortgage servicing rights is amortized in proportion to, and over the period
      of, estimated net servicing revenues. Impairment of mortgage servicing rights
      is
      assessed based on the fair value of those rights. Fair values are estimated
      using discounted cash flows based on a current market interest rate. For
      purposes of measuring impairment, the rights are stratified based on loan type,
      investor type, and interest rate. The amount of impairment recognized is the
      amount by which the capitalized mortgage servicing rights for a stratum exceed
      their fair value.





***Properties
      and Equipment***





Properties
      and equipment are stated at cost, less accumulated depreciation. The provision
      for depreciation is computed on the straight-line method and by accelerated
      methods over the estimated useful lives of the assets.





***Goodwill***





Effective
      January 1, 2002, the Company discontinued amortization of goodwill in accordance
      with SFAS Nos. 142, “Goodwill and Other Intangible Assets,” and 147,
“Acquisitions of Certain Financial Institutions.” Prior to 2002, goodwill was
      being amortized using the straight-line method over seven and fifteen years.
      In
      accordance with SFAS No. 142, goodwill will be reviewed for impairment on an
      annual basis and if certain conditions occur.





***Income
      Taxes***





The
      Company records deferred tax assets and liabilities for future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      assets and liabilities and their respective tax bases. Deferred tax assets
      and
      liabilities are measured using enacted tax rates expected to apply to taxable
      income in the years in which those temporary differences are expected to be
      recovered or settled.





***Off-Balance
      Sheet Financial Instruments***





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





***Derivative
      Financial Instruments***





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





Changes
      in fair value of a derivative that is highly effective and that qualifies as
      a
      cash flow hedge are recorded in other comprehensive income and are reclassified
      into earnings when the related forecasted transaction affects earnings. For
      fair
      value hedges that are fully effective, the gain or loss on the hedge would
      exactly offset the loss or gain on the hedged item attributable to the hedged
      risk. Any difference that does arise would be the result of hedge
      ineffectiveness, which is recognized in earnings. The Company discontinues
      hedge
      accounting when it is determined that the derivative is no longer highly
      effective in offsetting changes in the hedged risk of the hedge item, because
      it
      is unlikely that the forecasted transaction will occur, or management determines
      that the designation of the derivative as a hedging instrument is no longer
      appropriate.




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***Cash
      and Cash Equivalents***





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





***Advertising***





Advertising
      is expensed as incurred.





***Earnings
      Per Share***





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





The
      Company declared a 3% stock dividend in 2005, 2004 and 2003. Earnings and cash
      dividends per share and weighted-average shares outstanding have been
      retroactively restated to reflect the stock dividends.





***Impact
      of Recently Issued Accounting Standards***





The
      Financial Accounting Standards Board (FASB) has issued SFAS No. 123 (revised
      2004) (SFAS No. 123(R)), “Share-Based Payment.” SFAS No. 123(R) will, with
      certain exceptions, require entities that grant stock options and shares to
      employees to recognize the fair value of those options and shares as
      compensation cost over the service (vesting) period in their financial
      statements. The measurement of that cost will be based on the fair value of
      the
      equity or liability instruments issued.





SFAS
      No. 123(R) will be effective for the Company’s quarterly interim financial
      reporting period ending March 31, 2006. Management expects adoption of SFAS
      No.
      123(R) will not have a material effect on the Company’s consolidated financial
      statements.





In
      May
      2005 the FASB issued Statement of Financial Accounting Standards (SFAS) No.
      154, *Accounting
      Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB
      Statement No. 3,* which
      changes the requirements for the accounting for and reporting of a change in
      accounting principle. This Statement applies to all voluntary changes in
      accounting principle. It also applies to changes required by an accounting
      pronouncement in the unusual instance that the pronouncement does not include
      specific transition provisions. When a pronouncement includes specific
      transition provisions, those provisions should be followed. SFAS No. 154 is
      effective for accounting changes and corrections of errors made in fiscal years
      beginning after December 15, 2005. The Company will adopt this Statement, as
      applicable. Management expects this Statement will not have a material effect
      on
      the financial condition and results of operations of the Company.





FASB
      Staff Position (FSP) FAS 115-1, *The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments* ,
      was
      issued on November 3, 2005. This FSP addresses the determination as to when
      an
      investment is considered impaired, whether that impairment is other than
      temporary, and the measurement of an impairment loss. This FSP also includes
      accounting considerations subsequent to the recognition of an
      other-than-temporary impairment and requires certain disclosures about
      unrealized losses that have not been recognized as other-than-temporary
      impairments. Guidance in the FSP shall be applied to reporting periods beginning
      after December 15, 2005 with earlier application permitted. Management expects
      that application of this FSP will not have a material effect on the consolidated
      financial condition and results of operations of the Company.




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***Reclassifications***





Certain
      amounts in previously issued financial statements have been reclassified in
      the
      currently presented financial statements.





**2.**
            **Cash
                and Cash Equivalents**





The
      Federal Reserve Board requires the Bank to maintain a rolling average
      compensating balance of $400 in amounts on deposit. The Company maintains its
      cash in bank deposit accounts which, at times, may exceed federally insured
      limits. The Company has not experienced any losses in such accounts. The Company
      believes it is not exposed to any significant risk with respect to these
      accounts.





**3.**
            **Investment
                Securities Available for
                Sale**





The
      amortized cost of investment securities as shown in the consolidated statements
      of financial condition and their approximate fair values at December 31,
      2005 and 2004 follow:





**Amortized**
            
            **Unrealized**
            
            **Unrealized**
            
            **Fair****Cost**
            
            **Gains**
            
            **Losses**
            
            **Value****December
                31, 2005**Collateralized
                mortgage obligations
            
            $
            39,386
            
            $
            —
            
            $
            (628
            )
            $
            38,758U.S.
                Government agencies and corporations
            
            
            16,417
            
            
            —
            
            
            (168
            )
            
            16,249Mortgage-backed
                securities
            
            
            4,354
            
            
            5
            
            
            (104
            )
            
            4,255U.S.
                Government and agency money market funds
            
            
            1,050
            
            
            —
            
            
            —
            
            
            1,050Certificates
                of deposit
            
            
            4,827
            
            
            —
            
            
            —
            
            
            4,827State
                and local government debt securities
            
            
            2,933
            
            
            —
            
            
            —
            
            
            2,933Total
                debt securities
            
            
            68,967
            
            
            5
            
            
            (900
            )
            
            68,072Equity
                securities
            
            
            3,774
            
            
            643
            
            
            —
            
            
            4,417Total
                securities available for sale
            
            $
            72,741
            
            $
            648
            
            $
            (900
            )
            $
            72,489





**Amortized**
            
            **Unrealized**
            
            **Unrealized**
            
            **Fair****Cost**
            
            **Gains**
            
            **Losses**
            
            **Value****December
                31, 2004**Collateralized
                mortgage obligations
            
            $
            43,553
            
            $
            30
            
            $
            (315
            )
            $
            43,268U.S.
                Government agencies and corporations
            
            
            10,297
            
            
            18
            
            
            (34
            )
            
            10,281Mortgage-backed
                securities
            
            
            3,982
            
            
            38
            
            
            (40
            )
            
            3,980U.S.
                Government and agency money market funds
            
            
            480
            
            
            —
            
            
            —
            
            
            480Certificates
                of deposit
            
            
            1,346
            
            
            —
            
            
            —
            
            
            1,346State
                and local government debt securities
            
            
            2,311
            
            
            —
            
            
            —
            
            
            2,311Total
                debt securities
            
            
            61,969
            
            
            86
            
            
            (389
            )
            
            61,666Equity
                securities
            
            
            3,825
            
            
            608
            
            
            —
            
            
            4,433Total
                securities available for sale
            
            $
            65,794
            
            $
            694
            
            $
            (389
            )
            $
            66,099





Included
      in equity securities are the Company’s investments in Federal Home Loan Bank and
      Federal Reserve Bank stock, carried at their cost basis of $2,493. Management
      has determined that these investments are not impaired at December 31, 2005
      and
      2004.





During
      2005, 2004 and 2003, the Company sold investment securities available for sale
      for total proceeds of $70, $352 and $4,069, respectively. The sales resulted
      in
      gross realized gains of $19 and $155 for 2005 and 2004, respectively, and gross
      realized losses of $51 for 2003.




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          to Table of Contents**





The
      amortized cost and fair value of debt securities at December 31, 2005 by
      contractual maturity are shown below. Expected maturities may differ from
      contractual maturities because borrowers may have the right to call or prepay
      obligations with or without call or prepayment penalties. Mortgage-backed
      securities and collateralized mortgage obligations are allocated among the
      above
      maturity groupings based on their final maturity dates.




**Amortized**
            
            **Fair****Cost**
            
            **Value**Due
                in one year or less
            
            $
            11,252
            
            $
            11,185Due
                from one to five years
            
            
            15,595
            
            
            15,460Due
                from five to ten years
            
            
            21,081
            
            
            20,704Due
                after ten years
            
            
            21,039
            
            
            20,723Total
                debt securities
            
            $
            68,967
            
            $
            68,072





Management
      reviews securities with unrealized losses for other than temporary impairment.
      At the present time, there have been no material changes in the credit quality
      of these securities. The unrealized losses on the Company’s investments were
      caused by interest rate increases. Because the Company has the ability and
      intent to hold these investments until a recovery of their amortized cost,
      which
      may be at maturity, the Company does not consider these investments to be
      other-than-temporarily impaired at December 31, 2005. Information regarding
      securities temporarily impaired is summarized below:





**Less
                than 1 year**
            
            **More
                than 1 year**
            
            **Total****Fair**
            
            **Unrealized**
            
            **Fair**
            
            **Unrealized**
            
            **Fair**
            
            **Unrealized****Value**
            
            **Losses**
            
            **Value**
            
            **Losses**
            
            **Value**
            
            **Losses****December
                31, 2005**Collateralized
                mortgage obligations
            
            $
            17,715
            
            $
            (236
            )
            $
            20,317
            
            $
            (392
            )
            $
            38,032
            
            $
            (628
            )U.S.
                Government agencies and corporations
            
            
            10,263
            
            
            (95
            )
            
            5,985
            
            
            (73
            )
            
            16,248
            
            
            (168
            )Mortgage-backed
                securities
            
            
            1,448
            
            
            (28
            )
            
            1,726
            
            
            (76
            )
            
            3,174
            
            
            (104
            )$
            29,426
            
            $
            (359
            )
            $
            28,028
            
            $
            (541
            )
            $
            57,454
            
            $
            (900
            )





**Less
                than 1 year**
            
            **More
                than 1 year**
            
            **Total****Fair**
            
            **Unrealized**
            
            **Fair**
            
            **Unrealized**
            
            **Fair**
            
            **Unrealized****Value**
            
            **Losses**
            
            **Value**
            
            **Losses**
            
            **Value**
            
            **Losses****December
                31, 2004**Collateralized
                mortgage obligations
            
            $
            12,852
            
            $
            (105
            )
            $
            21,033
            
            $
            (210
            )
            $
            33,885
            
            $
            (315
            )U.S.
                Government agencies and corporations
            
            
            5,024
            
            
            (22
            )
            
            997
            
            
            (12
            )
            
            6,021
            
            
            (34
            )Mortgage-backed
                securities
            
            
            2,270
            
            
            (40
            )
            
            —
            
            
            —
            
            
            2,270
            
            
            (40
            )$
            20,146
            
            $
            (167
            )
            $
            22,030
            
            $
            (222
            )
            $
            42,176
            
            $
            (389
            )





**4.**
            **Derivative
                Financial Instruments**





The
      Company has interest rate swap agreements with notional amounts of $10,000
      at
      December 31, 2005. Under these agreements, the Company exchanges a variable
      rate
      asset for a fixed rate asset, thus protecting certain asset yields from falling
      interest rates. In accordance with SFAS No. 133, “Accounting for Derivative
      Instruments and Hedging Activities,” and related pronouncements, management
      designated these swaps as cash flow hedges and determined the hedging
      transaction to be 100% effective. Therefore, the changes in fair value of the
      swap agreements are recorded in other comprehensive income. As of December
      31,
      2005, the swaps represented a liability of $79, less tax of $27, which has
      been
      recorded as other comprehensive loss in the consolidated statements of changes
      in shareholders’ equity.




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The
      Company uses derivative instruments as partial hedges against large fluctuations
      in interest rates. The Company uses interest rate swap instruments to hedge
      against potentially lower yields on the variable prime rate loan category in
      a
      declining rate environment. If rates were to decline, resulting in reduced
      income on the adjustable rate loans, there would be an increased income flow
      from the interest rate swap.





On
      a
      quarterly basis, derivative instruments are reviewed as part of the
      asset/liability management process. Any derivatives are factored into the
      Company’s overall interest rate risk position. The Company regularly reviews the
      credit quality of the counterparty from which the instruments have been
      purchased. As of December 31, 2005, the Company had $10,000 (notional principal
      amount) in swap contracts in which the Company is hedging prime-based variable
      commercial loans to a fixed rate of 5.93%. The interest rate swap agreements
      mature in June 2006.




**5.**
            **Loans
                Receivable**





The
      components of loans receivable follow:


**2005**
            
            **2004**Real
                estate:Commercial
                real estate
            
            $
            108,553
            
            $
            96,956Residential
                real estate
            
            
            62,568
            
            
            60,314Construction
            
            
            15,345
            
            
            12,854Home
                equity
            
            
            41,469
            
            
            34,139Total
                real estate
            
            
            227,935
            
            
            204,263Commercial
            
            
            69,797
            
            
            60,111Consumer
            
            
            21,231
            
            
            18,715Plus
                (less) deferred loan costs (fees)
            
            
            2
            
            
            (101
            )Total
            
            $
            318,965
            
            $
            282,988





The
      Bank’s lending activities are conducted principally in eastern and central
      Maine.  The Bank grants single family and multi-family residential loans,
      commercial real estate loans, commercial loans, and a variety of consumer
      loans.  The Bank grants loans for the construction of residential homes,
      multi-family properties and commercial real estate properties.  In
      addition, the Bank provides indirect auto and recreational vehicle lending,
      as
      well as other types of loans, including personal unsecured, recreational
      vehicle, automobile, mobile home, and home equity loans. Most loans granted
      by
      the Bank are either collateralized by real estate and/or business assets or
      guaranteed by federal and local governmental authorities.  The ability and
      willingness of the single family residential and consumer borrowers to honor
      their repayment commitments is generally dependent on the level of overall
      economic activity within the borrowers’ geographic areas and real estate
      values.  The ability and willingness of commercial real estate, commercial
      and construction loan borrowers to honor their repayment commitments is
      generally dependent on the health of the real estate economic sector in the
      borrowers’ geographic areas and the general economy.




As
      of
      December 31, 2005 and 2004, non-accrual loans were $378 and $1,571,
      respectively. Interest foregone was $11, $47, and $24 for 2005, 2004 and 2003,
      respectively. Accruing loans which are 90 days past due or more totaled $4
      at
      December 31, 2004.





Impaired
      loans are commercial and commercial real estate loans which the Company believes
      will probably not result in the collection of all amounts due according to
      the
      contractual terms of the loan agreement. The definition of “impaired loans” is
      not the same as the definition of “non-accrual loans,” although the two
      categories overlap. All commercial and commercial real estate impaired loans
      are
      non-accrual loans, but not all non-accrual loans are considered impaired
      loans.




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The
      following table sets forth information on impaired loans:





**2005**
            
            **2004**
            
            **2003**Impaired
                loansValuation
                allowance required
            
            $
            208
            
            $
            —
            
            $
            222No
                valuation allowance required
            
            
            —
            
            
            5
            
            
            77Total
                impaired loans
            
            $
            208
            
            $
            5
            
            $
            299Average
                balance of impaired loans during the year
            
            $
            89
            
            $
            256
            
            $
            687Portion
                of allowance for loan losses allocated to the impaired loan
                balance
            
            
            112
            
            
            1
            
            
            60





Interest
      income recognized for cash payments on impaired loans during 2005, 2004 and
      2003
      was not material to the consolidated financial statements.





The
      Bank
      has entered into loan transactions with its directors, executive officers,
      significant shareholders of the Company and their affiliates (related parties).
      Such transactions were made in the ordinary course of business on substantially
      the same terms and conditions, including interest rates and collateral, as
      those
      prevailing at the same time for comparable transac-tions with other customers,
      and did not, in the opinion of management, involve more than normal credit
      risk
      or present other unfavorable features. Loans to related parties
      follows:




**2005**
            
            **2004**
            
            **2003**Balance,
                January 1
            
            $
            15,852
            
            $
            14,500
            
            $
            12,656Loans
                made/advanced and additions
            
            
            5,769
            
            
            6,533
            
            
            8,723Repayments
                and reductions
            
            
            (9,007
            )
            
            (5,181
            )
            
            (6,879
            )Balance,
                December 31
            
            $
            12,614
            
            $
            15,852
            
            $
            14,500





Commitments,
      as described in Note 14, to related parties totaled $3,256 and $1,254 at
      December 31, 2005 and 2004, respectively.





**6.**
            **Allowance
                for Loan Losses**





A
      summary
      of changes in the allowance for loan losses follows:





**2005**
            
            **2004**
            
            **2003**Balance
                at beginning of year
            
            $
            3,866
            
            $
            3,652
            
            $
            3,295Add:
                Provision for loan losses
            
            
            397
            
            
            348
            
            
            444Recoveries
                of previous charge-offs
            
            
            49
            
            
            44
            
            
            33Less:
                Loans charged off
            
            
            (226
            )
            
            (178
            )
            
            (120
            )Balance
                at end of year
            
            $
            4,086
            
            $
            3,866
            
            $
            3,652





**7.**
            **Mortgage
                Servicing**





Residential
      real estate mortgages are originated by the Company both for portfolio and
      for
      sale into the secondary market. The sale of loans is to institutional investors
      such as the Federal National Mortgage Association. Under loan sale and servicing
      agreements with the investor, the Company generally continues to service the
      residential real estate mortgages. The Company pays the investor an agreed-upon
      rate on the loan, which is less than the interest rate the Company receives
      from
      the borrower. The Company retains the difference as a fee for servicing the
      residential real estate mortgages. As required by SFAS No. 140, the Company
      capitalizes the mortgage servicing rights at their fair value upon sale of
      the
      related loans.




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The
      following summarizes mortgage servicing rights capitalized and amortized, along
      with the activity in the related valuation allowance:


**2005**
            
            **2004**
            
            **2003**Balance
                of loans serviced for others
            
            $
            141,125
            
            $
            122,125
            
            $
            106,864Mortgage
                servicing rightsBalance
                at beginning of year
            
            $
            938
            
            $
            792
            
            $
            423Mortgage
                servicing rights capitalized
            
            
            422
            
            
            494
            
            
            869Amortization
                charged against mortgage servicing income
            
            
            (360
            )
            
            (355
            )
            
            (476
            )Valuation
                adjustment
            
            
            13
            
            
            7
            
            
            (24
            )Balance
                at end of year
            
            $
            1,013
            
            $
            938
            
            $
            792Valuation
                allowanceBalance
                at beginning of year
            
            $
            (17
            )
            $
            (24
            )
            $
            —Increase
                in impairment reserve
            
            
            (48
            )
            
            (15
            )
            
            (38
            )Reduction
                of impairment reserve
            
            
            61
            
            
            22
            
            
            14Balance
                at end of year
            
            $
            (4
            )
            $
            (17
            )
            $
            (24
            )





Mortgage
      loans serviced for others are not included in the accompanying consolidated
      statements of financial condition of the Company.





**8.**
            **Properties
                and Equipment**





A
      summary
      of properties and equipment follows:


**2005**
            
            **2004**Land
                and land improvements
            
            $
            559
            
            $
            559Bank
                premises
            
            
            2,893
            
            
            2,347Construction
                in progress
            
            
            1,267
            
            
            687Furniture
                and equipment
            
            
            2,982
            
            
            3,221Leasehold
                improvements
            
            
            409
            
            
            400Total
                cost
            
            
            8,110
            
            
            7,214Less
                accumulated depreciation
            
            
            3,247
            
            
            3,364Net
                properties and equipment
            
            $
            4,863
            
            $
            3,850





Depreciation
      expense amounted to $388, $392 and $457 in 2005, 2004 and 2003,
      respectively.





In
      July
      2004, the Bank acquired a historic building located at 183 Main Street, Bangor,
      Maine. This property is adjacent to the Bank’s headquarters property at 201 Main
      Street. Construction is in progress to renovate the historic building and the
      $1,500 project is targeted for completion in March 2006.





Certain
      Bank facilities and equipment are leased under various operating leases. Rental
      expense was $334, $348 and $343 for 2005, 2004 and 2003, respectively. Future
      minimum rental commitments under non-cancelable leases at December 31, 2005
      follow:


2006
            
            $
            2882007
            
            
            2312008
            
            
            1732009
            
            
            1542010
            
            
            54Thereafter
            
            
            13$
            913






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**9.**
            **Investment
                in Partially-Owned Entity**





Merrill
      Merchants Bank has a 50% ownership interest in M&M Consulting Limited
      Liability Company (“M&M”). M&M provides loan review, regulatory
      compliance, training and internal auditing to financial institutions. The
      Company’s investment in M&M as of December 31, 2005 and 2004 totaled $502
      and $315, respectively. Income recognized from such investment for the years
      ended 2005, 2004 and 2003 totaled $187, $158 and $150, respectively, and is
      included in other income.




**10.**
            **Employee
                Benefit Plans**





The
      Company has established a defined contribution pension plan under Section 401(k)
      of the Internal Revenue Code. Plan participants, who consist of all employees
      meeting minimum age and service requirements who elect to participate, are
      permitted to contribute a percentage of their wages to the plan on a pre-tax
      basis. The Company matches a portion of each employee’s contribution, resulting
      in an expense of $149, $134 and $114 for 2005, 2004 and 2003, respectively.





The
      Company adopted a nonqualified supplemental executive retirement plan for the
      benefit of key employees. Life insurance policies were acquired to generate
      income to offset the cost of the plan. The amount of each annual benefit is
      indexed to the financial performance of each insurance policy owned by the
      Bank
      over the Bank’s cost of funds expense. The present value of these benefits is
      being expensed over the employment service period which amounted to $277, $247
      and $187 for 2005, 2004 and 2003, respectively. The cash value of these policies
      was $4,018 and $3,854 at December 31, 2005 and 2004, respectively.





**11.**
            **Deposits**





The
      aggregate amount of certificates of deposit with a minimum denomination of
      $100
      was $62,310 and $55,677 at December 31, 2005 and 2004, respectively.
      Certificates of deposit included brokered deposits in the amount of $47,762
      and
      $39,114 at December 31, 2005 and 2004, respectively.





At
      December 31, 2005, the scheduled maturities of certificates of deposit
      follow:


2005
            
            $
            53,6062006
            
            
            41,2332007
            
            
            9,8942008
            
            
            13,1572009
            
            
            5,384Thereafter
            
            
            138$
            123,412





**12.**
            **Borrowed
                Funds**





Borrowed
      funds consists of advances from the Federal Home Loan Bank (FHLB), commercial
      bank line of credit advances, Treasury, tax and loan notes and securities sold
      under agreements to repurchase with municipal, nonprofit and commercial
      customers.




Short-
      and long-term borrowings from the FHLB consist of fixed rate borrowings and
      are
      collateralized by all stock in the FHLB and a blanket lien on qualified
      collateral consisting primarily of loans with first mortgages secured by
      one-to-four family properties and other qualified assets. The Company, through
      its banking subsidiary, has an available line of credit with the FHLB of
      $3,509.




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A
      summary
      of long-term borrowings from the Federal Home Loan Bank follows:




**December
                31, 2005**
            
            **December
                31, 2004****Maturity**
            
            **Principal**
            
            
            
            **Maturity**
            
            **Principal****Dates**
            
            **Amounts**
            
            **Interest
                Rates**
            
            **Dates**
            
            **Amounts**
            
            **Interest
                Rates**2006
            
            $
            3,181
            
            
            3.38%
                - 6.47
            %
            
            2005
            
            $
            2,594
            
            
            3.38%
                - 7.34
            %2007
            
            
            4,795
            
            
            2.31%
                - 6.47
            %
            
            2006
            
            
            2,929
            
            
            2.31%
                - 6.47
            %2008
            
            
            6,218
            
            
            3.02%
                - 4.37
            %
            
            2007
            
            
            4,532
            
            
            3.02%
                - 6.47
            %2009
            
            
            1,056
            
            
            3.38%
                - 4.37
            %
            
            2008
            
            
            3,943
            
            
            3.38%
                - 3.82
            %2010
            
            
            6,095
            
            
            3.38%
                - 4.37
            %
            
            2009
            
            
            769
            
            
            3.38
            %Thereafter
            
            
            1,589
            
            
            3.38%
                - 4.37
            %
            
            Thereafter
            
            
            903
            
            
            3.38
            %$
            22,934
            
            
            
            
            
            
            
            $
            15,670





At
      December 31, 2005 and 2004, investment securities with amortized cost of $62,651
      and $55,575 and fair value of $61,755 and $54,986, respectively, were pledged
      to
      secure public deposits, Treasury, tax and loan deposits, securities sold under
      agreements to repurchase and borrowings and for other purposes required or
      permitted by law. Balances outstanding at December 31 are shown in the table
      below:





**2005**
            
            **2004**Securities
                sold under agreements to repurchase
            
            $
            18,534
            
            $
            16,486FHLB
                overnight borrowings
            
            
            3,500
            
            
            —Treasury,
                tax and loan deposits
            
            
            2,040
            
            
            1,168Federal
                funds purchased
            
            
            —
            
            
            200$
            24,074
            
            $
            17,854Average
                balance outstanding
            
            $
            19,851
            
            $
            22,820Weighted
                average interest rate at end of the year
            
            
            2.49
            %
            
            1.12
            %





At
      December 31, 2005, the Company had a $5,000 commercial bank line of credit
      that
      expires in 2006. The floating rate note is based on the one month London
      Interbank Offer Rate (4.40% at December 31, 2005) plus 1.75%.





**13.**
            **Income
                Taxes**





The
      current and deferred components of income tax expense follow:


**2005**
            
            **2004**
            
            **2003**CurrentFederal
            
            $
            2,892
            
            $
            2,530
            
            $
            2,249State
            
            
            85
            
            
            80
            
            
            722,977
            
            
            2,610
            
            
            2,321DeferredFederal
            
            
            (83
            )
            
            (129
            )
            
            (125
            )$
            2,894
            
            $
            2,481
            
            $
            2,196





The
      following table reconciles the expected federal income tax expense (computed
      by
      applying the federal statutory tax rate to income before taxes) to recorded
      income tax expense:





**2005**
            
            **2004**
            
            **2003**Computed
                federal tax expense
            
            $
            2,935
            
            $
            2,512
            
            $
            2,210State
                franchise tax, net of federal benefits
            
            
            56
            
            
            53
            
            
            48Benefit
                of tax-exempt income
            
            
            (34
            )
            
            (36
            )
            
            (47
            )Increase
                in cash surrender value of life insurance
            
            
            (56
            )
            
            (43
            )
            
            (40
            )Other,
                net
            
            
            (7
            )
            
            (5
            )
            
            25Recorded
                income tax expense
            
            $
            2,894
            
            $
            2,481
            
            $
            2,196






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The
      tax
      effects of temporary differences that give rise to deferred income tax assets
      and liabilities follow:


**2005**
            
            **2004**Deferred
                income tax assetsAllowance
                for loan losses
            
            $
            1,165
            
            $
            1,107Accrued
                post-retirement benefits
            
            
            369
            
            
            382Unrealized
                loss on securities available for sale
            
            
            86
            
            
            —Other
            
            
            237
            
            
            146Total
                gross deferred income tax assets
            
            
            1,857
            
            
            1,635Deferred
                income tax liabilitiesMortgage
                servicing rights
            
            
            344
            
            
            319Depreciation
                and amortization
            
            
            141
            
            
            133Unrealized
                gain on securities available for sale
            
            
            —
            
            
            104Total
                gross deferred income tax liabilities
            
            
            485
            
            
            556Net
                deferred income tax asset
            
            $
            1,372
            
            $
            1,079





Management
      expects the Company will realize all deferred income tax benefits to offset
      the
      income tax liabilities arising from the reversal of taxable temporary
      differences and taxable income generated in future years. Accordingly, the
      Company has not established a valuation allowance for deferred income tax
      benefits.





**14.**
            **Financial
                Instruments With Off-Balance Sheet
                Risk**





The
      Bank
      is a party to financial instruments with off-balance sheet risk in the normal
      course of business to meet the financing needs of its customers which involve,
      to varying degrees, elements of credit risk in excess of the amount recognized
      in the consolidated statements of financial condition. The Bank’s exposure to
      credit loss in the event of nonperformance by the other party to the financial
      instrument for commitments to extend credit is represented by the contractual
      notional amount of those instruments.





The
      Bank
      follows the same credit policies in making commitments and conditional
      obligations as it does for on-balance-sheet instruments, including requiring
      collateral or other security to support financial instruments with credit risk.
      Since many of the commitments are expected to expire without being drawn upon,
      the total amount does not necessarily represent future cash requirements. The
      Company has not incurred any losses on its commitments in 2005, 2004 or
      2003.




A
      summary
      of financial instruments with off-balance sheet risk at December 31, 2005 and
      2004 follows:


**2005**
            
            **2004**Commitments
                to extend credit
            
            $
            9,293
            
            $
            12,676Letters
                of credit
            
            
            1,392
            
            
            1,417Unadvanced
                commitmentsSecured
                by real estate
            
            
            38,680
            
            
            23,983Commercial
                lines of credit
            
            
            23,483
            
            
            23,759Consumer
                lines of credit
            
            
            1,700
            
            
            5,069Interest
                rate swaps (notional)
            
            
            10,000
            
            
            10,000





**15.**
            **Shareholders’
                Equity**





The
      Company distributed a 3% stock dividend in April of 2005, 2004 and 2003.
      Earnings per share for 2005, 2004 and 2003 have been restated to reflect these
      stock dividends.




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In
      June
      2004, the Board of Directors approved a fourth stock repurchase program
      authorizing the Company to repurchase up to 169,995, or 5%, of its outstanding
      shares of common stock. During 2005, the Company repurchased 5,500 shares at
      a
      total cost of $118. A total of 147,858 shares remain under this program at
      December 31, 2005.





A
      revision to the Maine Business Corporation Act requires that stock reacquired
      by
      a corporation be classified as "authorized but unissued,” effectively
      eliminating a company’s ability to hold stock in treasury. In order to recognize
      the effect of the revision, the Company effectively retired its treasury stock
      and reclassified the June 30, 2004 shareholders' equity balances to reflect
      the
      changes as follows:


Decreased
                common stock
            
            $
            80Decreased
                capital surplus
            
            
            1,839Eliminated
                treasury stock
            
            $
            1,919





**16.**
            **Earnings
                Per Share**





The
      following table sets forth the computation of basic and diluted earnings per
      share (in thousands, except for number of shares and per share
      data):


**2005**
            
            **2004**
            
            **2003****Basic
                earnings per share**Net
                income, as reported
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Weighted-average
                shares outstanding
            
            
            3,437,205
            
            
            3,472,281
            
            
            3,507,018Basic
                earnings per share
            
            $
            1.67
            
            $
            1.41
            
            $
            1.23**Diluted
                earnings per share**Net
                income, as reported
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Weighted-average
                shares outstanding
            
            
            3,437,205
            
            
            3,472,281
            
            
            3,507,018Effect
                of stock options, net of assumed stock purchases
            
            
            28,601
            
            
            29,416
            
            
            21,656Adjusted
                weighted-average shares outstanding
            
            
            3,465,806
            
            
            3,501,697
            
            
            3,528,674Diluted
                earnings per share
            
            $
            1.66
            
            $
            1.40
            
            $
            1.22





**17.**
            **Regulatory
                Matters**





The
      Company and Bank are subject to various regulatory capital requirements
      administered by the federal banking agencies. Failure to meet minimum capital
      requirements can initiate certain mandatory - and possibly additional
      discretionary - actions by regulators that, if undertaken, could have a direct
      material effect on the Company and Bank’s consolidated financial statements.
      Under capital adequacy guidelines and the regulatory framework for prompt
      corrective action, the Company and Bank must meet specific capital guidelines
      that involve quantitative measures of the Company’s and Bank’s assets,
      liabilities and certain off-balance sheet items as calculated under regulatory
      accounting practices. The Company’s and Bank’s capital amounts and
      classification are also subject to qualitative judgments by the regulators
      about
      components, risk weightings, and other factors.




Quantitative
      measures established by regulation to ensure capital adequacy require the
      Company and Bank to maintain minimum amounts and ratios (set forth in the table
      on the next page) of total and Tier I capital (as defined in the regulations)
      to
      risk-weighted assets (as defined), and of Tier I capital (as defined) to average
      assets (as defined). Management believes as of December 31, 2005 that the
      Company and Bank meet all capital adequacy requirements to which they are
      subject.




As
      of
      December 31, 2005, the most recent notification from the Federal Reserve
      Bank categorized the Bank as well capitalized under the regulatory framework
      for
      prompt corrective action. To be categorized “well capitalized,” the Bank must
      maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
      as set forth in the table. There are no conditions or events since that
      notification that management believes have changed this category.




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The
      following table summarizes the Company’s and Bank’s actual and minimum capital
      amounts and ratios at December 31, 2005 and 2004. No deduction was made from
      capital for interest-rate risk in 2005 and 2004.


**To
                be well****capitalized
                under****For
                capital**
            
            **prompt
              corrective****Actual**
            
            **adequacy
                purposes**
            
            **action
                provisions****Amount**
            
            **Ratio**
            
            **Amount**
            
            **Ratio**
            
            **Amount**
            
            **Ratio****As
                of December 31, 2005**Total
                capital (to risk-weighted assets)Consolidated
            
            $
            38,188
            
            
            12.40
            %
            $
            24,629
            
            
            8.00
            %
            
            N/ABank
            
            
            36,008
            
            
            11.76
            
            
            24,486
            
            
            8.00
            
            $
            30,608
            
            
            10.00
            %Tier
                1 capital (to risk-weighted assets)Consolidated
            
            
            34,048
            
            
            11.06
            
            
            12,314
            
            
            4.00
            
            
            N/ABank
            
            
            32,179
            
            
            10.51
            
            
            12,243
            
            
            4.00
            
            
            18,365
            
            
            6.00Tier
                1 capital ratio (to average assets)Consolidated
            
            
            34,048
            
            
            8.31
            
            
            16,396
            
            
            4.00
            
            
            N/ABank
            
            
            32,179
            
            
            7.88
            
            
            12,257
            
            
            3.00
            
            
            20,429
            
            
            5.00**As
                of December 31, 2004**Total
                capital (to risk-weighted assets)Consolidated
            
            $
            33,867
            
            
            13.09
            %
            $
            20,706
            
            
            8.00
            %
            
            N/ABank
            
            
            32,447
            
            
            12.60
            
            
            20,597
            
            
            8.00
            
            $
            25,746
            
            
            10.00
            %Tier
                1 capital (to risk-weighted assets)Consolidated
            
            
            30,624
            
            
            11.83
            
            
            10,353
            
            
            4.00
            
            
            N/ABank
            
            
            29,221
            
            
            11.35
            
            
            10,298
            
            
            4.00
            
            
            15,447
            
            
            6.00Tier
                1 capital ratio (to average assets)Consolidated
            
            
            30,624
            
            
            8.26
            
            
            14,824
            
            
            4.00
            
            
            N/ABank
            
            
            29,221
            
            
            7.91
            
            
            11,079
            
            
            3.00
            
            
            18,465
            
            
            5.00





**18.**
            **Stock
                Options**





Under
      the
      Employee and Director Stock Option Plan, the incentive stock option plan for
      officers and employees and the nonstatutory stock option plan for directors
      provide for the issuance of up to 763,314 shares of common stock.  The
      purchase price of the stock covered by each option shall be its fair market
      value, which must be equal to at least 100% of the book value of common stock,
      on the date such option is granted. Options granted are subject to an initial
      vesting period of one, two or three years, after which options become
      exercisable until ten years from the grant date.




The
      Company accounts for these options in accordance with Accounting Principles
      Board Opinion No. 25, “Accounting for Stock Issued to Employees.”  As the
      exercise price of each option equals the market price of the Company’s stock on
      the date of grant, no compensation cost has been recognized for the plan. 
Had compensation cost for the plan been determined based on the fair value
      of
      the options at the grant dates consistent with the method described in SFAS
      No.
      123, “Accounting for Stock-Based Compensation,” the Company’s 2005, 2004 and
      2003 net income and earnings per share would have been reduced to the proforma
      amounts indicated below.


**Year
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Net
                income, as reported
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of deferred income
                taxes
            
            
            (21
            )
            
            (23
            )
            
            (28
            )Proforma
                net income
            
            $
            5,717
            
            $
            4,884
            
            $
            4,274






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**Year
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Earnings
                per share:Basic
                - as reported
            
            $
            1.67
            
            $
            1.41
            
            $
            1.23Basic
                - proforma
            
            $
            1.66
            
            $
            1.40
            
            $
            1.22Diluted
                - as reported
            
            $
            1.66
            
            $
            1.40
            
            $
            1.22Diluted
                - proforma
            
            $
            1.65
            
            $
            1.39
            
            $
            1.21





The
      fair
      value of each option is estimated on the date of grant using the Black-Scholes
      option-pricing model with the following weighted-average assumptions used for
      all grants in 2003: dividend yield of 2.93%, expected volatility of 19%,
      risk-free interest rate of 4.4%, and expected lives of three years. There were
      no options granted in 2005 and 2004.





A
      summary
      of the status of the stock option plan as of December 31, 2005, 2004 and 2003,
      and changes during the years then ended, is presented below.


**2005**
            
            **2004**
            
            **2003****Weighted**
            
            
            
            **Weighted**
            
            
            
            **Weighted****Number**
            
            **Average**
            
            **Number**
            
            **Average**
            
            **Number**
            
            **Average****of**
            
            **Exercise**
            
            **of**
            
            **Exercise**
            
            **of**
            
            **Exercise****Shares**
            
            **Price**
            
            **Shares**
            
            **Price**
            
            **Shares**
            
            **Price**Outstanding
                at beginning of year
            
            
            60,086
            
            $
            12.13
            
            
            75,107
            
            $
            12.60
            
            
            279,333
            
            $
            7.32Granted
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            3,000
            
            
            15.50Exercised
            
            
            (1,005
            )
            
            12.22
            
            
            (7,277
            )
            
            9.86
            
            
            (186,142
            )
            
            5.01Forfeited
            
            
            (3,064
            )
            
            13.88
            
            
            (9,859
            )
            
            15.08
            
            
            (26,654
            )
            
            7.92Additional
                shares for which options are exercisable due to stock
                dividends
            
            
            1,799
            
            
            —
            
            
            2,115
            
            
            —
            
            
            5,570
            
            
            —Outstanding
                at end of year
            
            
            57,816
            
            $
            11.67
            
            
            60,086
            
            $
            12.13
            
            
            75,107
            
            $
            12.60Options
                exercisable at year end
            
            
            54,539
            
            $
            11.52
            
            
            29,441
            
            $
            9.29
            
            
            30,028
            
            $
            8.93Weighted-average
                fair value of options granted during the year
            
            
            
            
            $
            —
            
            
            
            
            $
            —
            
            
            
            
            $
            2.13




The
      following information applies to options outstanding at December 31,
      2005:


Options
                Outstanding
            
            Options
                ExercisableWtd.
                Avg.Number
            
            Remaining
            
            Wtd.
                Avg.
            
            Number
            
            Wtd.
                Avg.of
            
            Contractual
            
            Exercise
            
            of
            
            ExerciseRange
                of Exercise Prices
            
            Shares
            
            Life
            
            Price
            
            Shares
            
            Price$
                7.55 - $ 9.33
            
            
            25,403
            
            
            4.3
            
            $
            8.40
            
            
            25,403
            
            $
            8.40$12.51
                - $14.46
            
            
            32,413
            
            
            6.9
            
            
            14.22
            
            
            29,136
            
            
            14.23






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**19.**
            **Fair
                Value of Financial
                Instruments**





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





*Cash
      and Cash Equivalents.* The
      fair
      value of cash and due from banks and interest-bearing deposits with banks
      approximates their relative book values, as these financial instruments have
      short maturities.





*Investment
      Securities.* The
      fair
      values of investment securities are estimated based on bid prices published
      in
      financial newspapers or bid quotations received from securities
      dealers.





*Loans
      Held for Sale.* The fair
      values of loans held for sale are based on quoted market prices from the Federal
      National Mortgage Association.





*Loans
      Receivable.* Fair
      values are estimated for portfolios of loans receivable with similar financial
      characteristics. The fair values approximate carrying value for all loans with
      variable interest rates.





The
      fair
      values of fixed rate loans are calculated by discounting scheduled cash flows
      through the estimated maturity using estimated market discount rates that
      reflect the risk inherent in the loan. The estimates of maturity are based
      on
      the Bank’s historical experience with repayments for each loan classification,
      modified, as required, by an estimate of the effect of current economic and
      lending conditions, and the effects of estimated prepayments.




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





*Cash
      Surrender Value of Life Insurance.* The fair
      value is based on the actual cash surrender value of life insurance
      policies.





*Accrued
      Interest Receivable.* The
      fair
      value approximates the carrying value as this financial instrument has a short
      maturity. It is the Bank’s policy to stop accruing interest on loans for which
      it is probable that the interest is not collectible. Therefore, the fair value
      of this financial instrument has been adjusted to reflect credit
      risk.





*Capitalized
      Mortgage Servicing Rights.* The
      fair
      value of mortgage servicing rights is based on the expected present value of
      future mortgage servicing income, net of estimated servicing costs, considering
      market consensus loan prepayment predictions.





*Deposits.* The
      fair
      value of deposits with no stated maturity, such as noninterest-bearing demand
      deposits, savings, NOW accounts and money market accounts, is equal to the
      amount payable on demand. The fair value of certificates of deposit is based
      on
      the discounted value of contractual cash flows. The discount rate is estimated
      using the rates currently offered for deposits of similar remaining
      maturities.





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





*Borrowed
      Funds.* The
      fair
      value of borrowed funds is based on the discounted value of contractual cash
      flows. The discount rate is estimated using the rates currently available for
      borrowings of similar remaining maturities.




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*Accrued
      Interest Payable.* The
      fair
      value approximates the book value as this financial instrument has a short
      maturity.





*Off-Balance
      Sheet Instruments.*  The
      Company’s off-balance sheet instruments consist of loan commitments and
      derivative financial instruments. Fair values for loan commitments have not
      been
      presented as the future revenue derived from such financial instruments is
      not
      significant. The fair values of interest rate swap contracts are based on quoted
      market prices.





*Limitations.* Fair
      value estimates are made at a specific point in time, based on relevant market
      information and information about the financial instrument. These values do
      not
      reflect any premium or discount that could result from offering for sale at
      one
      time the Company’s entire holdings of a particular financial instrument. Because
      no market exists for a significant portion of the Company’s financial
      instruments, fair value estimates are based on judgments regarding future
      expected loss experience, current economic conditions, risk characteristics
      of
      various financial instruments, and other factors. These estimates are subjective
      in nature and involve uncertainties and matters of significant judgment and
      therefore cannot be determined with precision. Changes in assumptions could
      significantly affect the estimates.





Fair
      value estimates are based on existing on and off-balance sheet financial
      instruments without attempting to estimate the value of anticipated future
      business and the value of assets and liabilities that are not considered
      financial instruments. Other significant assets and liabilities that are not
      considered financial instruments include properties and equipment and other
      real
      estate owned. In addition, the tax ramifications related to the realization
      of
      the unrealized gains and losses can have a significant effect on fair value
      estimates and have not been considered in any of the estimates.





A
      summary
      of the estimated fair values for the Company’s significant financial instruments
      at December 31, 2005 and 2004 follows:


**2005**
            
            **2004****Estimate**
            
            
            
            **Estimate****Carrying**
            
            **of
                Fair**
            
            **Carrying**
            
            **of
                Fair****Value**
            
            **Value**
            
            **Value**
            
            **Value**Financial
                AssetsCash
                and cash equivalents
            
            $
            13,828
            
            $
            13,828
            
            $
            10,220
            
            $
            10,220Investment
                securities
            
            
            72,489
            
            
            72,489
            
            
            66,099
            
            
            66,099Loans
                held for sale
            
            
            925
            
            
            931
            
            
            617
            
            
            619Loans
                receivable, net
            
            
            314,879
            
            
            310,243
            
            
            279,122
            
            
            279,002Cash
                surrender value of life insurance
            
            
            4,018
            
            
            4,018
            
            
            3,854
            
            
            3,854Accrued
                interest receivable
            
            
            1,605
            
            
            1,605
            
            
            1,239
            
            
            1,239Capitalized
                mortgage servicing rights
            
            
            1,013
            
            
            1,463
            
            
            938
            
            
            1,190Financial
                LiabilitiesDeposits
                (with no stated maturity)
            
            
            208,002
            
            
            208,002
            
            
            194,559
            
            
            194,559Certificates
                of deposit
            
            
            123,412
            
            
            121,743
            
            
            105,223
            
            
            105,558Accrued
                interest payable
            
            
            756
            
            
            756
            
            
            637
            
            
            637Borrowed
                funds
            
            
            47,008
            
            
            46,080
            
            
            33,524
            
            
            33,493Interest
                rate swaps
            
            
            79
            
            
            79
            
            
            21
            
            
            21






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**20.**
            **Parent
                Company Financial
                Information**





Condensed
      financial information for Merrill Merchants Bancshares, Inc. exclusive of its
      subsidiary follows:


**Balance
                Sheet****December
                31,****2005**
            
            **2004**AssetsCash
            
            $
            21
            
            $
            12Investment
                securities at fair value
            
            
            2,974
            
            
            2,420Investment
                in subsidiary
            
            
            32,059
            
            
            29,524Other
                assets
            
            
            7
            
            
            1Total
                assets
            
            $
            35,061
            
            $
            31,957Liabilities
                and shareholders’ equityDividend
                payable and accrued expenses
            
            $
            709
            
            $
            628Shareholders’
                equity
            
            
            34,352
            
            
            31,329Total
                liabilities and shareholders’ equity
            
            $
            35,061
            
            $
            31,957





**Statements
                of Income****Years
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Operating
                income:Dividends
                from bank subsidiary
            
            $
            2,834
            
            $
            1,755
            
            $
            —Interest
                and dividend income on investments
            
            
            25
            
            
            28
            
            
            90Net
                gains (losses) on sales of securities
            
            
            19
            
            
            155
            
            
            (51
            )Total
                income
            
            
            2,878
            
            
            1,938
            
            
            39Operating
                expenses:Interest
                on borrowed funds
            
            
            1
            
            
            1
            
            
            —Other
                expenses
            
            
            125
            
            
            132
            
            
            97Total
                operating expenses
            
            
            126
            
            
            133
            
            
            97Income
                (loss) before income tax expense (benefit) and equity in undistributed
                net
                income of subsidiary.
            
            
            2,752
            
            
            1,805
            
            
            (58
            )Income
                tax expense (benefit)
            
            
            (22
            )
            
            17
            
            
            (29
            )Income
                (loss) before equity in undistributed net income of
                subsidiary
            
            
            2,774
            
            
            1,788
            
            
            (29
            )Equity
                in undistributed net income of subsidiary
            
            
            2,964
            
            
            3,119
            
            
            4,331Net
                income
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302





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**Statements
                of Cash Flows****Years
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Cash
                flows from operating activities:Net
                income
            
            $
            5,738
            
            $
            4,907
            
            $
            4,302Adjustments
                to reconcile net income to net cash provided by operating
                activities:Undistributed
                net income from subsidiary
            
            
            (2,964
            )
            
            (3,119
            )
            
            (4,331
            )Net
                (gain) loss on sale of investment securities
            
            
            (19
            )
            
            (155
            )
            
            51(Increase)
                decrease in other assets
            
            
            (6
            )
            
            231
            
            
            (12
            )Increase
                (decrease) in other liabilities
            
            
            (19
            )
            
            69
            
            
            91Net
                cash provided by operating activities
            
            
            2,730
            
            
            1,933
            
            
            101Cash
                flows from investing activities:Proceeds
                from sales and maturities of investment securities
            
            
            2,225
            
            
            3,802
            
            
            6,248Purchase
                of investment securities
            
            
            (2,725
            )
            
            (1,825
            )
            
            (4,370
            )Net
                cash (used) provided by investing activities
            
            
            (500
            )
            
            1,977
            
            
            1,878Cash
                flows from financing activities:Proceeds
                from issuance of common stock
            
            
            12
            
            
            66
            
            
            754Dividends
                paid
            
            
            (2,115
            )
            
            (1,816
            )
            
            (1,511
            )Repurchase
                of common stock
            
            
            (118
            )
            
            (2,156
            )
            
            (1,218
            )Net
                cash used by financing activities
            
            
            (2,221
            )
            
            (3,906
            )
            
            (1,975
            )Net
                increase in cash
            
            
            9
            
            
            4
            
            
            4Cash,
                beginning of year
            
            
            12
            
            
            8
            
            
            4Cash,
                end of year
            
            $
            21
            
            $
            12
            
            $
            8





**21.**
            **Selected
                Quarterly Data (unaudited)**





**2005**
            
            **2004****Fourth**
            
            **Third**
            
            **Second**
            
            **First**
            
            **Fourth**
            
            **Third**
            
            **Second**
            
            **First****Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**Interest
                and dividend income
            
            $
            6,311
            
            $
            5,951
            
            $
            5,503
            
            $
            5,059
            
            $
            4,957
            
            $
            4,782
            
            $
            4,563
            
            $
            4,406Interest
                expense
            
            
            2,092
            
            
            1,890
            
            
            1,635
            
            
            1,437
            
            
            1,341
            
            
            1,261
            
            
            1,176
            
            
            1,157Net
                interest income
            
            
            4,219
            
            
            4,061
            
            
            3,868
            
            
            3,622
            
            
            3,616
            
            
            3,521
            
            
            3,387
            
            
            3,249Provision
                for loan losses
            
            
            97
            
            
            106
            
            
            100
            
            
            94
            
            
            92
            
            
            88
            
            
            84
            
            
            84Net
                interest income after provision for loan losses
            
            
            4,122
            
            
            3,955
            
            
            3,768
            
            
            3,528
            
            
            3,524
            
            
            3,433
            
            
            3,303
            
            
            3,165Non-interest
                income
            
            
            1,435
            
            
            1,215
            
            
            1,287
            
            
            1,289
            
            
            1,224
            
            
            1,168
            
            
            1,304
            
            
            1,154Net
                gain on securities
            
            
            —
            
            
            —
            
            
            —
            
            
            19
            
            
            90
            
            
            —
            
            
            —
            
            
            65Non-interest
                expense
            
            
            3,095
            
            
            2,963
            
            
            2,998
            
            
            2,930
            
            
            2,833
            
            
            2,719
            
            
            2,815
            
            
            2,675Income
                before income taxes
            
            
            2,462
            
            
            2,207
            
            
            2,057
            
            
            1,906
            
            
            2,005
            
            
            1,882
            
            
            1,792
            
            
            1,709Income
                tax expense
            
            
            808
            
            
            745
            
            
            692
            
            
            649
            
            
            649
            
            
            648
            
            
            598
            
            
            586Net
                income
            
            $
            1,654
            
            $
            1,462
            
            $
            1,365
            
            $
            1,257
            
            $
            1,356
            
            $
            1,234
            
            $
            1,194
            
            $
            1,123Basic
                earnings per share
            
            $
            0.48
            
            $
            0.43
            
            $
            0.40
            
            $
            0.37
            
            $
            0.39
            
            $
            0.36
            
            $
            0.34
            
            $
            0.32Diluted
                earnings per share
            
            $
            0.48
            
            $
            0.42
            
            $
            0.39
            
            $
            0.36
            
            $
            0.39
            
            $
            0.36
            
            $
            0.34
            
            $
            0.32






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**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








To
      the
      Board of Directors and Shareholders


Merrill
      Merchants Bancshares, Inc.





We
      have
      audited the accompanying consolidated statements of financial condition of
      Merrill Merchants Bancshares, Inc. and Subsidiary as of December 31, 2005 and
      2004, and the related consolidated statements of income, changes in
      shareholders’ equity and cash flows for each of the three years in the period
      ended December 31, 2005. These consolidated financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these consolidated financial statements based on our
      audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the consolidated
      financial statements. An audit also includes assessing the accounting principles
      used and significant estimates made by management, as well as evaluating the
      overall financial statement presentation. We believe that our audits provide
      a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of Merrill
      Merchants Bancshares, Inc. and Subsidiary as of December 31, 2005 and 2004,
      and the consolidated results of their operations and their consolidated cash
      flows for each of the three years in the period ended December 31, 2005, in
      conformity with U.S. generally accepted accounting principles.











/s/Berry,
      Dunn, McNeil & Parker


BERRY
      DUNN MCNEIL & PARKER


Bangor,
      Maine


February
      24, 2006




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**ITEM
      9.****CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**





None.




**ITEM
      9A.****CONTROLS
      AND PROCEDURES**





Management,
      including the Company’s Chairman, Chief Executive Officer and Principal
      Executive Officer and Executive Vice President, Treasurer and Principal
      Financial Officer, has evaluated the effectiveness of the Company’s disclosure
      controls and procedures (as defined in Exchange Act Rules 13a-15(f) and
      15d-15(e)) as of the end of the period covered by this report. Based upon that
      evaluation, the Chairman and Chief Executive Officer and Executive Vice
      President and Treasurer concluded that the disclosure controls and procedures
      were effective to ensure that information required to be disclosed in the
      reports the Company files and submits under the Exchange Act is (i) recorded,
      processed, summarized and reported as and when required and (ii) accumulated
      and
      communicated to the Company’s management, including the Company’s Chairman,
      Chief Executive Officer and Principal Executive Officer and Executive Vice
      President, Treasurer and Principal Financial Officer, as appropriate to allow
      timely decisions regarding required disclosures.




There
      have been no changes in the Company’s internal control over financial reporting
      identified in connection with the evaluation that occurred during the Company’s
      last fiscal quarter that have materially affected, or that are reasonably likely
      to materially affect, the Company’s internal control over financial
      reporting.




**ITEM
      9B.****OTHER
      INFORMATION**





None.




**PART
      III**





**ITEM
      10.****DIRECTORS
      AND EXECUTIVE OFFICERS OF THE COMPANY**





The
      information included in the Proxy Statement under the captions “Voting
      Securities,” “Section 16(a) Beneficial Ownership Reporting Compliance,”
“Election of Directors of Merrill Merchants Bancshares, Inc.,” “Board of
      Directors and Its Committees - Audit Committee,” and “Remuneration of Directors
      and Officers - Executive Officers” is incorporated herein by
      reference.




The
      Company has adopted a Code of Ethics that applies to all employees, officers
      and
      directors of the Company, including the Company’s principal executive officer,
      principal financial officer, principal accounting officer or controller or
      person performing similar functions for the Company. The Code of Conduct and
      Ethics meets the requirements of a “code of ethics” as defined by Item 406 of
      Regulation S-K. The Company filed the Code of Ethics with the SEC as an exhibit
      to the Annual Report on Form 10-K for the year ended December 31,
      2003.




Copies
      of
      the Code of Ethics are available free of charge upon written request to Deborah
      A. Jordan, Secretary, Merrill Merchants Bancshares, Inc., 201 Main Street,
      Bangor, ME 04402-0925.




**ITEM
      11.****EXECUTIVE
      COMPENSATION**





The
      information included in the Proxy Statement under the captions “Remuneration of
      Directors and Officers,” “Compensation of Executive Officers and Transactions
      with Management,” and “Performance Graph” is incorporated herein by
      reference.




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**ITEM
      12.****SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND****MANAGEMENT
      AND RELATED SHAREHOLDER MATTERS**





*Security
      Ownership of Certain Beneficial Owners and Management* .
      Information included in the Proxy Statement under the caption “Beneficial
      Ownership of Common Stock by Certain Beneficial Owners and Management” is
      incorporated herein by reference.





*Equity
      Compensation Plan Information* .
      The
      following table sets forth the aggregate information for the Company’s equity
      compensation plans in effect at December 31, 2005.





**Equity
                Compensation Plan Information**Plan
                category
            
            Number of securities to
                be issued upon exercise
              of
                outstanding options, warrants and rights
            
            Weighted-average
                exercise price of outstanding options, warrants and
                rights
            
            Number of securities remaining
                available for future issuance
                under equity compensation plan (excluding
                securities referenced
              in
                column (a))(a)
            
            (b)
            
            (c)Equity
                compensation plans approved by security holders (1)
            
            
            57,816
            
            $
            11.67
            
            
            0Equity
                compensation plans not approved by security holders
            
            
            0
            
            
            N/A
            
            
            0Total
            
            
            57,816
            
            $
            11.67
            
            
            0





(1)
            
            Consists
                of options outstanding that were granted under the 1993 Plan prior
                to its
                expiration on April 26, 2003. The number of shares issued upon the
                exercise of outstanding options is subject to adjustment for any
                recapitalization of common stock, such as a stock dividend, stock
                split or
                reverse split of common stock.





**ITEM
      13.****CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS**





The
      information included in the Proxy Statement under the caption “Compensation of
      Executive Officers and Transactions with Management - Interests in Certain
      Transactions” is incorporated herein by reference.





**ITEM
      14.****PRINCIPAL
      ACCOUNTING FEES AND SERVICES**





Information
      included in the Proxy Statement under the caption “Ratification of Appointment
      of Independent Public Accountants” is incorporated herein by
      reference.




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**PART
      IV**





**ITEM
      15.****EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES**





(a)
                The
                    following financial statements are incorporated by reference
                    from Item 8
                    hereof:





Consolidated
      Statements of Financial Condition-December 31, 2005 and
      2004;


Consolidated
      Statements of Income-Years Ended December 31, 2005,
      2004 and 2003;


Consolidated
      Statements of Changes in Shareholders’ Equity-Years
      Ended December 31, 2004, 2004 and 2003;


Consolidated
      Statements of Cash Flows-Years Ended December 31, 2005,
      2004 and 2003; and


Notes
      to Consolidated Financial Statements





(b)
            Exhibits.The
                following exhibits are either filed as part of this report or are
                incorporated herein by reference:




3.1
            
            Articles
                of Incorporation of Merrill Merchants Bancshares, Inc. (incorporated
                by
                reference to the Company’s Registration Statement on Form SB-2, File No.
                333-56197).3.2
            
            By-laws
                of Merrill Merchants Bancshares, Inc. (incorporated by reference
                to the
                Company’s Registration Statement on Form SB-2, File No.
                333-56197).4
            
            Specimen
                Stock Certificate of Merrill Merchants Bancshares, Inc. (incorporated
                by
                reference to the Company’s Registration Statement on Form SB-2, File No.
                333-56197).10.1
            
            Operating
                Agreement between the Company and M&M Consulting Limited Liability
                Company (incorporated by reference to the Company’s Registration Statement
                on Form SB-2, File No. 333-56197).10.2
            
            Services
                Agreements between the Company and M&M Consulting Limited Liability
                Company (incorporated by reference to the Company’s Registration Statement
                on Form SB-2, File No. 333-56197).10.3
            
            Amended
                and Restated Employment Agreement with William C. Bullock, Jr.
                (incorporated by reference to the Company’s Form 10-Q for the quarter
                ended March 31, 2004).10.4
            
            Financial
                Services Agreement with Financial Institutions Service Corporation
                (incorporated by reference to the Company’s Registration Statement on Form
                SB-2, File No. 333-56197).10.5
            
            Form
                of Life Insurance Endorsement Method Split Dollar Plan Agreement
                (incorporated by reference to the Company’s Registration Statement on Form
                SB-2, File No. 333-56197).10.7
            
            Form
                of Amended and Restated Executive Supplemental Retirement
                Plan.10.8
            
            Form
                of Mandatory Convertible Debentures (incorporated by reference to
                the
                Company’s Registration Statement on Form SB-2, File No.
                333-56197).10.9
            
            Correspondent
                Trust Services Agreement with Northern Trust Company (incorporated
                by
                reference to the Company’s Registration Statement on Form SB-2, File No.
                333-56197).10.10
            
            Stock
                Option Plan, as amended (incorporated by reference to the Company’s
                Registration Statement on Form SB-2, File No.
                333-56197).10.11
            
            Form
                of Stock Option Agreement (incorporated by reference to the Company’s
                Registration Statement on Form SB-2, File No.
                333-56197).10.12
            
            Not
                used.10.13
            
            Employment
                Agreement between the Company and Edwin N. Clift (incorporated by
                reference to the Company’s Form 10-KSB for the year ended December 31,
                2003).10.14
            
            Employment
                Agreement between the Company and William P. Lucy (incorporated by
                reference to the Company’s Form 10-KSB for the year ended December 31,
                2003).10.15
            
            Employment
                Agreement between the Company and Deborah A. Jordan (incorporated
                by
                reference to the Company’s Form 10-KSB for the year ended December 31,
                2003).10.16
            
            2005
                Directors’ Deferred Compensation Plan (incorporated by reference to the
                Company’s Form 10-Q for the quarter ended March 31,
                2005).13
            
            Annual
                Report to Shareholders for the Year Ended December 31,
                2005.14
            
            Code
                of Ethics (incorporated by reference to the Company’s Form 10-KSB for the
                year ended December 31, 2003).21
            
            Subsidiaries
                of the Registrant.23
            
            Consent
                of Berry, Dunn, McNeil & Parker.31.1
            
            Rule
                13a-14(a) / 15d-14(a) Certifications.32.1
            
            Section
                1350 Certifications.






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**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant
      has duly caused this report to be signed on its behalf by the undersigned,
      thereunto duly authorized.





**MERRILL
                MERCHANTS BANCSHARES, INC.**Date: March
                10, 2006
              By:
              /s/ EDWIN
                N.
                CLIFT*Chairman
                and
                Chief Executive Officer*


In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.





Name
            
            Title
            
            Date/s/
                Edwin N. Clift
            
            Director,
                Chairman and Chief Executive Officer
            
            March
                10, 2006Edwin
              N. Clift
            
            (Principal
              executive officer)/s/
                Deborah A. Jordan
            
            Treasurer
                (Principal financial officer)
            
            March
                10, 2006Deborah
              A. Jordan/s/
                William C. Bullock, Jr.
            
            Director
            
            March
                10, 2006William
              C. Bullock, Jr./s/
                Joseph H. Cyr
            
            Director
            
            March
                10, 2006Joseph
              H. Cyr/s/
                Perry B. Hansen
            
            Director
            
            March
                10, 2006Perry
              B. Hansen/s/
                William P. Lucy
            
            Director
            
            March
                10, 2006William
              P. Lucy/s/
                Frederick A. Oldenburg, Jr., M.D.
            
            Director
            
            March
                10, 2006Frederick
              A. Oldenburg, Jr., M.D./s/
                Lloyd D. Robinson
            
            Director
            
            March
                10, 2006Lloyd
              D. Robinson/s/
                Dennis L. Shubert, M.D., Ph.D.
            
            Director
            
            March
                10, 2006Dennis
              L. Shubert, M.D., Ph.D.





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      page
      intentionally left blank


















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MERRILL
      MERCHANTS BANCSHARES, INC.


201
      Main
      Street


Post
      Office Box 925


Bangor,
      Maine 04402-0925


(207)
      942-4800


www.merrillmerchants.com











































**Back
          to Table of Contents**






**Merrill
        Merchants Bancshares, Inc.**
 
 Notice
        of
        2006 Annual Meeting
 Proxy
        Statement
 and
 Form
        10-K
        Annual Report
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 **Back
            to Table of Contents**
 
 
 
  
 March
        16,
        2006
 
 
 
 
 Dear
        Stockholder:
 
 On
        behalf
        of the Board of Directors and management of Merrill Merchants Bancshares,
        Inc.
        (the “Company”), you are cordially invited to attend the 2006 Annual Meeting of
        Stockholders which will be held at the Bangor Conference Center, 701 Hogan
        Road,
        Bangor, Maine 04401, on Thursday, May 4, 2006 at 5:00 p.m.
 
 The
        notice of meeting and proxy statement accompanying this letter describe the
        specific business to be acted upon. In addition to the specific matters to
        be
        acted upon, there will be a report on the progress of the Company and an
        opportunity for questions of general interest to the stockholders.
 
 It
        is
        important that your shares be represented at the meeting. Whether or not
        you
        plan to attend in person, you are requested to vote, sign, date, and promptly
        return the enclosed proxy card in the envelope provided.
 
 
 Sincerely
        yours,
  
 Edwin
        N.
        Clift
 *Chairman
        and Chief Executive Officer*
  **Back
            to Table of Contents**
 
 **Merrill
        Merchants Bancshares, Inc.**
 **201
        Main Street**
 **Bangor,
        Maine 04401-0925**
 **(207)
        942-4800**
 
 **NOTICE
        OF ANNUAL MEETING OF STOCKHOLDERS**
 
 The
        2006
        Annual Meeting of Stockholders of Merrill Merchants Bancshares, Inc. (the
        “Company”) will be held at the Bangor Motor Inn, 701 Hogan Road, Bangor, Maine
        04401, on Thursday, May 4, 2006 at 5:00 p.m. for the following purposes,
        all of
        which are more completely set forth in the accompanying proxy
        statement:
 
 1.
              To
                  elect three directors for a three-year term and to elect one director
                  for
                  a one-year term and;
 
 2.
              To
                  ratify the appointment of Berry, Dunn, McNeil & Parker as our
                  independent registered public accountants for 2006;
                  and
 
 3.
              To
                  transact such other business as may properly come before the meeting
                  or
                  any adjournment thereof. We are not aware of any other such
                  business.
 
 You
        may
        vote at the Annual Meeting and at any adjournment or postponement thereof,
        if
        you were a stockholder of the Company on March 6, 2006, the record
        date.
 
 By
        Order
        of the Board of Directors,
  
 Deborah
        A. Jordan
 *Secretary*
 
 
 
 March
        16,
        2006
 
  ***Whether
        you expect to attend the meeting or not, please vote, sign, date, and return
        the
        enclosed proxy card in the envelope provided as promptly as possible. If
        you
        attend the meeting, you may vote your shares in person, even though you have
        previously signed and returned your proxy card.***
  **Back
            to Table of Contents**
  ***MERRILL
        MERCHANTS BANCSHARES, INC.***
 201
        Main
        Street
 Bangor,
        ME 04401
 
 **Proxy
        Statement**
 **2006
        Annual Meeting of Stockholders to be held May 4, 2006**
 
 **Solicitation
        and Revocation of Proxies**
 
 This
        proxy statement is furnished to the stockholders of Merrill Merchants
        Bancshares, Inc., a Maine corporation (the “Company”), in connection with the
        2006 Annual Meeting of Stockholders of the Company.
 
 A
        proxy
        card is furnished by the Company. This proxy is being solicited by the Board
        of
        Directors of the Company for use at the May 4, 2006 Annual Meeting of
        Stockholders and at any adjournment thereof. A proxy duly executed and returned
        by a stockholder will be voted as directed by the proxy. If no choice is
        specified, the proxy will be voted “FOR” proposals 1 and 2. As to other matters,
        if any, to be voted upon, the persons named in the proxy will take such action
        as a majority of the Board of Directors may deem advisable.
 
 A
        stockholder who signs and returns a proxy may revoke it at any time before
        it is
        exercised by signing and submitting a new proxy with a later date, notifying
        the
        Secretary of the Company in writing before the Annual Meeting or by attending
        the meeting and voting in person.
 
 All
        expenses of the solicitation of proxies are being borne by the Company. It
        is
        expected that solicitations will be made primarily by mail, but regular
        employees or representatives of the Company and Merrill Merchants Bank (the
        “Bank”) may also solicit proxies by telephone, telex, facsimile and in person,
        but no employee will receive any compensation for solicitation activities
        in
        addition to his or her regular compensation. We will, upon request, reimburse
        brokerage firms and others for their reasonable expenses in forwarding
        solicitation material to the beneficial owners of stock.
 
 We
        began
        mailing this Proxy Statement, the Notice of Annual Meeting and the enclosed
        proxy card on or about March 16, 2006, to all stockholders entitled to vote.
        If
        you owned the Company’s common stock at the close of business on March 6, 2006,
        the record date, you are entitled to vote at the Annual Meeting.
 
 **Quorum**
 A
        quorum
        of stockholders is necessary to hold a valid meeting. If the holders of at
        least
        a majority of the total number of the outstanding shares of common stock
        of the
        Company entitled to vote are represented in person or by proxy at the Annual
        Meeting, a quorum will exist. We will include proxies marked as abstentions
        and
        broker non-votes to determine the number of shares present at the Annual
        Meeting.
 
 **Confidential
        Voting Policy**
 The
        Company maintains a policy of keeping stockholder votes confidential. We
        only
        let our Inspector of Election and our transfer agent examine the voting
        materials. We will not disclose your vote to management unless it is necessary
        to meet legal requirements. We will, however, forward any written comments
        that
        you may have to management.
 
 **Voting
        Securities**
 
 Only
        stockholders of record at the close of business on March 6, 2006, are entitled
        to vote at the Annual Meeting. As of March 6, 2006, there were 3,441,463
        shares
        of common stock outstanding. Each share has one vote.
  -1-
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            to Table of Contents**
 
 The
        nominees for directors who receive the most votes will be elected. If you
        vote
        against the nominees for director or “withhold authority” for any nominee on
        your proxy card, your vote will not count “for” or “against” the nominee. The
        approval of the independent registered public accountants requires the majority
        of the votes cast by stockholders present in person or by proxy and entitled
        to
        vote at the Annual Meeting. If you “abstain” from voting on the independent
        registered public accountant proposal, your vote will not count “for” or
“against” the proposal. Broker non-votes will not be counted as having voted in
        person or by proxy for each proposal and will have no effect on the outcome
        of
        the proposals.
 
 **BENEFICIAL
        OWNERSHIP OF COMMON STOCK**
 **BY
        CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**
 
 The
        following table shows the amount of Merrill Merchants Bancshares, Inc. common
        stock beneficially owned by each person or entity (or group of affiliated
        persons or entities) known by management to beneficially own more than five
        percent of the outstanding common stock of the Company, the Company's directors,
        the executive officers named in the Summary Compensation Table and the directors
        and executive officers as a group. For purposes of the table below, in
        accordance with Rule 13(d)(3) of the Securities Exchange Act of 1934, as
        amended, a person is deemed to be the beneficial owner, for purposes of any
        shares of common stock: (1) over which he or she has or shares, directly
        or
        indirectly, voting or investment power; or (2) of which he or she has the
        right
        to acquire beneficial ownership at any time within 60 days after December
        31,
        2005. As used in this proxy statement, "voting power" is the power to vote
        or
        direct the voting of shares, and "investment power" includes the power to
        dispose or direct the disposition of shares.
 **Shares
                  Beneficially Owned****As
                  of December 31, 2005 (1****)****Name
                  of Beneficial Owner**
              
              **Amount**
              
              **Percent**Directors
                  and Executive Officers:The
                  Bullock Family Trust
              
              
              207,821
              (2)
              
              6.0
              %William
                  C. Bullock, Jr.
              
              
              —
              (2)
              
              6.0
              %Edwin
                  N. Clift
              
              
              70,938
              
              
              2.1
              %Joseph
                  H. Cyr
              
              
              166,216
              (3)
              
              4.8
              %John
                  R. Graham
              
              
              61,009
              (4)
              
              1.8
              %Perry
                  B. Hansen
              
              
              356,364
              (5)
              
              10.4
              %Deborah
                  A. Jordan
              
              
              20,311
              (6)
              
              0.6
              %William
                  P. Lucy
              
              
              19,449
              (7)
              
              0.6
              %Frederick
                  A. Oldenburg, Jr., M.D.
              
              
              52,734
              (8)
              
              1.5
              %Lloyd
                  D. Robinson
              
              
              48,871
              (9)
              
              1.4
              %Dennis
                  L. Shubert, M.D., Ph.D.
              
              
              67,009
              (10)
              
              2.0
              %All
                  current directors and executive officers as a group (10
                  persons)
              
              
              1,070,722
              
              
              31.2
              %
 
 (1)
                  Except
                      as otherwise noted, each individual in the table above has
                      sole voting and
                      investment power over the shares listed.
 (2)
                  Mr.
                      Bullock is the trustee of The Bullock Family Trust and as such,
                      has voting
                      and investment power over the shares held in the Trust. Mr.
                      Bullock holds
                      no other shares of common stock. Mr. Bullock’s mailing address is 44 Bald
                      Hill Reach Road, Orrington, Maine 04474.
 (3)
                  Includes
                      138,493 shares of common stock held jointly with
                      spouse.
 (4)
                  Includes
                      2,785 shares of common stock held by spouse and 5,544 shares
                      of common
                      stock held by Automatic Distributors,
                      Inc.
 (5)
                  Mr.
                      Hansen’s mailing address is P.O. Box 280, Rapids City, Illinois
                      61278-0280.
 (6)
                  Includes
                      436 shares of common stock held by
                      spouse.
 (7)
                  Includes
                      1,251 shares of common stock held by
                      spouse.
 (8)
                  Includes
                      23,616 shares of common stock held under the name Penobscot
                      Respiratory PA
                      FBO Frederick A. Oldenburg, Jr. and 19,647 shares of common
                      stock held by
                      spouse.
 (9)
                  Includes
                      24,823 shares of common stock held by
                      spouse.
 (10)
                  Includes
                      33,265 shares of common stock held by spouse. Also includes
                      5,645 shares
                      of common stock held in the name of Dr. Shubert’s children, of which his
                      spouse serves as
                      Trustee.
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            to Table of Contents**
  **Section
        16(a) Beneficial Ownership Reporting Compliance**
 Section
        16(a) of the Securities Exchange Act of 1934 requires that the Company’s
        directors, executive officers, and any person holding more than ten percent
        of
        the Company’s common stock file with the SEC reports of their ownership and
        changes in ownership of the Company’s securities. The Company believes that
        during 2005, its directors, executive officers and 10% shareholders complied
        with all Section 16(a) filing requirements. In making this statement, the
        Company has relied upon examination of the copies of Forms 3, 4 and 5 provided
        to the Company and the representations of its directors, executive officers
        and
        10% shareholders.
 
 **Election
        of Directors of Merrill Merchants Bancshares, Inc.**
 (Item
        1
        on Proxy Card)
 
 The
        Board
        has nominated four persons for election as directors at the Annual Meeting.
        Mr.
        Cyr and Mr. Lucy currently serve on the Company’s Board of Directors. Mr. Shea
        and Mr. Graham both serve on the Merrill Merchants Bank’s Board of Directors.
        Mr. Graham was nominated by the Board of Directors to replace a vacant position
        and Mr. Shea was nominated by the Board of Directors to replace Mr. Robinson,
        who is retiring from the Board of Directors and whose term was to expire
        in
        2007. If you elect the nominees, Mr. Cyr, Mr. Lucy and Mr. Graham will hold
        office until the Annual Meeting in 2009 and Mr. Shea will hold office until
        the
        Annual Meeting of 2007, or until their successors have been
        elected.
 
 We
        know
        of no reason why any nominee may be unable to serve as a director. If any
        nominee is unable to serve, your proxy may vote for another nominee proposed
        by
        the Board. If for any reason these nominees prove unable or unwilling to
        stand
        for election, the Board will nominate alternates or reduce the size of the
        Board
        of Directors to eliminate the vacancy. The Board has no reason to believe
        that
        its nominees would prove unable to serve if elected. **We
        recommend that you vote “FOR” each of the nominees for election as
        directors.**
 
 ***Nominees***
 **Joseph
        H. Cyr** ,
        65, **** has
        served as a Director of the Company and the Bank since 1992. He has been
        the
        owner of John T. Cyr & Sons, Inc., Old Town, Maine, a privately held charter
        bus service, since 1967. Mr. Cyr has been involved in that business since
        1962.
        He was formerly a director of Norstar Bank in Bangor. He has been active
        in a
        number of civic and charitable organizations including: trustee of Husson
        College and St. Joseph Hospital and president of the Bangor Area Chamber
        of
        Commerce. He is a former director of Bangor Hydro-Electric Company and the
        Maine
        Community Foundation. Mr. Cyr’s term expires in 2009.
 
 **John
        R. Graham, III**
 John
        R. Graham, III, 68, has served as a director of the Bank since its inception
        in
        1992. Mr. Graham is the president of Automatic Distributors, Inc. in Bangor,
        a
        wholesale and retail distribution company he has owned and operated for over
        thirty years. He has also been involved in real estate development in the
        Bangor
        area for many years. Mr. Graham’s term expires in 2009.
 
 **William
        P. Lucy** ,
        age 47,
        has served as President of the Company and Bank since April 2004, as Executive
        Vice President of the Bank since December 1999, and as Senior Loan Officer
        of
        the Bank since 1992. Mr. Lucy began his banking career at The Merrill Trust
        Company in 1981, and he has both commercial lending and branch administration
        experience. He is a graduate of the University of Maine and Williams College
        School of Banking. Mr. Lucy serves on the board of directors of the Penobscot
        Community Healthcare, New Hope Hospice, Action Committee of 50 and M & J
        Company, a subsidiary of St. Joseph Healthcare Foundation. In addition, he
        is a
        trustee of the YMCA Foundation and he formerly served as chairman of the
        United
        Way Campaign. Mr. Lucy’s term expires in 2009.
  -3-
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            to Table of Contents**
 
 **Michael
        T. Shea**
 Michael
        T. Shea, 56, has served as a director of the Bank since 2004. Mr. Shea is
        the
        president and chief executive officer of Webber Energy Fuels of Bangor, a
        position he has held since 2000. He also serves as a director of the Webber
        board. Prior to assuming his current responsibilities, he had been with the
        company for four years and his career in the petroleum business spans thirty
        years. He is a member of the Board of Governors of the New England Fuel
        Institute, has served as a trustee of St. Joseph College, his alma mater,
        for
        more than twenty years, and he recently completed a term as chairman of the
        board of United Way of Eastern Maine.
 
 ***Continuing
        Directors***
 **William
        C. Bullock, Jr.,** 69,
        served as Chairman of the Company and the Bank from 1992 to April 2004. He
        is
        the former Chairman of The Merrill Trust Company and its successor bank,
        Merrill/Norstar Bank. He also served as an executive vice president and director
        of the holding company, Fleet/Norstar Financial Group of Providence, Rhode
        Island. Prior to moving to Maine in 1969, he held a number of officer positions
        with Morgan Guaranty Trust Company of New York. Mr. Bullock has served on
        and
        chaired several committees of the American Bankers Association (“ABA”) and is a
        former chairman of the Maine Bankers Association (“MBA”). From 1987 to 1989, Mr.
        Bullock was a Class A director of the Federal Reserve Bank of Boston. Mr.
        Bullock is a graduate of Yale University. He is a former trustee of the State
        of
        Maine Retirement System, Maine Maritime Academy, the Maine Community Foundation
        and Bangor Theological Seminary. Mr. Bullock is a former director of a number
        of
        companies including Fieldcrest Cannon, Bangor & Aroostook Railroad and
        Bangor Hydro-Electric Company and he served as a director of Eastern Maine
        Healthcare. Mr. Bullock’s term expires in 2007.
 
 **Edwin
        N. Clift,** 66,
        has
        served as Chairman and Chief Executive Officer of the Company and Bank since
        April 2004 and served as President and Chief Executive Officer of the Company
        and the Bank from its inception in 1992 to April 2004. Prior to that, Mr.
        Clift
        was associated with three other Maine banks including more than 20 years
        as an
        executive of The Merrill Trust Company. Mr. Clift is a graduate of Strayer
        College in Washington, D.C. Mr. Clift is chairman of the St. Joseph Healthcare
        Foundation board of trustees, past president and current director of the
        Bangor
        Target Area Development Corporation and director and treasurer of the Bangor
        Historical Society. He is former chairman of the Maine Committee for Employer
        Support for the Guard and Reserve and a member of the Advisory Board for
        Maine’s
        Bureau of Financial Institutions. Mr. Clift also serves as a member of the
        ABA’s
        Community Bankers Council. Mr. Clift completed a three-year term in 2000
        as a
        Class A director of the Federal Reserve Bank of Boston. He is a past chairman
        of
        the MBA and a past president of the Independent Community Bankers Association
        of
        Maine. He serves as chairman of the board of directors of Seven Islands Land
        Company, a privately held company that manages one million acres of certified
        forest in Maine. Mr. Clift’s term expires in 2007.
 
 **Perry
        B. Hansen** ,
        58, has
        been a Director of the Company and the Bank since 1992. He is chairman of
        THE
        National Bank, Bettendorf, Iowa and a director of its bank holding company,
        National Bancshares, Inc. Mr. Hansen’s thirty-six years of banking experience
        includes management of two other banks in the Quad City area. Presently he
        is
        also an investor, holding senior management positions in several privately
        held
        companies. Mr. Hansen’s term expires in 2008.
 
 **Frederick
        A. Oldenburg, Jr., M.D.** ,
        58, has
        served as a Director of the Company since 1999 and a Director of the Bank
        since
        1996. He has been a practicing physician since 1973 and a director of Penobscot
        Respiratory, P.A. He was head of Respiratory Care at St. Joseph Hospital
        in
        Bangor from 1993 to 2003. He is a graduate of Dartmouth College and Case
        Western
        Reserve University Medical School. Dr. Oldenburg is past president of the
        National Association for the Medical Direction of Respiratory Care. He also
        has
        been involved in real estate development in Bangor and Brooksville, Maine.
        Dr.
        Oldenburg’s term expires in 2008.
 
 **Dennis
        L. Shubert, M.D., Ph.D.** ,
        58, **** has
        served as a Director of the Company since May 1998 and a Director of the
        Bank
        since 1992. He is a neurosurgeon and past president of Maine Neurosurgery
        of
        Bangor and Portland, Maine. Dr. Shubert is a Bangor native who graduated
        from
        Tufts University, received an M.D. from George Washington University, a Ph.D.
        from the University of Minnesota, and a M.S. in Health Care Management from
        Harvard. He serves as executive director of Maine Quality Forum and served
        as a
        director of Eastern Maine Healthcare. Dr. Shubert has been active in a number
        of
        professional organizations including: president of the Penobscot County Medical
        Association and president of the Maine Neurosurgical Society. Dr. Shubert’s term
        expires in 2008.
  -4-
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            to Table of Contents**
 
 ***Retiring
        Director***
 **Lloyd
        D. Robinson** ,
        70, has
        served as a Director of the Company since May 2001 and a Director of the
        Bank
        since 1992. He has been retired since 1985. From 1977 to 1985, he was the
        owner/operator of McKay’s R.V. Center, a privately held recreational equipment
        business. He also has real estate investments in the Bangor area. Mr. Robinson
        is a U.S. Air Force veteran.
 
 **Ratification
        of Appointment of Independent Registered Public Accountants** ****
 (Item
        2
        on Proxy Card)
 
 The
        Audit
        Committee of the Board of Directors has appointed Berry, Dunn, McNeil &
Parker (“BDMP”) as the Company’s independent registered public accountants for
        the fiscal year ending December 31, 2006. BDMP has served as the Company’s
        independent registered public accountants since the incorporation of the
        Company
        in 1992. **We
        recommend that you vote “FOR” the ratification of the appointment of
        BDMP.**
 
 Representatives
        of BDMP will be present at the Annual Meeting to respond to appropriate
        questions and will have the opportunity to make a statement if they desire
        to do
        so.
 
 During
        the fiscal year ended December 31, 2005, the Company retained and paid BDMP
        to
        provide audit and other services. The following table displays the aggregate
        fees for professional audit services for the audit of the financial statements
        for the years ended December 31, 2005 and 2004 and fees billed for other
        services during those periods by our independent registered public accountants.
  **2005**
              
              **2004**Audit
                  fees (1)
              
              $
              55,525
              
              $
              50,550Audit-related
                  fees
              
              
              —
              
              
              —Tax
                  fees (2)
              
              
              8,290
              
              
              5,500All
                  other fees (3)
              
              
              8,150
              
              
              5,550Total
              
              $
              71,965
              
              $
              61,600
 
 (1)
                  Audit
                      fees consisted of audit work performed in the preparation of
                      financial
                      statements as well as work generally only the independent registered
                      public accountants can reasonably be expected to provide, such
                      as
                      statutory audits.
 (2)
                  Tax
                      fees consisted of assistance with matters related to tax compliance,
                      tax
                      advice and tax planning. The nature of the services comprising
                      the fees
                      disclosed under this category are preparation of federal and
                      state tax
                      returns, review of estimated tax payments and review of tax
                      planning, and
                      assistance with an Internal Revenue Service
                      audit.
 (3)
                  The
                      nature of the services comprising the fees disclosed under
                      this category
                      are an employee benefit plan audit and training for the Board
                      of Directors
                      relative to Section 404 of the Sarbanes-Oxley
                      Act.
 
 The
        Audit
        Committee's pre-approval policies and procedures require the Audit Committee
        Chair to pre-approve all audit and non-audit services, and report such
        pre-approvals to the Audit Committee at its next regularly scheduled meeting.
 
 With
        respect to each of the services described in the table above, pre-approval
        by
        the Audit Committee pursuant to 17 CFR 210.2-01(c)(7)(i)(C) was not
        waived.
  -5-
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  **Board
        of Directors and Its Committees**
 
 The
        Company’s Board of Directors currently consists of eight members. The Company’s
        Articles of Incorporation provides that the Board of Directors shall be divided
        into three classes, as nearly equal in number as possible. The terms of two
        directors expire at the Annual Meeting, and a third director is retiring
        effective at the Annual Meeting.
 
 The
        Board
        of Directors oversees our business and monitors the performance of our
        management. In accordance with our corporate governance procedures, the Board
        of
        Directors does not involve itself in the day-to-day operations of the Company.
        The Company’s executive officers and management oversee the day-to-day
        operations of the Company. Our directors fulfill their duties and
        responsibilities by attending regular meetings of the Board.
 
 The
        Board
        of Directors of the Company held five meetings during the calendar year 2005
        and
        each director attended at least 75% of all Board meetings.
 
 It
        is our
        policy that all directors and nominees should attend the Annual Meeting.
        At the
        2005 Annual Meeting, all the members of the Board of Directors were in
        attendance.
 
 The
        Board
        of Directors has established the following standing committees:
 
 **Executive
        Committee**
 The
        Executive Committee is comprised of Directors Clift (Chair), Bullock, Cyr,
        Robinson, and Shubert. The Executive Committee considers strategic planning
        and
        industry issues and is authorized to act as appropriate between meetings
        of the
        Board of Directors. The Executive Committee held one meeting during
        2005.
 
 **Compensation
        Committee**
 The
        Compensation Committee is comprised of Directors Hansen (Chair), Cyr, Oldenburg,
        and Shubert, each of whom is independent, as defined under The Nasdaq Stock
        Market listing standards. The Compensation Committee determines the salaries
        and
        incentive compensation of the officers of the Company and Bank and provides
        recommendations for the salaries and incentive compensation of the other
        employees of the Bank. The Compensation Committee also administers the Company’s
        various incentive compensation, stock and benefit plans. The Compensation
        Committee met four times during 2005 and each director attended at least
        75% of
        all committee meetings.
 
 **Nominating
        and Corporate Governance Committee**
 The
        Nominating and Corporate Governance Committee is comprised of Directors Hansen
        (Chair), Cyr, Oldenburg, Robinson, and Shubert, each of whom is independent,
        as
        defined under The Nasdaq Stock Market listing standards. The Nominating and
        Corporate Governance Committee met three times during 2005 and each director
        attended at least 75% of all committee meetings.
 
 The
        Nominating and Corporate Governance Committee’s written charter, which sets
        forth the duties and responsibilities of the Committee, was attached as an
        appendix to the proxy statement for the 2004 Annual Meeting and filed with
        the
        SEC on March 18, 2004.
 
 The
        Nominating and Corporate Governance Committee discusses director nominations
        prior to each Annual Meeting of the Company and recommends nominees for election
        as directors and reviews, if any, shareholder nominations to ensure compliance
        with the notice procedures set forth in the Company's Bylaws.
 
 In
        accordance with our Bylaws, nominations of individuals for election to the
        Board
        at an annual meeting of stockholders may be made by any stockholder of record
        entitled to vote for the election of directors at such meeting who provides
        timely notice in writing to the clerk. With respect to an election of directors
        to be held at an annual meeting of stockholders, to be timely, a stockholder's
        notice must be delivered to or received by the clerk not later than ninety
        (90)
        days prior to the anniversary of the previous year's annual meeting. With
        respect to an election to be held at a special meeting of stockholders for
        the
        election of directors, a stockholder's notice must be received by the clerk
        by
        the close of business on the tenth (10th) day following the date on which
        notice
        of such meeting is first given to stockholders. The stockholder's notice
        to the
        clerk must set forth certain information regarding the proposed nominee and
        the
        stockholder making such nomination. If a nomination is not properly brought
        before the meeting in accordance with the Company's Bylaws, the chairperson
        of
        the meeting may determine that the nomination was not properly brought before
        the meeting and shall not be considered. For additional information about
        the
        Company's director nomination requirements, please see the Company's
        Bylaws.
  -6-
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            to Table of Contents**
 
 It
        is the
        policy of the Nominating and Corporate Governance Committee to select
        individuals as director nominees who shall have the highest personal and
        professional integrity, who shall have demonstrated exceptional ability and
        judgment and who shall be most effective, in conjunction with the other nominees
        to the Board, in collectively serving the long-term interests of the
        stockholders. Stockholder nominees are analyzed by the Nominating and Corporate
        Governance Committee in the same manner as nominees that are identified by
        the
        Nominating and Corporate Governance Committee. The Corporation does not pay
        a
        fee to any third party to identify or evaluate nominees.
 
 Joseph
        H.
        Cyr, John R. Graham, William P. Lucy and Michael T. Shea were each nominated
        by
        the non-management, independent directors that comprise the Nominating and
        Corporate Governance Committee. As of January 27, 2006, the Nominating and
        Corporate Governance Committee had not received any stockholder recommendations
        for nominees in connection with the 2006 Annual Meeting.
 
 **Audit
        Committee**
 The
        Company’s Audit Committee is comprised of Directors Shubert (Chair) and Hansen,
        each of whom is independent, as defined under The Nasdaq Stock Market listing
        standards. The Bank’s Audit Committee is comprised of Directors Shubert and
        Hansen as well as Michael Shea, Royce Cross and Herbert Sargent, who are
        members
        of the Board of Directors of the Bank. The Board of Directors has determined
        that Perry B. Hansen qualifies as an Audit Committee Financial Expert, as
        the
        term is defined by SEC regulations and in satisfaction of The Nasdaq Stock
        Market listing standards. The function of the Audit Committee is described
        below
        under the heading Report of the Audit Committee. The Audit Committee met
        eight
        times during 2005. The Audit Committee meets the requirements of Section
        3(a)(58)(A) of the Securities Exchange Act of 1934, as amended, and operates
        under a written charter adopted by the Board of Directors of the Company
        and
        attached as an appendix to the proxy statement for the 2004 Annual Meeting
        and
        filed with the SEC on March 18, 2004. ****
 
 The
        Audit
        Committee of the Board of Directors of the Company serves as the representative
        of the Board by overseeing the audit coverage and monitoring the accounting,
        financial reporting, data processing, regulatory and internal control
        environments. The primary duties and responsibilities of the Audit Committee
        are
        to: (1) serve as an independent and objective party to monitor the Company's
        financial reporting process and internal control systems; (2) select and
        monitor
        the independent registered public accountants; (3) pre-approve all audit
        and
        permissible non-audit services performed by the independent registered public
        accountants; (4) review and appraise the audit efforts of the Company's
        independent registered public accountants and internal audit department;
        (5)
        review the Company's quarterly financial performance, as well as its compliance
        with laws and regulations; (6) oversee management's establishment and
        enforcement of financial policies; (7) provide an open avenue of communication
        among the independent registered public accountants, financial and senior
        management, the internal audit department, and the Board; and (8) establish
        procedures for the receipt, retention and treatment of complaints or concerns,
        including confidential employee submissions, about accounting, internal
        accounting controls or auditing matters. The Company's independent registered
        public accountants, Berry, Dunn, McNeil & Parker, are responsible for
        expressing an opinion on the fairness of presentation of the Company's audited
        financial statements in accordance with generally accepted accounting
        principles.
  -7-
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 **Report
        of the Audit Committee** **
 *The
        following Audit Committee Report is provided in accordance with the rules
        and
        regulations of the Securities and Exchange Commission (the "SEC"). Pursuant
        to
        such rules and regulations, this report shall not be deemed "soliciting
        materials," filed with the SEC, subject to Regulation 14A or 14C of the SEC
        or
        subject to the liabilities of section 18 of the Securities Exchange Act of
        1934,
        as amended.*
 
 In
        this
        context, the Audit Committee hereby reports as follows:
 
 1.
              The
                  Audit Committee has reviewed and discussed the audited financial
                  statements with management.
 2.
              The
                  Audit Committee has discussed with the independent registered public
                  accountants the matters required to be discussed by Statement on
                  Auditing
                  Standards No. 61 (Communication with Audit
                  Committees).
 3.
              The
                  Audit Committee has received written disclosures and the letter
                  from the
                  independent registered public accountants required by Independence
                  Standards Board Standard No. 1 (Independence Discussions with Audit
                  Committees) and has discussed with the independent registered public
                  accountants the independent registered public accountants’
                  independence.
 
 On
        the
        basis of these reviews and discussions referred to above, the Audit Committee
        recommended to the Board of Directors that the audited financial statements
        be
        included in the Company's Annual Report on Form 10-K for the year ended December
        31, 2005, for filing with the Securities and Exchange Commission.
 
 Members
        of the Audit Committee
 *Dennis
        L. Shubert, M.D., Ph.D., Chair*  *Perry
        B. Hansen*  **
 
 **Remuneration
        of Directors and Officers**
 
 **Directors’
        Fees**
 Each
        non-employee director of the Company receives the following fees:
 
 ·
              Directors
                  of the Bank receive an annual retainer fee of
                  $3,000.
 ·
              Directors
                  of the Bank receive $500 per meeting for their attendance at monthly
                  and
                  any special meetings of the Board of
                  Directors.
 ·
              Directors
                  of the Company receive $200 per meeting for their attendance at
                  monthly
                  and any special meetings of the Board of Directors and any committee
                  meeting held on the same day as the Board of Directors’
                  meetings.
 ·
              Committee
                  members also receive $300 for each committee meeting that is not
                  held on
                  the same day as the Board of Directors
                  meetings.
 
 Non-employee
        directors may elect to have the payment of their directors’ fees deferred
        pursuant to the Directors’ Deferred Compensation Plan. Total directors’ meeting
        and committee fees for fiscal 2005 were $120,000. We do not compensate our
        employees for service as directors. Directors are also entitled to the
        protection of certain indemnification provisions in our Articles of
        Incorporation and Bylaws.
 
 **Executive
        Officers**
 The
        following individuals are executive officers of the Company and the Bank
        and
        hold the offices set forth below opposite their names.
 ****
              **Position
                  Held**Edwin
                  N. Clift
              Chairman
                  and Chief Executive Officer of the Company and BankWilliam
                  P. Lucy
              President
                  of the Company and BankDeborah
                  A. Jordan
              Secretary/Treasurer
                  of the Company and Executive Vice President/Treasurer of the
                  Bank
   -8-
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  The
        Board
        of Directors elects the executive officers of the Company and the Bank annually.
        The elected officers hold office until their respective successors have been
        elected and qualified, or until death, resignation or removal by the Board
        of
        Directors.
 
 Biographical
        information of executive officers, who are not directors or proposed directors
        of the Company, is set forth below.
 
 **Deborah
        A. Jordan** ,
        age 40,
        has served as Executive Vice President since December 1999, and as Chief
        Financial Officer of the Bank and Treasurer of the Company since 1993. From
        1987
        to 1992, she was employed as an audit manager at Arthur Andersen, LLP in
        Boston.
        She is a graduate of Husson College, Eastern Maine Technical College and
        is a
        Certified Public Accountant. Ms. Jordan serves as a director of Eastern Maine
        Technical College Foundation.
 
 **Compensation
        of Executive Officers and Transactions with Management**
 
 The
        following table sets forth cash and non-cash compensation received during
        each
        of the Company’s last three fiscal years by Mr. Clift, Mr. Lucy and Ms. Jordan,
        who are the only executive officers for whom compensation exceeded $100,000
        in
        any year.
 
 **Summary
        Compensation Table**
 
 **Annual
                  Compensation**
              
              **Long-Term
                  Compensation****Number
                  of Stock**
              
              **All
                  Other****Executive
                  Officer**
              
              **Year**
              
              **Salary**
              
              **Bonus**
              
              **Options
                  Granted**
              
              **Compensation**Edwin
                  N. Clift
              
              
              2005
              
              $
              200,000
              
              $
              110,000
              
              
              —
              
              $
              32,496(1
              )Chairman
                  and Chief
              
              
              2004
              
              
              190,000
              
              
              100,000
              
              
              —
              
              
              41,699Executive
                  Officer
              
              
              2003
              
              
              170,000
              
              
              90,000
              
              
              —
              
              
              39,712William
                  P. Lucy
              
              
              2005
              
              
              150,000
              
              
              50,000
              
              
              —
              
              
              12,316(1
              )President
              
              
              2004
              
              
              130,000
              
              
              45,000
              
              
              —
              
              
              12,8052003
              
              
              115,000
              
              
              45,000
              
              
              —
              
              
              14,667Deborah
                  A. Jordan
              
              
              2005
              
              
              122,500
              
              
              45,000
              
              
              —
              
              
              13,932(1
              )Executive
                  Vice President
              
              
              2004
              
              
              112,500
              
              
              40,000
              
              
              —
              
              
              12,4442003
              
              
              100,000
              
              
              40,000
              
              
              —
              
              
              11,343
 
 (1)
                  Totals
                      for 2005 in this column are comprised of: (a) employer contributions
                      to
                      the 401(k) plan of $6,300 for Mr. Clift, $5,862 for Mr. Lucy
                      and $4,887
                      for Ms. Jordan; (b) dollar value of premiums paid by the Bank
                      with respect
                      to term life insurance and life insurance under the Life Insurance
                      Endorsement Method Split-Dollar Plan Agreement of $6,834 for
                      Mr. Clift,
                      $577 for Mr. Lucy and $640 for Ms. Jordan; (c) the value to
                      the officers
                      of a Company-owned vehicle of $5,824 for Mr. Clift, $4,082
                      for Mr. Lucy
                      and $7,091 for Ms. Jordan; and (d) the vested benefit accrued
                      under the
                      Supplemental Executive Retirement Plan of $13,538 for Mr. Clift,
                      $1,795
                      for Mr. Lucy and $1,314 for Ms. Jordan.
 
 **Supplemental
        Executive Retirement Plan**
 The
        Company provides a non-qualified supplemental executive retirement plan (the
        “SERP”) for the benefit of key employees. Life insurance policies were acquired
        for the purpose of serving as the primary funding source. The amount of each
        annual benefit is indexed to the financial performance of each insurance
        policy
        owned by the Bank over the Bank’s cost of funds expense. The first year’s
        projected retirement benefit for Mr. Clift is $37,000. Assuming twenty years
        of
        service, the projected retirement benefits for Mr. Lucy and Ms. Jordan are
        $30,000 per year. The SERP provides that in the event of a change of control
        and
        the executive suffers a termination of service, then the executive shall
        receive
        full retirement benefits upon early retirement age.
  -9-
 **Back
            to Table of Contents**
 
 **Employment
        Agreements**
 The
        Company currently has an employment agreement with Mr. Bullock. This agreement
        provides for the payment of an annual salary of $24,000 through April 2007
        and a
        $24,000 annual payment thereafter for the remainder of Mr. Bullock’s life or his
        spouse, whichever survives.
 
 The
        agreement also provides that, to the extent not inconsistent with applicable
        federal, state or local law (including common law), or with the Articles
        of
        Incorporation or Bylaws of the Company and the Bank, and to the extent that
        Mr.
        Bullock is not in material breach of the agreement, the Company will provide
        for
        representation on or will recommend nomination for election to the Board
        of
        Directors of the Company and the Bank for Mr. Bullock, another designee of
        the
        Bullock Family Trust (the “Trust”) or a member of Mr. Bullock’s immediate
        family, so long as the Trust and/or Mr. Bullock’s immediate family owns more
        than 3% of the common stock of the Company.
 
 The
        Bank
        has also entered into employment agreements with each of Edwin N. Clift,
        William
        P. Lucy and Deborah A. Jordan to secure their services to the Bank in their
        current positions. The employment agreements may be renewed annually after
        a
        review of each executive's performance. These agreements provide for a minimum
        annual salary of $200,000, $150,000 and $122,500 to be paid to Mr. Clift,
        Mr.
        Lucy and Ms. Jordan, respectively. The employment agreements also provide
        for
        discretionary cash bonuses and participation on generally applicable terms
        and
        conditions in other compensation and fringe benefit plans. The Bank may
        terminate each executive's employment, and each executive may resign, at
        any
        time with or without cause. However, in the event of termination during the
        term
        without cause, the Bank will owe the executive severance benefits generally
        equal to the value of the salary that the executive would have received if
        he or
        she had continued working for the remaining unexpired term of the agreement
        plus
        continued insurance benefits for the remaining unexpired term of the agreement.
        The same severance benefits would be payable if an executive resigns during
        the
        term following a material breach of contract by the Bank which is not cured
        within 30 days. For 90 days after a change in control, each executive may
        also
        resign for any reason and collect severance benefits as if he or she had
        been
        discharged without cause calculated as if the remaining unexpired term of
        the
        agreement is two years.
 
 If
        the
        Company or the Bank experiences a change in ownership, a change in effective
        ownership or control or a change in the ownership of a substantial portion
        of
        their assets as contemplated by section 280G of the Internal Revenue Code
        ("Section 280G"), the severance payments under the employment agreements
        will be
        capped at 2.99 multiplied by each executive's respective "base amount" as
        such
        term is defined in Section 280G such that no amount might constitute an "excess
        parachute payment" under current federal tax laws. The effect of this provision
        is that deductions for payments made under the employment agreements to Mr.
        Clift, Mr. Lucy and Ms. Jordan will not be disallowed due to Section
        280G.
 
 **Interests
        in Certain Transactions**
 The
        Company’s executive officers, its directors and their associates have had, and
        can be expected to have in the future, financial transactions with the Bank
        in
        the ordinary course of business. All such transactions have been and will
        be
        made on substantially the same terms, including interest rates and collateral,
        as those prevailing at the time for comparable transactions with others.
        These
        transactions do not involve more than normal risk of collectibility or present
        other unfavorable features.
 
 **Compensation
        Committee Report**
 *The
        Compensation Committee Report (the “Report”) and the Performance Graph (the
“Graph”) included in this section are provided in accordance with the rules and
        regulations of the SEC. Pursuant to such rules and regulations, the Report
        and
        the Graph shall not be deemed “soliciting material,” filed with the SEC, subject
        to Regulation 14A or 14C of the SEC or subject to the liabilities of Section
        18
        of the Exchange Act.*
 
 The
        2005 compensation program described in this Proxy Statement was established
        by
        the Compensation Committee of the Company’s Board of Directors. This Committee
        is comprised entirely of non-employee directors. Each member of the Compensation
        Committee is independent, as set forth in The Nasdaq Stock Market’s listing
        standards.
  -10-
 **Back
            to Table of Contents**
  Each
        December, the members of the Compensation Committee review and approve changes
        to base compensation, bonuses and benefits for senior management and other
        officers. The Company’s compensation program is designed to attract, develop and
        retain strong individuals who are capable of maximizing the Company’s
        performance for the benefit of the stockholders.
 
 The
        2005 compensation program consisted of three components: (1) base salary;
        (2)
        bonuses; and (3) long-term incentives, e.g., fringe benefits. These elements
        were intended to provide an overall compensation package that is commensurate
        with the Company’s financial resources, that is appropriate to assure the
        retention of experienced management personnel, and align their financial
        interests with those of the Company’s stockholders.
 
 During
        2005, base salaries were set at levels determined, in the subjective judgment
        of
        the Compensation Committee, to be commensurate with the officers’ customary
        respective duties and responsibilities. Bonuses were based primarily on the
        achievement of established goals. Fringe benefit plans, consisting of a 401(k)
        plan and group insurance coverage, were designed to provide for health and
        welfare of the officers and their families, as well as for their long-term
        financial needs.
 
 The
        Committee established the Chief Executive Officer’s base salary for 2005 at
        $200,000, a 5% increase over his base salary for 2004, using the criteria
        above,
        together with an independent salary survey of Chief Executive Officers of
        similar financial institutions located in New England.
 
 Members
                  of the Compensation Committee*Perry
                  B. Hansen, Chair*
              *Dennis
                  L. Shubert, M.D., Ph.D.**Joseph
                  H. Cyr*
              *Frederick
                  A. Oldenburg, Jr., M.D.*
  ***Compensation
        Committee Interlocks and Insider Participation.*** The
        Compensation Committee consists of Directors Hansen (Chair), Cyr, Oldenburg,
        and
        Shubert. No member of the Compensation Committee was an officer or employee
        of
        the Company or the Bank during 2005 or was formerly an officer of the Company
        or
        the Bank. In addition, no executive officer of the Company served as a member
        of
        another entity’s Board of Directors or as a member of the Compensation Committee
        of another entity (or other board committee performing equivalent functions)
        during 2005, which entity had an executive officer serving on the Board of
        Directors of the Company or the Bank.
  -11-
 **Back
            to Table of Contents**
 
 **Performance
        Graph**
 
 Set
        forth
        below is a line graph comparing the five-year cumulative total return of
        $100.00
        invested in the Company’s common stock (“MERB”), assuming reinvestment of all
        cash dividends and retention of all stock dividends, with a comparable amount
        invested in the Russell 2000 Stock Index (“Russell”) and the NASDAQ Bank Stock
        Index (“NASDAQ Bank”). The NASDAQ Bank Index is a capitalization-weighted index
        designed to measure the performance of all NASDAQ stocks in the banking
        sector.
 
 
 
 **Additional
        Information**
 
 **Stockholder
        Communications with our Board of Directors**
 Stockholders
        may contact our Board of Directors by contacting Deborah A. Jordan, Secretary,
        Merrill Merchants Bancshares, Inc., 201 Main Street, Bangor, ME 04402-0925.
        All
        comments will be forwarded directly to the Board of Directors.
 
 **Stockholder
        Proposals for the 2007 Annual Meeting**
 Stockholders
        interested in submitting a proposal for inclusion in the proxy materials
        for the
        Annual Meeting of Stockholders in 2007 may do so by following the procedures
        prescribed in SEC Rule 14a-8. To be eligible for inclusion, stockholder
        proposals must be received by the Company’s Corporate Secretary no later than
        November 11, 2006. In addition, under our Bylaws, if you wish to nominate
        a
        director or bring other business before the Annual Meeting, you must be a
        stockholder and give timely notice in writing to the Company as specified
        in our
        Bylaws.
 
 **Other
        Matters**
 The
        Board
        of Directors of the Company knows of no business that will be presented for
        consideration at the Annual Meeting other than the items referred to above.
        If
        any other matter is properly brought before the meeting for action by
        stockholders, proxies in the enclosed form returned to the Company will be
        voted
        in accordance with the recommendation of the Board of Directors or, in the
        absence of such a recommendation, in accordance with the judgment of the
        proxy
        holder.
 
 A
        copy of
        our annual report on Form 10-K for the year ending December 31, 2005 accompanies
        this proxy statement, as does a summary annual report to stockholders for
        this
        year. These reports are not part of the proxy solicitation
        materials.
  -12-
 **REVOCABLE
          PROXY**
 **Merrill
          Merchants Bancshares, Inc.**
 **Annual
          Meeting of Stockholders**
 **May
          4, 2006**
  The
          undersigned hereby appoints Deborah A. Jordan and Edwin N. Clift, and each
          of
          them, as proxies of the undersigned, with full powers of substitution,
          to act
          and to vote all the shares of common stock of Merrill Merchants
          Bancshares, Inc. held of record by the undersigned on March 6, 2006, at the
          Annual Meeting of Stockholders to be held on May 4, 2006, or at any adjournment
          thereof, and hereby revokes all former proxies.
  This
          Proxy, when properly executed, will be voted in the manner directed herein
          by
          the undersigned stockholder. If no direction is given, this Proxy will
          be voted
          "FOR" the election of all nominees listed in Item 1 and "FOR" the proposal
          listed in Item 2.
  PLEASE
          MARK VOTES AS IN THIS EXAMPLE. ý
  1.
                Election
                    of Directors-Directors
                    with Terms Expiringin
                    2009:
                For
                Withhold
                  All
                For
                    All
                  Except
                
                2.
                Ratification
                    of the appointment of Berry, Dunn, McNeil & Parker asindependent
                    registered public accountants for the fiscal year ending December
                    31,
                    2006.
                For
                Against
                Abstaino
                o
                o
                
                
                
                o
                o
                o**01**-
                    Joseph H. Cyr**02**-
                    John R. Graham, III**03**-
                    William P. LucyDirectors
                    with Terms Expiringin
                    2007:**04**-
                    Michael T. Shea(Except
                    nominee(s) written above)
 
 In
                    their discretion the Proxies are authorized to vote as the Board
                    of
                    Directors may deem advisable upon such other business as may
                    properly come
                    before the meeting.THIS
                    PROXY WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED
                    HEREIN
                    BY THE UNDERSIGNED STOCKOWNER.**IF
                    NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED FOR ITEMS 1 AND
                    2.**THE
                    BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH OF THE LISTED
                    PROPOSALS.THIS
                    PROXY IS SOLICITED BY THE BOARD OF
                    DIRECTORS.
 
 Signature
                SignatureDated:                                    ,
                    2006
  Please
          sign exactly as your name or names appear above. For joint accounts, each
          owner
          should sign. When signing as executor, administrator, attorney, trustee
          or
          guardian, please give your full title.