SALISBURY BANCORP INC
(a)  General Development of the Business  Salisbury  Bancorp, Inc. (AMEX:SAL) (the "Company") is a Connecticut corporation that  was  formed in 1998. Its primary activity is to act as the holding company for  its  sole  subsidiary,  the  Salisbury Bank and Trust Company (the "Bank"), which  accounts  for  most  of  the  Company's  net income. The Bank assumed its present  name  in  1925  following  the acquisition by the Robbins Burrall Trust Company  of the Salisbury Savings Society. The Robbins Burrall Trust Company was incorporated  in  1909 as the successor to a private banking firm established in 1874.  The  Salisbury  Savings  Society  was  incorporated  in 1848. The Bank is chartered  as a state bank and trust company by the State of Connecticut and its deposits  are insured by the Federal Deposit Insurance Corporation in accordance with  the  Federal Deposit Insurance Act. The Bank's main office is at 5 Bissell Street,  Lakeville,  Connecticut  06039. Its telephone number is (860) 435-9801, and  its website address is: www.salisbury-bank.com. The Company makes available free  of charge on the Bank's website a link to its Annual Reports on Form 10-K, Quarterly  Reports on Forms 10-Q and Current Reports on Form 8-K, promptly after filing  such  reports  with  the  SEC.  On  September  10, 2004 the Company completed the acquisition of Canaan National Bancorp,  Inc.  and  the merger with and into the Company. Following the merger, the  Bank  operated  five  (5) full service offices which are located in Canaan, Lakeville,  Salisbury and Sharon, Connecticut and South Egremont, Massachusetts. In  addition, a branch in Sheffield, Massachusetts opened in March 2005. Most of the  Bank's  business  is  derived  from customers located in Litchfield County, Connecticut, Dutchess County and Columbia County, New York and Berkshire County, Massachusetts.  (b)  Financial Information about Industry Segments  The Company's products and services are all of a nature of a commercial bank and trust company.       Lending  Lending is a principal business of the Bank, and loans represent a large portion of the Bank's  assets.  The  portfolio  consists  of many types of loans.  These include residential mortgages,  home equity lines of credit, monthly installment loans for consumers, as well as commercial loans, which include lines of credit, short term loans,  Small Business  Administration  ("SBA") loans and real estate loans for business customers.  The primary  lending  activity has been the  origination of first mortgage loans for the purchase,  refinance or  construction  of residential  properties in the Bank's  market  area.  Loans  secured by  mortgages  on a  borrower's  principal residence are generally viewed as the least vulnerable to major economic changes and at the same time  provide a  significant  yet  relatively  stable  source of interest income. Presently, loans are maintained in the Bank's portfolio as well as sold to investors on the secondary  mortgage market.  This provides customers the opportunity to choose from a wide array of competitive mortgage products and rate structures.  The Bank also  originates  a variety of other loans for  consumer  and  business purposes.  Although these loans represent a smaller percentage of the total loan portfolio,  the Bank is in the position of being a full service retail lender to its consumers and a full service commercial lender to its business customers.       Investments  The Company's investment portfolio is also an important component of the Balance Sheet.  It provides a source of earnings in the form of interest and  dividends. It also plays a role in the interest rate risk management of the Company, and it provides a source of liquidity.  The portfolio is comprised primarily of U.S. Government sponsored agencies, U.S. Treasury and mortgage-backed securities and securities of political subdivisions of the states.  At December 31, 2005, the portfolio totaled  $151,168,000  which represents  approximately  37.52% of total assets,  and it produced interest and dividend  income of $7,427,000 for the year 2005 as compared with $6,905,000 for 2004 and $6,385,000 for 2003, respectively.                                         1        Deposits and Borrowings  The Bank's  primary  sources of funds are  deposits,  borrowings  and  principal payments on loans. Although competition for funds from non-banking  institutions remains   aggressive,   the  Bank   continues   its  efforts  to  build  account relationships  with its customers.  Average daily deposits totaled  $293,453,000 during 2005.  The  Bank is a  member  of the  Federal  Home  Loan  Bank of  Boston  ("FHLBB"). Borrowings from FHLBB totaled  $71,016,000 at December 31, 2005 as compared with $79,213,000 at December 31, 2004.  For  additional  information  relating  to  the  asset,  deposit  and  borrowing components of the Company,  see Item 7, Management's  Discussion and Analysis of Financial Condition and Results of Operations and the accompanying  Consolidated Financial Statements, and Notes thereto.       Fiduciary  The Bank  provides  trust,  investment  and financial  planning  services to its customers.  The Bank has a full service Trust  Department.  Among the services  offered are: custody and agency  accounts,  estate  planning and estate  settlement.  Another service is that of serving as Guardian or  Conservator  of estates and  managing the financial position of Guardianships or Conservatorships.  Self directed IRAs and Pension plans are also offered.       All Others  The Company also offers safe deposit rentals,  foreign exchange,  a full menu of electronic fund transfer services and other ancillary services to businesses and individuals.  (c)  Narrative Description of Business  Salisbury Bancorp, Inc. is a bank holding company, which as described above, has one subsidiary, Salisbury Bank and Trust Company (the "Bank").  The Bank is a full-service  commercial bank and its activities encompass a broad range of services,  which include a complete menu of deposit services,  multiple mortgage  products  and  various  other  types of loans  for both  business  and personal  needs.  Full  trust  services  are also  available.  The Bank owns and operates two  subsidiaries,  SBT Realty,  Inc., which is incorporated  under the laws of the State of New York, and SBT Mortgage  Service  Corporation,  which is incorporated under the laws of the State of Connecticut.  SBT Realty, Inc. holds and manages  bank owned real estate  situated  in New York state.  SBT  Mortgage Service  Corporation,  a Passive  Investment  Company ("PIC") was formed to take advantage of favorable  Connecticut  corporate tax benefits which results when a Bank transfers a portion of its mortgage portfolio to a PIC. In general, the PIC will earn mortgage  interest income and may dividend funds to the Bank. In turn, those funds will be exempt from the Connecticut corporate business tax.       Competition  The Company and the Bank encounter  competition in all phases of their business. There are  numerous  financial  institutions  that have  offices in the areas in which  the  Company  and  Bank  compete  in  Northwestern  Connecticut,  Western Massachusetts and proximate areas of New York state.  The  offices  of  the  Bank  are  located  in the northwest corner of Litchfield County,  Connecticut  and  South  Berkshire  County,  Massachusetts.   The  Bank maintains  six  (6)  banking offices within these two counties and also attracts customers  from nearby Columbia County and Dutchess County, New York. The Bank's market  area  within  the  four  counties  is  served by 45 commercial banks and savings  banks.  Banks  compete  on the basis of price,  including  rates  paid on  deposits  and charged on  borrowings,  convenience  and quality of  service.  Savings and loan associations  are able to  compete  aggressively  with  commercial  banks in the important area of consumer  lending.  Credit unions and small loan companies are each significant factors in the consumer market. Insurance companies, investment firms, credit and mortgage companies,  brokerage firms cash management accounts, money-market  funds and retailers are all  significant  competitors  for various types of business.  Insurance companies,  investment  counseling firms and other                                         2   businesses  and  individuals  actively  compete  with the Bank for  personal and corporate  trust  services and  investment  counseling  services.  Many non-bank competitors  are not subject to the extensive  regulation  described below under "LEGISLATION,  REGULATION AND  SUPERVISION"  and in certain  respects may have a competitive advantage over banks in providing certain services.  In marketing its services,  the Bank  emphasizes its position as a hometown bank with personal service, flexibility and prompt responsiveness to the needs of its customers.  Moreover,  the Bank competes for both deposits and loans by offering competitive  rates and  convenient  business  hours.  In addition  to  providing banking services to customers in its primary service areas, the Bank is a member of the automatic teller machine  networks and offers internet banking  services, which  allow  the  Bank to  deliver  certain  financial  services  to  customers regardless of their proximity to the primary service area of the Bank.  Connecticut has enacted  legislation that liberalizes  banking powers for thrift institutions  thereby improving their competitive  position with other banks. In addition,   the  Connecticut   Interstate  Banking  and  Branching  Act  permits acquisitions  and mergers of Connecticut  banks and bank holding  companies with banks and bank holding  companies in other states.  Accordingly,  it is possible for large super-regional  organizations to enter many new markets, including the market served by the Bank. Certain of these competitors, by virtue of their size and resources,  may enjoy certain  efficiencies and competitive  advantages over the Bank in the pricing, delivery, and marketing of their products and services. It is possible that such  legislative  authority will increase the number or the size of financial institutions competing with the Bank for deposits and loans in its  market  place,  although  it is  impossible  to  predict  the  effect  upon competition of such legislation.  Legislation, Regulation and Supervision  General  Virtually  every  aspect of the  business  of banking is subject to  regulation, including  such  matters  as the  amount of  reserves  that must be  established against various deposits,  the establishment of branches,  mergers,  non-banking activities and other  operations.  Numerous laws and regulations  also set forth special  restrictions and procedural  requirements with respect to the extension of credit,  credit practices,  the disclosure of credit terms and discrimination in credit transactions.  The descriptions of the statutory provisions and regulations applicable to banks set forth below do not purport to be a complete description of such statutes and regulations  and their  effects  on the Bank.  Proposals  to change the laws and regulations   governing  the  banking  industry  are  frequently  introduced  in Congress,  in the state  legislatures  and before the  various  bank  regulatory agencies.  The  likelihood and timing of any changes and the impact such changes might  have  on the  Bank's  future  business  and  earnings  are  difficult  to determine.  Federal Reserve Board Regulation  The Company is a registered  bank holding company under the Bank Holding Company Act of 1956,  as amended  (the  "BHCA").  It is subject to the  supervision  and examination  of the  Board of  Governors  of the  Federal  Reserve  System  (the "Federal Reserve Board") and files with the Federal Reserve Board the reports as required under the BHCA.  The BHCA generally  requires prior approval by the Federal  Reserve Board of the acquisition by the Company of substantially  all of the assets or more than five percent (5%) of the voting  stock of any bank.  The BHCA also allows the Federal Reserve Board to determine (by order or by  regulation)  what  activities are so closely  related to banking as to be a proper  incident  of  banking,  and thus, whether  the  Company  can engage in such  activities.  The BHCA  prohibits  the Company and the Bank from engaging in certain tie-in  arrangements in connection with any extension of credit, sale of property or furnishing of services.  Federal  legislation  permits  adequately  capitalized bank holding companies to venture across state lines to offer banking services  through bank  subsidiaries to  a  wide  geographic   market.  It  is  possible  for  large   super-regional organizations  to enter many new  markets,  including  the market  served by the Bank,  although  it is  impossible  to assess  what impact this will have on the Company or the Bank.  The Federal Reserve Act imposes certain restrictions on loans by the Bank to the Company  and  certain  other  activities,  on  investments,  in  their  stock or securities,  and on the  taking  by the  Bank of such  stock  or  securities  as collateral security for loans to any borrower.                                         3   Under the BHCA and the  regulations of the Federal  Reserve  System  promulgated thereunder ("Regulation Y"), no corporation may become a bank holding company as defined  therein,  without  prior  approval of the Federal  Reserve  Board.  The Company received the approval to become a bank holding company on June 18, 1998. The Company will also have to secure prior approval of the Federal Reserve Board if it  wishes  to  acquire  voting  shares  of any  other  bank,  if after  such acquisition  it would own or control  more than five  percent (5%) of the voting share of such bank.  The BHCA  imposes  limitations  upon the  Company as to the types of business in which it may engage.  Regulation  Y requires  bank holding  companies  to provide the Federal  Reserve Board with written notice before  purchasing or redeeming  equity  securities if the gross consideration for the purchase or redemption, when aggregated with the net  consideration  paid by the Company for all such  purchases  or  redemptions during the preceding  twelve (12) months,  is equal to ten percent (10%) or more of the  Company's  consolidated  net worth.  For purposes of  Regulation Y, "net consideration"  is the  gross  consideration  paid by a  company  for all of its equity  securities  purchased  or redeemed  during the  period,  minus the gross consideration  received for all of its equity  securities sold during the period other than as part of a new issue.  However,  a bank  holding  company  need not obtain Federal  Reserve Board approval of any equity security  redemption  when: (i) the bank holding company's  capital ratios exceed the threshold  established for  "well-capitalized"  state  member banks  before and  immediately  after the redemption;  (ii) the bank holding company is  well-managed;  and (iii) the bank holding company is not the subject of any unresolved supervisory issues.  The  Gramm-Leach-Bliley  Financial  Services  Modernization  Act  of  1999  (the "GLBA"),  provides bank holding companies,  banks,  securities firms,  insurance companies,  and  investment  management  firms the option of engaging in a broad range of  financial  and  related  activities  by opting to become a  "financial holding  company." The Company  qualified and registered as a financial  holding company on May 3, 2000.  Financial holding companies are subject to oversight by the Federal Reserve Board, in addition to other regulatory  agencies.  Under the financial holding company structure, bank holding companies have greater ability to purchase or establish nonbank  subsidiaries,  that are financial in nature or that engage in activities  incidental or complementary to a financial  activity. Additionally, pursuant to the GLBA, securities and insurance firms are permitted to  purchase  full-service  banks.  While the GLBA  facilitates  the  ability of financial  institutions  to offer a wide  range  of  financial  services,  large financial  institutions would appear to be the beneficiaries as a result of this Act  because  many  community  banks  are less able to devote  the  capital  and management resources needed to facilitate broad expansion of financial services.  In July, 2002,  President Bush signed into law the  Sarbanes-Oxley  Act of 2002. The purpose of the  Sarbanes-Oxley  Act is to protect investors by improving the accuracy  and  reliability  of  corporate   disclosures  made  pursuant  to  the securities laws, and for other purposes.  The Sarbanes-Oxley Act amends the Securities  Exchange Act of 1934 to prohibit a registered  public accounting firm from performing  specified  nonaudit services contemporaneously  with a mandatory audit. The Sarbanes-Oxley Act also vests the audit  committee  of  an  issuer  with   responsibility   for  the  appointment, compensation, and oversight of any registered public accounting firm employed to perform audit services.  It requires each committee member to be a member of the board  of  directors  of  the  issuer,  and  to be  otherwise  independent.  The Sarbanes-Oxley  Act  further  requires  the chief  executive  officer  and chief financial officer of an issuer to make certain  certifications as to each annual or quarterly report.  In addition, the Sarbanes-Oxley Act requires officers to forfeit certain bonuses and profits under certain circumstances.  Specifically, if an issuer is required to prepare an accounting  restatement due to the material  noncompliance  of the issuer as a result of misconduct with any financial reporting requirements under the securities laws, the chief executive  officer and chief financial officer of the issuer shall be required to reimburse  the issuer for (1) any bonus or other incentive-based  or equity based  compensation  received by that person from the issuer during the 12-month period  following the first public issuance or filing with  the SEC of the  financial  document  embodying  such  financial  reporting requirements;  and (2) any profits  realized  from the sale of securities of the issuer during that 12-month period.  The Sarbanes-Oxley Act also instructs the SEC to require by rule:  o    Disclosure of all material  off-balance sheet transactions and relationship      that may have a material effect upon the financial status of an issuer; and  o    The presentation of pro forma financial information in a manner that is not      misleading,  and which is reconcilable with the financial  condition of the      issuer under generally accepted accounting principles.                                         4   The  Sarbanes-Oxley  Act also prohibits  insider  transactions  in the Company's stock during a lock out period of Company's  pension  plans,  and any profits of such  insider  transactions  are  to  be  disgorged.  In  addition,  there  is a prohibition of company loans to its executives, except in certain circumstances. The  Sarbanes-Oxley  Act also provides for mandated  internal control report and assessment with the annual report and an attestation and a report on such report by  Company's  auditor.  The SEC also  requires an issuer to institute a code of ethics  for  senior  financial  officers  of  the  company.   Furthermore,   the Sarbanes-Oxley Act adds a criminal penalty of fines and imprisonment of up to 10 years for securities fraud.  The terrorist  attacks in September,  2001 have impacted the financial  services industry and led to federal  legislation that attempts to address certain issues involving financial  institutions.  In 2001,  President Bush signed into law the Uniting and  Strengthening  America by Providing  Appropriate  Tools Required to Intercept and Obstruct  Terrorism Act of 2001 (the "Patriot  Act"). On March 10, 2006, the President signed  legislation  making permanent certain  provisions of the Patriot Act.  Part of the Patriot Act is the  International  Money  Laundering  Abatement  and Financial  Anti-Terrorism Act of 2001 ("IMLA"). IMLA authorizes the Secretary of the Treasury,  in consultation with the heads of other government  agencies,  to adopt special measures applicable to banks, bank holding companies, and/or other financial  institutions.  These measures may include enhanced  recordkeeping and reporting  requirements for certain  financial  transactions that are of primary money laundering concern, due diligence  requirements  concerning the beneficial ownership of certain types of accounts,  and  restrictions  or  prohibitions  on certain types of accounts with foreign financial institutions.  Among its other  provisions,  IMLA requires each financial  institution  to: (i) establish  an  anti-money  laundering  program;  (ii)  establish  due  diligence policies,  procedures and controls with respect to its private banking  accounts and correspondent  banking accounts  involving  foreign  individuals and certain foreign banks;  and (iii) avoid  establishing,  maintaining,  administering,  or managing  correspondent  accounts  in the United  States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, IMLA contains a provision encouraging  cooperation among financial institutions, regulatory   authorities  and  law  enforcement   authorities  with  respect  to individuals,  entities and organizations  engaged in, or reasonably suspected of engaging in,  terrorist acts or money  laundering  activities.  IMLA expands the circumstances  under which funds in a bank account may be forfeited and requires covered  financial  institutions  to  respond  under  certain  circumstances  to requests for information  from federal banking  agencies within 120 hours.  IMLA also  amends the BHCA and the Bank  Merger Act to require  the  federal  banking agencies to consider the effectiveness of a financial  institution's  anti-money laundering activities when reviewing an application under these acts.  Connecticut Regulation  The Company is  incorporated  in the State of Connecticut  and is subject to the Connecticut  Business  Corporation Act and the Connecticut  Bank Holding Company Statutes.  As  a  state-chartered   bank  and  member  of  the  Federal  Deposit  Insurance Corporation ("FDIC"),  the Bank is subject to regulation both by the Connecticut Banking  Commissioner  and the  FDIC.  Applicable  laws and  regulations  impose restrictions and  requirements in many areas,  including  capital  requirements, maintenance of reserves, establishment of new branch offices, mergers, making of loans and  investments,  consumer  protection,  employment  practices  and other matters.   Any  new  regulations  or  amendments  to  existing  regulations  may materially  affect  the  services  offered,   expenses  incurred  and/or  income generated by the Bank.  The Connecticut Banking Commissioner  regulates the Bank's internal organization as well as its deposit,  lending and investment activities.  The approval of the Connecticut Banking Commissioner is required to, among other things, open branch offices and consummate merger transactions and other business combinations.  The Connecticut Banking Commissioner conducts periodic examinations of the Bank. The Connecticut banking statutes also restrict the ability of a bank to declare cash dividends to its stockholders.  Subject to certain  limited  exceptions,  loans made to any one  obligor may not exceed fifteen percent (15%) of the Bank's capital,  surplus,  undivided profits and loan reserves. In addition,  under Connecticut law, the beneficial ownership of more than ten percent  (10%) of any class of voting  securities of a bank may not be acquired by any person or groups of persons acting in concert without the approval of the Connecticut Banking Commissioner.  FDIC Regulation                                         5   The FDIC  currently  insures  the  Bank's  deposit  accounts  in an amount up to $100,000 for each insured depositor.  In addition,  effective April 1, 2006, the federal  deposit  insurance  limits  on  certain  retirement  accounts  will  be increased so that such  retirement  accounts  will be  separately  insured up to $250,000. FDIC insurance of deposits may be terminated by the FDIC, after notice and a  hearing,  upon a finding  by the FDIC that the  insured  institution  has engaged in unsafe or unsound practices,  or is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation,  rule or order of, or  condition  imposed  by,  the FDIC.  A bank's  failure  to meet the minimum  capital and  risk-based  capital  guidelines  discussed  below would be considered  to  be  unsafe  and  unsound  banking  practices.  The  Bank,  as  a Connecticut-chartered FDIC-insured bank, is regulated by the FDIC in many of the areas also  regulated by the  Connecticut  Banking  Commissioner.  The FDIC also conducts its own periodic examinations of the Bank, and the  Bank is  required  to  submit  financial  and  other  reports  to the  FDIC on a quarterly and annual basis, or as otherwise required by the FDIC.  FDIC-insured banks, such as the Bank, pay premiums to the FDIC for the insurance of deposits.  Under  FDIC  regulations,  FDIC-insured,  state-chartered  banks  which  are not members  of the  Federal  Reserve  System,  must meet  certain  minimum  capital requirements, including a leverage capital ratio and a risk-based capital ratio. See "MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".  The  Community  Reinvestment  Act  ("CRA")  requires  lenders  to  identify  the communities  served by the  institution's  offices and to identify  the types of credit the institution is prepared to extend within such  communities.  The FDIC conducts  examinations  of insured  institutions'  CRA compliance and rates such institutions   as   "Outstanding",   "Satisfactory",   "Needs  to  Improve"  and "Substantial Noncompliance". As of its last CRA examination, the Bank received a rating of "Outstanding". Failure to receive at least a "Satisfactory" rating may inhibit  an  institution   from  engaging  in  certain   activities,   including acquisitions of other financial institutions,  which require regulatory approval based, in part, on CRA compliance considerations.  Similarly,  failure of a bank to maintain a CRA rating of  "Satisfactory"  or better would  preclude it or its holding  company from engaging in any new financial  activities  pursuant to the Gramm-Leach-Bliley Act.  Employees  The  Company's  current  workforce at March 3, 2006 consists of 125 employees of whom 111 were full time and 14 were part time. The employees are not represented by a collective bargaining unit.  (d)  Financial  Information  about  Foreign and Domestic  Operations  and Export      Sales  The Company does not have any foreign business operations or export sales of its own. However,  it does provide financial  services  including wire transfers and foreign currency exchange to other businesses involved in foreign trade.  STATISTICAL  DISCLOSURE  REQUIRED PURSUANT TO SECURITIES  EXCHANGE ACT, INDUSTRY GUIDE 3  The statistical disclosures required pursuant to Industry Guide 3, not contained in  Management's  Discussion and Analysis of Financial  Condition and Results of Operations, are presented on the following pages of this Report on Form 10-K.                                                                    Page(s) of Item of Guide 3                                                   This Report - ---------------                                                   -----------  I.   Distribution of Assets, Liabilities and Stockholders'      Equity; Interest Rates and Interest Differential                  18  II.  Investment Portfolio                                               7  III. Loan Portfolio                                                     8  IV.  Summary of Loan Loss Experience                                    9  V.   Deposits                                                          25  VI.  Return on Equity and Assets                                        8  VII. Short-Term Borrowings                                             10                                         6   Investment Portfolio  The Company  categorizes  investments into three groups and further provides for the  accounting  and  reporting  treatment  of each  group.  Investments  may be classified as  held-to-maturity,  available-for-sale,  or trading. The Bank does not purchase or hold any  investment  securities for the purpose of trading such investments.  The  following  tables  set  forth  the  carrying  amounts  of the investment securities as of December 31:    (dollars in thousands)                                2005       2004       2003                                                    ------------------------------     Available-for-sale securities:  (at fair value) Equity securities                                  $    148   $    146   $    136 U.S. government agencies preferred stock             12,446     12,209      7,610 U.S. Treasury securities and other    U.S. government corporations and agencies         50,516     53,416     51,979 Obligations of states and political subdivisions     41,332     58,452     45,988 Mortgage-backed securities                           41,166     54,432     37,307                                                    ------------------------------                                                    $145,608   $178,655   $143,020                                                    ==============================  Held-to-maturity securities  (at amortized cost) Mortgage-backed securities                         $    147   $    218   $    229                                                    ==============================  Federal Home Loan Bank stock                       $  5,413   $  5,413   $  3,771                                                    ==============================   For the  following  table,  yields are not  calculated  and presented on a fully taxable-equivalent ("FTE") basis.  The scheduled maturities of held-to-maturity  securities and  available-for-sale securities  (other than equity  securities)  were as follows as of December  31, 2005:    (dollars in thousands)                               Under                  1-5                   5-10                  Over 10                               1 Year      Yield     Years      Yield       Years        Yield     Years       Yield       Total                              ---------------------------------------------------------------------------------------------------           Held-to-maturity - ---------------- securities - ---------- (at amortized cost) Mortgage-backed  securities                  $      0              $      0               $      0               $    147       4.38%   $    147                              ========              ========               ========               ========               ========  Available-for-sale - ------------------ securities - ---------- (at fair value) U.S. Treasury securities  and other U.S. government  corporations and agencies   $      0              $      0               $ 17,384       4.91%   $ 33,132       5.96%   $ 50,516  Obligations of states and  political subdivisions             0                     0                    171       3.50%     41,161       4.41%     41,332  Mortgage-backed  securities                         0                   774       6.65%        434       7.58%     39,958       5.33%     41,166                              --------              --------               --------               --------               --------                              $      0              $    774               $ 17,989               $114,251               $133,014                              ========              ========               ========               ========               ========                                          7   Loan Portfolio Analysis by Category (dollars in thousands)                                                             December 31                                   2005         2004         2003         2002         2001                                -------------------------------------------------------------       Commercial, financial and    agricultural                $  15,354    $  15,127    $   9,149    $  10,127    $  10,797 Real Estate-construction and    land development               18,814       14,290       15,307        6,027        3,935 Real Estate - residential        135,619      130,414       90,807       93,636      102,201 Real Estate-commercial            40,889       35,487       19,199       18,002       17,423 Consumer                           7,900        9,122        6,692        9,007       10,030 Other                                 47           69           73          291          125                                -------------------------------------------------------------                                  218,623      204,509      141,227      137,090      144,511 Allowance for loan losses         (2,626)      (2,512)      (1,664)      (1,458)      (1,445) Unearned income                       (8)         (19)          (0)          (0)          (0)                                -------------------------------------------------------------      Net loans                 $ 215,989    $ 201,978    $ 139,563    $ 135,632    $ 143,066                                =============================================================   There are no industry concentrations in the Bank's loan portfolio.  The following table shows the maturity of commercial, financial and agricultural loans,  real  estate  commercial  loans  and  real   estate-construction   loans outstanding as of December 31, 2005. Also provided are the amounts due after one (1) year classified according to the sensitivity to changes in interest rates.                                                                  Due after                                                Due in one     one year to    Due after (dollars in thousands)                         year or less   five years     five years                                                ------------------------------------------     Commercial, financial,  agricultural and real estate commercial       $      1,341   $     10,297   $     44,605 Real estate-construction and land development        18,814              0              0                                                ------------------------------------------                                                $     20,155   $     10,297   $     44,605                                                ==========================================  Maturities after one year with:   Fixed interest rates                                        $      6,850   $      7,475   Variable interest rates                                            3,447         37,130                                                ------------------------------------------                                                               $     10,297   $     44,605                                                ==========================================   Return on Equity and Assets  The following table summarizes  various financial ratios of the Company for each of the last three (3) years:                                                                    At or for the                                                                 -------------                                                            Year ended December 31,                                                            -----------------------                                                           2005       2004       2003                                                           ----       ----       ----     Return on average total assets  (net income divided by average total assets)              1.12%      1.14%      1.24%  Return on average stockholders' equity  (net income divided by average stockholders' equity)     10.81%     12.34%     13.41%  Dividend payout ratio  (total declared dividends per share    divided by net income per share)                       36.90%     35.96%     34.07%  Equity to assets ratio  (average stockholders' equity as a percentage of    average total assets)                                  10.38%      9.20%      9.26%                                          8   Nonaccrual, Past Due and Restructured Loans  At  December  31,  2005,  there  were seven (7)  nonaccrual  loans in the Bank's portfolio six of which were secured by real estate.  In the month  following the month in which a  mortgage  loan  becomes 90 days past due,  the Bank  generally stops accruing interest unless there are unusual  circumstances which warrant an exception.  Generally  the  only  loan  types  that  the  Bank  reclassifies  to nonaccrual are those secured by real estate or large  commercial  loans on which substantial  collateral  exists.  Other types of loans are generally charged off when they become 120 days or more delinquent. However, exceptions may be made as warranted.  Nonaccrual, Past Due and Restructured Loans (dollars in thousands)                                                            December 31                                         2005      2004      2003      2002      2001                                       ----------------------------------------------       Nonaccrual                            $  694    $1,739    $   75    $  855    $  372 90 days or more past due                  79       528       535       124       215     Restructured loans                     0         0         0       271         0                                       ---------------------------------------------- Total nonperforming loans             $  773    $2,267    $  610    $1,250    $  587                                       ==============================================  Total nonperforming loans as per-    centage of the loan portfolio        0.35%     1.11%     0.43%     0.92%     0.41% Allowance for loan losses as a per-    centage of nonperforming loans     339.72%   110.81%   272.79%   116.64%   246.17%             Information with respect to nonaccrual and restructured loans                at December 31, 2005, 2004 and 2003 is as follows:    (dollars in thousands)                                                Year Ended December 31                                                                        2005     2004     2003                                                                      ------------------------     Interest income that would have been recorded under original terms   $  157   $  100   $    4 Less gross interest recorded                                            133       72        0                                                                      ------------------------ Foregone interest                                                    $   24   $   28   $    4                                                                      ========================    Summary of Loan Loss Experience (dollars in thousands)                                 Year Ended December 31                                           2005       2004       2003       2002        2001                                         ----------------------------------------------------       Balance of the allowance for   loan losses at beginning of year      $ 2,512    $ 1,664    $ 1,458    $ 1,445     $ 1,292 Charge-offs:    Commercial, financial and       agricultural                            7          0         71         60           0    Real estate mortgage                       0          0          0         46          13    Consumer                                 128         70         84        146          88                                         ----------------------------------------------------        Total charge-offs                    135         70        155        252         101                                         ----------------------------------------------------  Recoveries:    Commercial, financial and        agricultural                           0          0         25          2           0    Real estate mortgage                       0          0          0          1          87    Consumer                                  39         28         24         26          17                                         ----------------------------------------------------         Total recoveries                      39         28         49         29         104                                         ---------------------------------------------------- Net charge-offs (recoveries)                 96         42        106        223          (3) Provisions charged to operations            210        250        312        300         150 Balance acquired from CNB                     0        640          0          0           0 Transfer of allowance for loan   losses to other liabilities                 0          0          0        (64)          0                                         ---------------------------------------------------- Balance at end of year                  $ 2,626    $ 2,512    $ 1,664    $ 1,458     $ 1,445                                         ==================================================== Ratio of net charge-offs (recoveries)   to average loans outstanding              .05%       .03%       .07%       .02%      (.002%) Ratio of allowance for loan losses   to year end loans                        1.20%      1.23%      1.18%      1.07%       1.01%                                          9    Allocation of the Allowance for Loan Losses (dollars in thousands)                                                                        December 31                                   2005                2004                2003                2002                2001                             Amount    Percent   Amount    Percent   Amount    Percent   Amount    Percent   Amount    Percent                             -----------------   -----------------   -----------------   -----------------   -----------------            Commercial, financial and  agricultural               $  495      7.02%   $  613      7.40%   $  441      6.47%   $  316      7.39%   $  120      7.47% Real estate construction  and land development           95      8.61%       83      6.99%      112     10.82%       50      4.40%       24      2.72% Real estate mortgage         1,761     80.74%    1,614     81.12%      749     77.94%      840     81.43%    1,200     82.78% Consumer                       247      3.61%      198      4.46%      357      4.72%      244      6.57%      100      6.94% Other loans                     28       .02%        4       .03%        5       .05%        8       .21%        1       .09%                             ------    ------    ------    ------    ------    ------    ------    ------    ------    ------                             $2,626    100.00%   $2,512    100.00%   $1,664    100.00%   $1,458    100.00%   $1,445    100.00%                             ======    ======    ======    ======    ======    ======    ======    ======    ======    ======   Provisions to the  allowance  for loan losses are charged to operating  expenses and are based on past experience,  current economic  conditions and management's judgement of the amount necessary to cover losses inherent in the portfolio. The Bank records  provisions  for estimated loan losses,  which are charged  against earnings, in the period they are established.  Short-Term Borrowings (dollars in thousands)                                  December 31                                                2005        2004        2003                                              -------------------------------- Federal Home Loan Bank Advances  Average interest rate     At year end                                  4.90%       4.29%       4.06%     For the year                                 4.69%       3.90%       4.21% Average amount outstanding during the year   $ 67,793    $ 74,954    $ 65,282 Maximum amount outstanding at any month      $ 75,536    $100,680    $ 74,705 Amount outstanding at year end               $ 71,016    $ 79,213    $ 60,897
In addition to the other  information  contained in this report,  the  following risks may  affect the  Company.  If any of these  risks  occurs,  the  Company's business,  financial condition or operating results could be adversely affected. The  Company's  business and  financial  condition  is directly  affected by the Bank's  business and financial  condition and, thus, is subject to certain risks of the Bank.       Changes  in  economic   conditions  could  materially  hurt  the  Company's business.  The business of the Company and the Bank is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory  changes,  changes in government  monetary and fiscal policies and inflation,  all of which are beyond the Company's control. The Bank is  particularly   affected  by  economic   conditions  in  Litchfield   County, Connecticut, Berkshire County, Massachusetts, and Colombia and Dutchess Counties in New York.  Deterioration in economic conditions could result in the following consequences, any of which could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows:       o    problem assets and foreclosures may increase;      o    demand for the Bank's products and services may decline;      o    low cost or non-interest bearing deposits may decrease; and,      o    collateral  for loans made by the Bank,  especially  real estate,  may           decline in value, in turn reducing  customers'  borrowing  power,  and           reducing the value of assets and collateral associated with the Bank's           existing loans.  In  view  of the  geographic  concentration  of the  Bank's  operations  and the collateral  securing the Bank's loan portfolio,  the Company may be particularly susceptible to the adverse  effects of any of these  consequences,  any of which could  have a  material  adverse  effect on the  Company's  business,  financial condition, results of operations and cash flows.                                         10        The Company is  dependent on key  personnel  and the loss of one or more of those key personnel may materially and adversely affect the Company's prospects.  Competition  for qualified  employees  and personnel in the banking  industry is intense and there are a limited  number of qualified  persons with knowledge of, and experience in, the banking  industry within the communities the Bank serves. The Company's and the Bank's  success  depends to a significant  degree upon the ability to attract and retain qualified management,  loan origination,  finance, administrative,  marketing  and  technical  personnel  and  upon  the  continued contributions  of  management  and  personnel.  The loss of the  services of the senior  executive  management team members or other key executives  could have a material adverse effect on the Company's business,  financial condition, results of operations and cash flows.       The Bank's business is subject to interest rate risk.  A substantial  portion of the Company's  income is derived from the differential or "spread"  between the Bank's interest  earned on loans,  securities and other interest  earning  assets,  and interest paid on deposits,  borrowings and other interest bearing  liabilities.  Because of the differences in the maturities and repricing  characteristics  of  interest  earning  assets and  interest  bearing liabilities,  changes in  interest  rates do not produce  equivalent  changes in interest income earned on interest  earning assets and interest paid on interest bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect the interest rate spread and, in turn,  the Company's  profitability.  In addition, loan origination volumes are affected by market interest rates. Rising interest  rates,  generally,   are  associated  with  a  lower  volume  of  loan originations  while lower interest rates are usually associated with higher loan originations.  Conversely, in rising interest rate environments,  loan repayment rates may decline and in falling  interest  rate  environments,  loan  repayment rates may increase.  Falling  interest rate  environments  may cause  additional refinancing of commercial real estate and 1-4 family residence loans,  which may depress  the  Company's  loan  volumes or cause  rates on loans to  decline.  In addition,  an increase  in the general  level of  short-term  interest  rates on variable rate loans may adversely affect the ability of certain borrowers to pay the  interest on and  principal of their  obligations  or reduce the amount they wish to borrow.  As  short-term  rates  continue to rise,  retention of existing deposit  customers and the  attraction of new deposit  customers may require the Company  to  increase  rates it pays on deposit  accounts.  Changes in levels of market interest rates could materially and adversely affect net interest spread, asset quality, loan origination volume, business,  financial condition,  results of operations and cash flows.       Certain types of loans have a higher degree of risk.  A downturn  in the  Company's  real  estate  markets  could  hurt the  Company's business  because  most of the Bank's  loans are  secured by real  estate.  Real estate  values and real  estate  markets  are  generally  affected by changes in national, regional or local economic conditions,  fluctuations in interest rates and the availability of loans to potential  purchasers,  changes in tax laws and other  governmental  statutes,  regulations and policies and acts of nature.  If real estate prices  decline,  the value of real estate  collateral  securing the Bank's loans could be reduced.  The Bank's ability to recover on defaulted loans by foreclosing and selling the real estate  collateral  would then be diminished and the Company  would be more likely to suffer  losses on defaulted  loans.  If there  is a  significant  decline  in  real  estate  values,  especially  in the Company's  market area,  the  collateral  for the Bank's loans will provide less security.  Any  such  downturn  could  have a  material  adverse  effect  on the Company's business, financial condition, results of operations and cash flows.       The ability to attract deposits may effect Bank's growth.  The Company's ability to increase its assets depends in large part on the Bank's ability to attract additional  deposits at favorable rates. The Bank anticipates seeking  additional  deposits by offering  deposit products that are competitive with those offered by other financial  institutions in the Company's markets and by establishing  personal  relationships  with the Bank's customers.  The Bank's ability  to  attract  additional  deposits  at  competitive  rates  could have a material  effect on the  Company's  business,  financial  condition,  results of operations and cash flows.       In the business of banking,  the  allowance for loan and lease losses is an estimate and may not be adequate to cover all future actual losses.  A source of risk arises from the  possibility  that  losses  could be  sustained because  borrowers,  guarantors,  and  related  parties  may fail to  perform in accordance with the terms of their loans and leases. The underwriting and credit monitoring  policies and procedures that the Company has adopted to address this risk may not prevent unexpected losses that could have a material adverse effect on the Company's business,  financial condition,  results of operations and cash flows.  Unexpected  losses may arise from a                                         11   wide  variety of  specific  or  systemic  factors,  many of which are beyond the Company's ability to predict, influence or control.  Like all banking  institutions,  the Bank  maintains an  allowance  for loan and lease  losses to provide for loan and lease  defaults and  non-performance.  The allowance for loan and lease losses reflects the Bank's estimate of the probable losses in the Bank's loan and lease  portfolio  at the  relevant  balance  sheet date.  The  Bank's  allowance  for  loan  and  lease  losses  is  based on prior experience,  as  well  as an  evaluation  of the  known  risks  in  the  current portfolio,  composition  and growth of the loan and lease portfolio and economic factors.  The  determination  of an  appropriate  level of loan and  lease  loss allowance  is  an  inherently   difficult  process  and  is  based  on  numerous assumptions.  The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond the Bank's control and these losses may exceed current estimates. Federal and state regulatory agencies, as an integral part of their examination process, review the Bank's loans and leases and allowance for loan and lease losses.       Banks  rely on communications, information, operating and financial control systems  technology  from third-party service providers, and banks may suffer an interruption in those systems that may result in lost business and banks may not be  able  to  obtain  substitute  providers  on terms that are as favorable if a bank's  relationships  with  bank's  existing service providers are interrupted.  The Bank relies on certain  third-party service providers for much of the Bank's communications, information, operating and financial control systems technology. Any failure or  interruption or breach in security of these systems could result in failures or  interruptions  in the Bank's customer  relationship  management, general ledger,  deposit,  servicing and/or loan origination  systems.  The Bank cannot be certain that such failures or interruptions will not occur or, if they do  occur,  that  they  will be  adequately  addressed  by the Bank or the third parties  on  which  the  Bank  relies.   The   occurrence  of  any  failures  or interruptions  could have a  material  adverse  effect on the  Bank's  business, financial condition,  results of operations and cash flows. If any of the Bank's third-party service providers experience financial, operational or technological difficulties,  or if there is any other  disruption in the Bank's  relationships with  them,  the Bank may be  required  to locate  alternative  sources  of such services,  and the Company cannot be certain that the Bank could negotiate terms that are as  favorable to the Company,  or could  obtain  services  with similar functionality as found in the Bank's existing systems without the need to expend substantial  resources,  if at all.  Any of  these  circumstances  could  have a material adverse effect on the Company's business,  financial condition, results of operations and cash flows.       The Bank faces strong  competition  from  financial  service  companies and other companies that offer banking services.  Increased  competition  in  the  Bank's  markets may result in reduced loans and deposits.  Ultimately,  the Bank may not be able to compete successfully against current and future competitors. Many competitors offer the banking services that the  Bank offers in its service areas. These competitors include national banks, regional  banks  and other community banks. The Bank also faces competition from many  other  types  of   financial  institutions,  including  savings  and  loan associations,  finance  companies,  brokerage firms, insurance companies, credit unions,  mortgage  banks  and other financial intermediaries. In particular, the Bank's  competitors  include  several  major  financial  companies whose greater resources  may  afford them a marketplace advantage by enabling them to maintain numerous  locations  and  mount extensive promotional and advertising campaigns. Additionally,  banks and other financial institutions with larger capitalization and  financial  intermediaries  not  subject to bank regulatory restrictions may have  larger lending limits, which would allow them to serve the credit needs of larger  customers.  Areas  of  competition  include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products  and  services  provided,  including new technology-driven products and services.   Technological   innovation   continues   to  contribute  to  greater competition  in  domestic  and   international  financial  services  markets  as technological  advances enable more companies to provide financial services. The Bank  also  faces  competition  from  out-of-state financial intermediaries that solicit  deposits  in  the Bank's market areas. If the Bank is unable to attract and  retain  banking customers, it may be unable to continue the Bank's loan and deposit  growth  and  the  Company's  business,  financial condition, results of operations  and  cash  flows  may  be  adversely  affected.       The Company and the Bank are subject to extensive government regulation.  The  operations of the Company and the Bank are subject to extensive  regulation by federal, state and local governmental  authorities and are subject to various laws  and  judicial  and  administrative  decisions  imposing  requirements  and restrictions  on part or all of the  operations  of the  Company  and the  Bank. Because  the  Company's  and  the  Bank's  business  is  highly  regulated,  the applicable laws,  rules and regulations are subject to regular  modification and change.  The Company cannot be certain that laws, rules and regulations will not be adopted in the future,  which could make  compliance  much more  difficult or expensive,  or                                         12   otherwise  adversely  affect the  Company's and the Bank's  business,  financial condition, results of operations or cash flows.       The  Company  may be  exposed  to risk of  environmental  liabilities  with respect to properties to which the Bank takes title.  In the course of the Bank's  business,  the Bank may foreclose and take title to real estate,  and could subject the Company to  environmental  liabilities  with respect to these properties.
Not applicable.
The  Company is not the owner or lessee of any  properties.  The Bank leases two (2) properties; a branch office at 51 Main Street, South Egremont, Massachusetts and a branch at 73 Main Street,  Sheffield,  Massachusetts which opened in March 2005.  The Bank  serves its  customers  from its six (6)  offices  which are located in Canaan,  Lakeville,  Salisbury and Sharon,  Connecticut  and Sheffield and South Egremont,  Massachusetts.  The Bank's trust  department is located in a separate building adjacent to the main office of the Bank.  The  following  table  includes  all  property  owned by the Bank,  but does not include Other Real Estate Owned.             OFFICES                         LOCATION                STATUS          Main Office                     5 Bissell Street          Owned                                    Lakeville, Connecticut           Trust Department               19 Bissell Street          Owned                                    Lakeville, Connecticut           Salisbury Office               18 Main Street             Owned                                    Salisbury, Connecticut           Sharon Office                  29 Low Road                Owned                                    Sharon, Connecticut           Canaan Operations              94 Main Street             Owned                                    Canaan, Connecticut           Canaan Office                 100 Main Street             Owned                                    Canaan, Connecticut
Other than routine litigation incidental to its business,  there are no material legal  proceedings  pending to which the Company,  Bank, or their properties are subject.
No  matters  were  submitted  to a vote of  security  holders  during the fourth quarter of the Company's 2005 fiscal year.                                          13   PART II
(a)  Market Information  The Company's  common stock is traded on The American  Stock  Exchange under the symbol "SAL".  The following table presents the high and low sales prices of the Company's common stock.                                       2005 Quarters                       2004 Quarters                          ----------------------------------  ----------------------------------                            4th      3rd     2nd      1st       4th      3rd     2nd      1st                          ----------------------------------  ----------------------------------           Range of Stock prices:      High                $40.20   $40.70   $40.80   $43.50   $45.55   $43.05   $38.80   $41.55      Low                 $37.90   $35.60   $36.50   $39.00   $43.00   $36.00   $36.25   $38.50   (b)  Holders  There  were  approximately  743  holders  of record of the  common  stock of the Company as of March 3, 2006.  This  number  includes  brokerage  firms and other financial  institutions  which hold stock in their  name,  but which is actually owned by third parties.  (c)  Dividends  Dividends are currently  declared four times a year, and the Company  expects to follow such practices in the future.  During the year 2005, the Company declared a cash  dividend  each  quarter of $.25 per share.  Dividends  for the year 2005 totaled  $1.00 per share  which  compared to total  dividends  of $.96 that were declared in the year 2004. At their March 6, 2006 meeting,  the Directors of the Company  declared  a cash  dividend  of $.26 per share for the first  quarter of 2006. The dividend will be paid on April 28, 2006 to  stockholders  of record as of March 31, 2006.  Payments of all dividends  are dependent  upon the condition and earnings of the Company.  The Company's  ability to pay dividends is limited by the prudent banking  principles  applicable to all bank holding companies and by  the  provisions  of  Connecticut   Corporate  law,  which  provide  that  no distribution  may be made by a  company  if,  after  giving it  effect:  (1) the company  would  not be able to pay its  debts as they  become  due in the  usual course of business or (2) the company's  total assets would be less than the sum of its total  liabilities  plus amounts  needed to satisfy any  preferred  stock rights.  The following table presents cash dividends  declared per share for the last two years:                             2005 Quarters                2004 Quarters                  -----------------------------   -----------------------------                   4th     3rd     2nd     1st     4th     3rd     2nd     1st                  -----------------------------   ----------------------------- Cash dividends     declared     $0.25   $0.25   $0.25   $0.25   $0.24   $0.24   $0.24   $0.24  The dividends  paid to  stockholders  of the Company are funded  primarily  from dividends  received by the Company  from the Bank.  Reference  should be made to Note  13  of  the  Consolidated   Financial  Statements  for  a  description  of restrictions on the ability of the Bank to pay dividends to the Company.  (d)  Securities Authorized for Issuance Under Equity Compensation Plans  Equity Compensation Plan information is provided in Item 11 of this Form 10-K.                                          14
At or For the Years Ended December 31                                                     2005        2004        2003        2002        2001                                                  --------    --------    --------    --------    --------                                                               (dollars in thousands except per share data) Statement of Condition Data:  Loans, Net                                       $215,989    $201,978    $139,563    $135,632    $143,066 Allowance For Loan Losses                           2,626       2,512       1,664       1,458       1,445 Investments                                       151,168     184,286     147,021     138,435     105,593 Total Assets                                      402,922     423,101     311,100     293,107     283,602 Deposits                                          287,271     298,842     218,457     211,037     201,351 Borrowings                                         71,016      79,213      60,897      51,891      53,004 Stockholders' Equity                               41,442      40,700      28,850      27,345      23,363 Nonperforming Assets                                  773       2,267         685       1,400         587  Statement of Income Data:  Interest and Fees on Loans                       $ 13,320    $  9,592    $  9,226    $  9,677    $ 11,344 Interest and Dividends on Securities                   and Other Interest Income         7,496       6,959       6,423       6,481       5,746 Interest Expense                                    7,352       5,659       5,613       6,898       8,301                                                  --------    --------    --------    --------    -------- Net Interest and Dividend Income                   13,464      10,892      10,036       9,260       8,789 Provision for Loan Losses                             210         250         312         300         150 Trust Department Income                             1,571       1,411       1,252       1,100       1,070 Other Noninterest Income                            2,084       1,854       1,674       1,388       1,187 Net Gain on Sales and writedown                   of Securities                     1,210       1,490       1,058         634         130 Noninterst Expenses                                12,444      10,603       8,600       7,775       6,755                                                  --------    --------    --------    --------    --------  Pre Tax Income                                      5,675       4,794       5,108       4,307       4,271 Income Taxes                                        1,114         775       1,268       1,108       1,370                                                  --------    --------    --------    --------    --------  Net Income                                       $  4,561    $  4,019    $  3,840    $  3,199    $  2,901                                                  ========    ========    ========    ========    ========  Per Share Data:  Earnings per common share                        $   2.71    $   2.67    $   2.70    $   2.25    $   2.03 Earnings per common share, assuming dilution     $   2.71    $   2.67    $   2.70    $   2.25    $   2.03 Cash Dividends Declared per share                $   1.00    $   0.96    $   0.92    $   0.88    $   0.84 Book Value (at year end)                         $  24.62    $  24.19    $  20.26    $  19.21    $  16.43  Selected Statistical Data:  Return on Average Assets                             1.12%       1.14%       1.24%       1.13%       1.14% Return on Average Stockholders' Equity              10.81%      12.34%      13.41%      12.63%      12.25% Dividend Payout Ratio                               36.90%      35.96%      34.07%      39.11%      41.38% Average Stockholders' Equity to Average Assets      10.38%       9.20%       9.26%       8.92%       9.27% Net Interest Spread                                  3.35%       3.22%       3.37%       3.21%       2.91% Net Interest Margin                                  3.89%       3.63%       3.80%       3.80%       3.71%                                          15
The following  provides  Management's  comments on the  financial  condition and results of operations of Salisbury Bancorp, Inc. (the "Company"),  a Connecticut corporation  which is the holding  company for Salisbury Bank and Trust Company, (the "Bank").  The Company's sole subsidiary is the Bank, which has six (6) full service offices  including a Trust and Investment  Services  Division located in the towns of North  Canaan,  Lakeville,  Salisbury and Sharon,  Connecticut  and South  Egremont  and  Sheffield,  Massachusetts.  The  Company and the Bank were formed in 1998 and 1848,  respectively.  In order to  provide a  foundation  for building  stockholder  value  and  servicing  customers,   the  Company  remains committed to investing in the  technological  and human  resources  necessary to developing new personalized financial products and services to meet the needs of customers.  This  discussion  should be read  inconjunction  with the  Company's consolidated  financial  statements and the notes to the consolidated  financial statements that are presented as part of this Annual Report on Form 10-K.  RESULTS OF OPERATIONS - --------------------- Comparison of the Years Ended December 31, 2005 and 2004 - --------------------------------------------------------  Overview - --------  The reported earnings for the Company totaled $4,561,000 in 2005, an increase of $542,000 or 13.49% over year 2004 earnings of  $4,019,000.  Earnings per average share  outstanding  totaled $2.71 in 2005. This compares to earnings per average share  outstanding  of $2.67 in 2004 and $2.70 in 2003. The increase in earnings per share is  primarily  the result of the  increased  base of  earnings  assets following the merger with Canaan National Bancorp, Inc. on September 10, 2004.  The Company's assets at December 31, 2005 totaled $402,922,000 compared to total assets  of  $423,101,000  at  December  31,  2004.  The  decrease  is  primarily attributable to a reduction in the securities  portfolio.  During the year 2005, net loans  outstanding  increased  $14,011,000 or 6.94% and total  $215,989,000. This compares to net loans outstanding of $201,978,000 at December 31, 2004. The Bank  continues to monitor the quality of the loan portfolio to ensure that loan quality will not be sacrificed for growth or otherwise  compromise the Company's objectives.  Nonperforming  loans  totaled  $773,000  at  December  31,  2005 as compared to nonperforming  loans totaling  $2,267,000 at December 31, 2004. This represents  a decrease of  $1,494,000  or 65.90%.  Deposits at December 31, 2005 totaled  $287,271,000  as compared to total deposits of $298,842,000 at December 31, 2004, representing a decrease of $11,571,000.  The Company is "well  capitalized".  The Company's  risk-based capital ratios at December 31, 2005,  which includes the  risk-weighted  assets and capital of the Salisbury Bank and Trust Company,  were 14.58% for Tier 1 capital and 15.76% for total capital. The Company's leverage ratio was 8.27% at December 31, 2005. This compares  to a Tier 1 capital  ratio at  December  31,  2004 of 11.12%,  a total capital ratio of 12.13% and a Company  leverage  ratio of 7.22%.  As a result of the Company's  financial  performance,  the Board of Directors  increased  total dividends  declared on the  Company's  common  stock to $1.00 per share in 2005. This compares to a $.96 per share dividend declared in 2004 and a $.92 per share dividend that was declared in 2003.  Critical Accounting Estimates  In preparing the Company's financial statements,  management selects and applies numerous accounting policies.  In applying these policies,  management must make estimates and  assumptions.  The accounting  policy that is most  susceptible to critical  estimates  and  assumptions  is the  allowance  for loan  losses.  The determination  of an appropriate  provision is based on a  determination  of the probable amount of credit losses in the loan portfolio.  Many factors  influence the amount of future loan losses, relating to both the specific  characteristics of the loan portfolio and general  economic  conditions  nationally and locally. While management  carefully considers these factors in determining the amount of the  allowance  for loan losses,  future  adjustments  may be  necessary  due to changed  conditions,  which could have an adverse impact on reported earnings in the future. (See "Provisions and Allowance for Loan Losses".)  Net Interest and Dividend Income  The Company earns income from two basic  sources.  The primary source is through the management of its financial assets and liabilities and involves  functioning as a financial  intermediary.  The Company  accepts  funds from  depositors  and borrows  funds and either lends the funds to borrowers or invests those funds in various types of securities. The second source is fee income, which is discussed in the noninterest income section of this analysis.                                         16   Net interest  income is the  difference  between the interest and fees earned on loans,  interest and  dividends  earned on  securities  (the  Company's  earning assets) and the interest expense paid on deposits and borrowed funds,  primarily in the form of  advances  from the Federal  Home Loan Bank.  The amount by which interest  income will exceed interest  expense  depends on two factors:  (1) the volume or  balance  of  earning  assets  compared  to the  volume or  balance of interest-bearing deposits and borrowed funds and (2) the interest rate earned on those  interest-earning  assets  compared  with the interest  rate paid on those interest-bearing deposits and borrowed funds. For this discussion,  net interest income is presented on a fully  taxable-equivalent  ("FTE") basis.  FTE interest income restates  reported  interest income on tax exempt loans and securities as if such interest were taxed at the applicable State and Federal income tax rates for all periods presented.  (dollars in thousands)                            December 31,                                           2005        2004        2003                                        --------------------------------  Interest and Dividend Income (financial statements)                 $ 20,816    $ 16,551    $ 15,650  Tax Equivalent Adjustment                 1,200       1,182       1,075                                        --------    --------    --------        Total Interest and Dividend        Income (on an FTE basis)          22,016      17,733      16,725  Interest Expense                         (7,352)     (5,659)     (5,613)                                        --------    --------    --------  Net Interest and Dividend Income-FTE   $ 14,664    $ 12,074    $ 11,112                                        ========    ========    ========  The Company's  2005 total  interest and dividend  income on an FTE basis for the period ended December 31, 2005  increased  $4,283,000 or 24.15% when compared to the same period in 2004. The increase is primarily  attributable  to an increase in earning assets as well an economic  environment  experiencing a slow increase in interest rates.  Interest  expense  on  deposits  in  2005  increased  $1,432,000  or  52.28%  to $4,171,000  compared  to  $2,739,000  for  the  corresponding period in 2004 and $2,866,000  in  2003.  Interest  expense  for  Federal  Home  Loan Bank advances increased  $261,000  to  $3,181,000  in  2005 compared to $2,920,000 in 2004 and $2,747,000  in  2003.  The  increase  was primarily the result of an increase in advances  during  the year. Although competition remains aggressive and interest margins  continue  to  be  pressured, net interest and dividend income on an FTE basis  increased  $2,590,000 or 21.45% over 2004 and totaled $14,664,000 for the year  ended December 31, 2005 compared to net interest and dividend income on an FTE  basis  of  $12,074,000 for the year ended December 31, 2004 and $11,112,000 for  the  year  ended  2003.  Net  interest  margin  is  net  interest  and  dividend  income  expressed  as a percentage  of average  earning  assets.  It is used to measure  the  difference between the  average  rate of interest  and  dividends  earned on assets and the average rate of interest that must be paid to support those assets.  To maintain its net  interest  margin,  the  Company  must manage the  relationship  between interest earned and paid. The Company's 2005 net interest margin on an FTE basis was  3.89%.  This  compares  to a net  interest  margin of 3.63%  for 2004.  The following table reflects average balances, interest earned or paid and rates for the three  years ended  December  31,  2005,  2004 and 2003.  The  average  loan balances  include both non-accrual and  restructured  loans.  Interest earned on loans also includes fees on loans such as late charges that are not deemed to be material.  Interest earned on tax exempt securities in the table is presented on a fully  taxable-equivalent basis ("FTE"). A federal tax rate of 34% was used in performing  these  calculations.  Actual  tax exempt  income  earned in 2005 was $2,329,000  with a yield of 4.44%.  Actual  tax  exempt  income in 2004  totaled $2,294,000  with a yield of 4.68%  and in 2003  actual  tax  exempt  income  was $2,086,000 with a yield of 4.78%.                                          17     YIELD ANALYSIS                            ------------------------------------------------------------------------------------------------- Average Balances, Interest Earned/Paid and Rates                                                                   Year Ended December 31                            ------------------------------------------------------------------------------------------------- (dollars in thousands)                      2005                            2004                             2003                            -------------------------------------------------------------------------------------------------                                          INTEREST                         INTEREST                         INTEREST                              AVERAGE      EARNED/    YIELD    AVERAGE      EARNED/   YIELD     AVERAGE      EARNED/    YIELD                              BALANCE       PAID      RATE     BALANCE       PAID     RATE      BALANCE       PAID      RATE            ASSETS  Interest-Earning Assets: Loans                       $ 208,786    $  13,320   6.38%   $ 160,382    $   9,592   5.98%   $ 142,752    $   9,226   6.46% Taxable Securities          $ 112,746    $   5,097   4.52%   $ 117,535    $   4,613   3.92%   $ 101,931    $   4,299   4.22% Tax-Exempt Securities*      $  52,435    $   3,529   6.73%   $  49,017    $   3,475   7.09%   $  43,603    $   3,161   7.25% Federal Funds               $   1,840    $      48   2.61%   $   3,455    $      39   1.13%   $   3,125    $      29   0.93% Other Interest-Earning      $   1,096    $      22   2.01%   $   1,809    $      14   0.77%   $   1,359    $      10   0.74%                             ----------------------           ----------------------           ---------------------- Total Interest-Earning   Assets                    $ 376,903    $  22,016   5.84%   $ 332,198    $  17,733   5.34%   $ 292,770    $  16,725   5.71%                                          ---------                        ---------                        --------- Allowance for Loan   Losses                    ($  2,652)                       ($  1,952)                       ($  1,468) Cash & Due From   Banks                     $   8,189                        $   7,987                        $   6,425 Premises, Equipment         $   6,432                        $   3,865                        $   3,000 Net unrealized (loss)gain   on AFS Securities         ($  2,127)                       ($    412)                       $   2,316 Other Assets                $  19,707                        $  12,330                        $   6,403                             ---------                        ---------                        --------- Total Average Assets        $ 406,452                        $ 354,016                        $ 309,446                             =========                        =========                        =========  LIABILITIES AND STOCKHOLDERS' EQUITY Interest-Bearing   Liabilities: NOW/Money Market   Deposits                  $  81,602    $   1,229   1.51%   $  62,681    $     382   0.61%   $  59,521    $     363   0.61% Savings Deposits            $  59,466    $     456   0.77%   $  54,596    $     373   0.68%   $  45,975    $     450   0.98% Time Deposits               $  86,794    $   2,486   2.86%   $  75,241    $   1,984   2.64%   $  68,898    $   2,054   2.98% Borrowed Funds              $  67,793    $   3,181   4.69%   $  74,954    $   2,920   3.90%   $  65,282    $   2,746   4.21%                             ----------------------           ----------------------           ---------------------- Total Interest-Bearing   Liabilities               $ 295,655    $   7,352   2.49%   $ 267,472    $   5,659   2.12%   $ 239,676    $   5,613   2.34%                                          ---------                        ---------                        --------- Demand Deposits             $  65,591                        $  51,649                        $  38,998 Other Liabilities           $   3,008                        $   2,329                        $   2,130 Stockholders' Equity        $  42,198                        $  32,566                        $  28,642                             ---------                        ---------                        --------- Total Liabilities and   Stockholders' Equity      $ 406,452                        $ 354,016                        $ 309,446                             =========                        =========                        ========= Net Interest Income                      $  14,664                        $  12,074                        $  11,112                                          =========                        =========                        ========= Net Interest Spread                                  3.35%                            3.22%                            3.37% Net Interest Margin                                  3.89%                            3.63%                            3.80%       * Presented on a fully taxable equivalent ("FTE") basis                                         18    Volume and Rate Variance Analysis of Net Interest and Dividend Income (Taxable equivalent basis)    (dollars in thousands)                      2005  over 2004                 2004 over 2003                                       -----------------------------   ----------------------------                                       Volume       Rate      Total    Volume      Rate     Total                                       -----------------------------   ----------------------------        Increase (decrease) in: Interest and dividend income on:    Loans                              $ 2,895    $   833    $ 3,728   $ 1,139   $  (773)   $   366    Taxable investment securities         (188)       672        484       658      (344)       314    Tax-exempt investment securities       242       (188)        54       393       (79)       314    Other interest earning                 (23)        40         17         6         8         14                                       -------    -------    -------   -------   -------    ------- Total interest and dividend income    $ 2,926    $ 1,357    $ 4,283   $ 2,196   $(1,188)   $ 1,008                                       -------    -------    -------   -------   -------    -------  Interest expense on:    NOW/Money Market deposits          $   115    $   732    $   847   $    19   $     0    $    19    Savings deposits                        33         50         83        84      (161)       (77)    Time deposits                          305        197        502       189      (259)       (70)    Borrowed funds                        (279)       540        261       407      (233)       174                                       -------    -------    -------   -------   -------    ------- Total interest expense                $   174    $ 1,519    $ 1,693   $   699   $  (653)   $    46                                       -------    -------    -------   -------   -------    -------  Net interest and dividend income      $ 2,752    $  (162)   $ 2,590   $ 1,497   $  (535)   $   962                                       =======    =======    =======   =======   =======    =======   Noninterest Income - ------------------  Noninterest  income increased  $110,000 or 2.31% and totaled  $4,865,000 for the year ended  December  31,  2005 as  compared  to  $4,755,000  for the year ended December 31, 2004. Trust Department income increased from $160,000 to $1,571,000 primarily  as a result  of the  efforts  of new  business  development.  Service charges on deposit  accounts  totaled  $642,000 for 2005. This is an increase of $21,000 or 3.38% when compared to total service charges of $621,000 in 2004. The increase can be attributed to an increase in deposit account transactions. Gains on sales and writedowns of available-for-sale securities, net totaled $1,210,000 in 2005  representing a decrease of $280,000 or 18.79% compared to $1,490,000 in 2004. This decrease reflects a writedown of approximately $182,000,  however, is primarily  attributable  to  movements  in the markets  which  resulted in fewer opportunities  for the  Company  to  enhance  the  return  from  the  securities portfolio  and at the same  time  realize  gains on sales of  available-for-sale securities.  Mortgage  refinancing remained active during 2005 as rates remained attractive to consumers.  Competition in the secondary mortgage market continues to be very aggressive. Gains on sales of loans held-for-sale totaled $270,000 in 2005  compared  to $304,000 in 2004,  representing  a decrease of 11.18%.  Other income and loan commissions however,  increased $243,000 or 26.16% to $1,172,000 in 2005 compared to $929,000 in 2004. This increase is primarily attributable to the increase in fees earned from activity in the secondary  mortgage  market due to the change of investors.  Noninterest Expense - -------------------  Noninterest  expense  increased  17.36% for the year ended  December 31, 2005 as compared to the  corresponding  period in 2004. The increases in the noninterest expenses listed below are primarily  attributable  to the Company's  growth as a result of the merger with Canaan  National  Bancorp,  Inc. with the exception of Trust department  expense,  which reflects  additional costs associated with the continuing  growth of new  accounts  in the  department.  The  decrease in other expense is a  reflection  of  non-recurring  expenses  in 2004  relating  to the conversion  of  the  Company's  core  processing   system.   The  components  of noninterest  expense and the  changes in the period were as follows  (amounts in thousands):                                             2005      2004   $ Change   % Change  ------------------------------------------------------------------------------ Salaries and employee benefits           $ 7,355   $ 5,971   $ 1,384      23.18 Occupancy expense                            728       436       292      66.97 Equipment expense                            777       600       177      29.50 Trust department expense                     398       339        59      17.40 Data processing                              783       711        72      10.13 Insurance                                    148       122        26      21.31 Printing and stationery                      252       254        (2)      (.79) Professional fees                            301       272        29      10.66 Legal expense                                174       106        68      64.15 Amortization of core deposit intangible      164       101        63      62.38 Other expense                              1,364     1,691      (327)    (19.34)                                          -------   -------   -------              Total noninterest expense   $12,444   $10,603   $ 1,841      17.36                                          =======   =======   =======                                         19   Income Taxes - ------------  In 2005, the Company's income tax provision totaled  $1,114,000 that reflects an effective  tax rate of  19.63%.  This  compares  to an income tax  provision  of $775,000 and an effective  tax rate of 16.16% for the same period in 2004.  This increase is primarily attributable to an increase in taxable income.  Net Income - ----------  Overall,  net income  totaled  $4,561,000  for the year ended December 31, 2005. This compares to net income of $4,019,000  for the year ended December 31, 2004. This is an increase of $542,000 or 13.49% and  represents  earnings  per average share outstanding of $2.71.  Earnings per average share outstanding for the year ended  December 31, 2004 was $2.67.  The increase in net income is primarily the result of an increase in earning  assets  resulting  from the merger with Canaan National Bancorp, Inc.  RESULTS OF OPERATIONS - --------------------- Comparison of the Years Ended December 31, 2004 and 2003 - --------------------------------------------------------  Overview - --------  The earnings for the Company were $4,019,000 in 2004, an increase of $179,000 or 4.66%  over year  2003  earnings  of  $3,840,000.  Earnings  per  average  share outstanding  were $2.67 in 2004.  This  compared to earnings  per average  share outstanding  of $2.70 in 2003 and $2.25 in 2002.  The  decrease in earnings  per average share for 2004 was primarily the result of issuing 257,483 new shares of Company stock, in connection  with the  acquisition of Canaan National  Bancorp, Inc. that closed in September of 2004.  The  Company's  assets at December 31, 2004 were  $423,101,000  and  represented growth of  $112,001,000  or 36.00% from  December  31, 2003.  This  increase was primarily  attributable to the Bank's  acquisition of Canaan  National  Bancorp, Inc.,  which was  completed  during  September  2004.  In  connection  with this transaction,  the Bank received approximately $54,000,000 in loans, a securities portfolio   totaling   approximately   $44,000,000  and  recorded   goodwill  of approximately  $7.1 million.  Canaan National  Bancorp,  Inc.'s fixed assets and bank  premises were also  included in the merger.  Non-performing  loans totaled $2,267,000 at December 31, 2004. This compared to non-performing  loans totaling $610,000  for the  corresponding  period in 2003.  Deposits at December 31, 2004 totaled  $298,842,000 and compared to total deposits of $218,457,000 at December 31,  2003.  The  increase  was  primarily   attributable  to  the  approximately $76,000,000  in deposits  that were  assumed in the merger with Canaan  National Bancorp, Inc.  The Company is "well  capitalized".  The Company's  risk-based capital ratios at December 31, 2004,  which included the  risk-weighted  assets and capital of the Salisbury Bank and Trust Company,  were 11.12% for Tier 1 capital and 12.13% for total capital. The Company's leverage ratio was 7.22% at December 31, 2004. This compared  to a Tier 1 capital  ratio at  December  31,  2003 of 15.35%,  a total capital ratio of 16.44%, and a Company leverage ratio of 8.05%.  The Board of  Directors  increased  total  dividends  declared on the  Company's common  stock to $.96  per  share in 2004.  This  compared  to a $.92 per  share dividend  declared in 2003 and a $.88 per share  dividend  that was  declared in 2002.                                          20   Net Interest and Dividend Income - --------------------------------  For this  discussion,  net interest and dividend  income is presented on a fully taxable-equivalent  ("FTE")  basis.  FTE interest and dividend  income  restates reported  interest income on tax exempt loans and securities as if such interest were taxed at the applicable  State and Federal income tax rates for all periods presented.  (dollars in thousands)                             December 31,                                           2004       2003         2002                                        --------------------------------- Interest and Dividend Income (financial statements)                 $ 16,551    $ 15,650    $ 16,157  Tax Equivalent Adjustment                 1,182       1,075       1,028                                        --------    --------    --------        Total Interest and Dividend            Income (on an FTE basis)      17,733      16,725      17,185  Interest Expense                         (5,659)     (5,613)     (6,898)                                        --------    --------    --------  Net Interest and Dividend Income-FTE   $ 12,074    $ 11,112    $ 10,287                                        ========    ========    ========  The  Company's  2004  total  interest  and  dividend  income  on an FTE basis of $17,733,000 was $1,008,000 or 6.03% more than the total interest and dividend on an FTE basis of $16,725,000 in 2003. The increase was primarily  attributable to an increase in earning assets as well as an economic environment experiencing an increase in interest  rates.  A change in the mix of earning  assets during 2004 resulted in an increase of tax exempt  securities  in the  securities  portfolio which resulted in an increase in the tax equivalent  adjustment of $1,182,000 in 2004 and  $1,075,000 in 2003 when compared to the tax  equivalent  adjustment of $1,028,000 in 2002.  Interest  expense on deposits in 2004 decreased  $127,000 or 4.43% to $2,739,000 compared to $2,866,000  for the  corresponding  period in 2003 and $4,039,000 in 2002. Interest expense for Federal Home Loan Bank advances increased $173,000 to $2,920,000 in 2004 compared to  $2,747,000 in 2003 and  $2,858,000 in 2002.  The increase was  primarily  the result of an increase in advances  during the year. Although  competition  remains  aggressive and interest  margins  continue to be pressured,  net interest and dividend income on an FTE basis increased  $962,000 or 8.66% over 2003 and totaled $12,074,000 at December 31, 2004, compared to net interest and dividend income on an FTE basis of $11,112,000 at December 31, 2003 and $10,287,000 in 2002.  The  Company's 2004 net interest margin on an FTE basis was 3.63%. This compared to a net interest margin of 3.80% for 2003. Actual tax exempt income in 2004 was $2,294,000  with  a  yeild  of  4.68%.  Actual tax exempt income in 2003 totaled $2,086,000  with  a  yield  of  4.78%  and  in 2002 actual tax exempt income was $1,995,000  with  a  yield  of  4.83%.  Volume and Rate Variance Analysis of Net Interest and Dividend Income (Taxable equivalent basis)     (dollars in thousands)                       2004  over 2003                  2003 over 2002                                       ----------------------------    -----------------------------                                        Volume     Rate      Total     Volume      Rate       Total                                       ----------------------------    -----------------------------        Increase (decrease) in: Interest and dividend income on:    Loans                              $ 1,139   $  (773)   $   366    $   220    $  (671)   $  (451)    Taxable investment securities          658      (344)       314      1,025     (1,294)      (269)    Tax-exempt investment securities       393       (79)       314        165        (27)       138    Other interest earning                   6         8         14        (51)       (33)       (84)                                       -------   -------    -------    -------    -------    ------- Total interest and dividend income    $ 2,196   $(1,188)   $ 1,008    $ 1,359    $(2,025)   $  (666)                                       -------   -------    -------    -------    -------    -------  Interest expense on:    NOW/Money Market deposits          $    19   $     0    $    19    $   (42)   $  (402)   $  (444)    Savings deposits                        84      (161)       (77)      (164)      (129)      (293)    Time deposits                          189      (259)       (70)        65       (502)      (437)    Borrowed funds                         407      (233)       174        732       (843)      (111)                                       -------   -------    -------    -------    -------    ------- Total interest expense                $   699   $  (653)   $    46    $   591    $(1,876)   $(1,285)                                       -------   -------    -------    -------    -------    -------  Net interest and dividend income      $ 1,497   $  (535)   $   962    $   768    $  (149)   $   619                                       =======   =======    =======    =======    =======    =======                                          21   Noninterest Income  Noninterest  income increased  $771,000 or 19.35% and totaled $4,755,000 for the year ended  December  31,  2004 as  compared  to  $3,984,000  for the year ended December 31, 2003.  Trust  Department  income  increased  $159,000 to $1,411,000 primarily  as a result  of the  efforts  of new  business  development.  Service charges on deposit  accounts  totaled $621,000 for 2004. This was an increase of $61,000 or 10.89% when  compared to total  service  charges of $560,000 in 2003. The  increase was  attributed  to an increase in deposit  account  transactions. Gains on sales and  writedowns  of  available-for-sale  securities,  net totaled $1,490,000  in 2004 and  represented  an  increase  of  $432,000  or 40.83% when compared to $1,058,000 in 2003.  This  increase was  primarily  attributable  to movements  in the markets  which  resulted in  opportunities  for the Company to enhance the return from the  securities  portfolio  and at the same time realize gains on sales of available-for-sale  securities.  Mortgage refinancing was very active during 2004 as rates remained attractive to consumers. Competition in the secondary  mortgage  market  was  very  aggressive.  Gains  on  sales  of  loans held-for-sale  increased  $43,000  or 16.48% to  $304,000  in 2004  compared  to $261,000 in 2003. Other income and loan commissions  increased 9.04% to $929,000 in 2004 compared to $852,000 in 2003.  This increase was primarily  attributable to the increase in fees earned from  activity in the secondary  mortgage  market due to the change of  investors.  Historically  the Company has few instances in which it  forecloses  on  properties  and  therefore  has a low  volume  of OREO properties.  The Company sold one OREO property during 2003.  There were no OREO property sales in 2004.  Noninterest Expense - -------------------  Noninterest  expense  increased  23.29% for the year ended  December 31, 2004 as compared to the  corresponding  period in 2003.  The  components of  noninterest expense and the changes in the period were as follows (amounts in thousands):                                             2004      2003     Change     %Change - -------------------------------------------------------------------------------- Salaries and employee benefits           $ 5,971   $ 4,834   $ 1,137      23.52 Occupancy expense                            436       359        77      21.45 Equipment expense                            600       579        21       3.63 Trust department expense                     339       409       (70)    (17.11) Data processing                              711       576       135      23.44 Insurance                                    122       115         7       6.09 Printing and stationery                      254       184        70      38.04 Professional fees                            272       300       (28)     (9.33) Legal expense                                106       128       (22)    (17.19) Amortization of core deposit intangible      101        68        33      48.53 Other expense                              1,691     1,048       643      61.36                                          -------   -------   -------              Total noninterest expense   $10,603   $ 8,600   $ 2,003      23.29                                          =======   =======   =======  The increase in salary and employee benefits was primarily due to an increase in staff  attributable  to the merger with Canaan  National  Bancorp,  Inc. and the required  employee  time  needed  to make the  system  changes  relating  to the conversion of the core processing  system,  along with salary  increases and the increase in the cost of employee benefits. The increase in occupancy expense was also directly related to the merger.  The decrease in Trust department  expenses was the  result of  management's  efforts  to control  operating  expenses.  The increase in data processing  costs were  attributable to the changes made in the core processing  system during the third quarter  coupled with additional  costs related to the merger.  Conversion expenses were various  nonrecurring  expenses related to the  conversion and the  enhancement  of the core account  processing system. The increase in the core deposit  intangible  amortization was primarily the result of the fair market adjustment of the assets and liabilities  acquired from Canaan  National  Bancorp,  Inc. at merger.  Other expense  increases  were primarily  attributable  to costs  associated  with  the  merger  as  previously mentioned.  Income Taxes - ------------  In 2004,  the Company's  income tax provision  was $775,000  which  reflected an effective  tax rate of  16.16%.  This  compared  to an income tax  provision  of $1,268,000 and an effective tax rate of 24.82% for the same period in 2003. This decrease  was  primarily  attributable  to a  decrease  in  taxable  income.  In addition,  the  Company  formed  a  passive  investment  company  to  operate  a significant  component of the Bank's  residential  mortgage lending activity.  A passive investment  company's  structure is such that income earned results in a reduction of tax liability for the Company.                                         22   Net Income - ----------  Overall,  net income was $4,019,000  for the year ended December 31, 2004.  This compared to net income of $3,840,000 for the year ended December 31, 2003.  This was an increase of $179,000 or 4.66% and represented  earnings per average share outstanding of $2.67.  Earnings per average share outstanding for the year ended December 31, 2003 was $2.70.  The  decrease in the  earnings  per average  share outstanding was primarily the result of issuing an additional  257,483 shares in connection with the acquisition of Canaan National Bancorp, Inc.  FINANCIAL CONDITION - ------------------- Comparison of December 31, 2005 and 2004 - ----------------------------------------  Total assets at December 31, 2005 were $402,922,000  compared to $423,101,000 at December  31, 2004.  This is a decrease of  $20,179,000  or 4.77%.  The decrease primarily reflects a reduction in the securities portfolio.  Securities Portfolio - --------------------  The Company  manages the securities  portfolio in accordance with the investment policy  adopted by the Board of Directors.  The primary  objectives  are to earn interest and dividend income,  provide  liquidity to meet cash flow needs and to manage interest rate risk and  asset-quality  diversifications  to the Company's assets. The securities  portfolio also acts as collateral for deposits of public agencies. As of December 31, 2005, the securities  portfolio,  including Federal Home Loan Bank of Boston stock, totaled $151,168,000. This represents a decrease of $33,118,000 or 17.97% over year-end  2004.  The decrease is  attributable  to portfolio  securities  being sold and called during the period with the proceeds being used to fund loan  growth and reduce  total  advances  outstanding  at the Federal Home Loan Bank of Boston.  Securities     are      classified     in     the     portfolio    as     either securities-available-for-sale  or  securities-held-to-maturity.  Securities  for which the Company has the ability and positive intent to hold until maturity are reported  as held-to-maturity. These securities are carried at cost adjusted for amortization  of  premiums  and accretion of discounts. Securities that are held for  indefinite  periods  of time and which management intends to use as part of its  asset/liability  management  strategy,  or  that may be sold in response to changes  in  interest  rates,  changes  in prepayment risk, increases in capital requirements  or  other  similar  factors, are classified as available-for-sale. These  securities  are  stated  at fair value in the financial statements of the Company.  Temporary differences between available-for-sale securities' amortized cost  and fair market value (accumulated other comprehensive income or loss when net of tax) are not included in earnings, but are reported as a net amount (less expected  tax) in a separate component of capital until realized. The cost basis of  individual  securities  is  written  down  to estimated fair value through a charge  to  earnings when decreases in value below amortized cost are considered to  be  other than temporary. This other than temporary impairment is charged to securities  gain  on  the Company's financial statements. .At December 31, 2005, the  unrealized  loss  (accumulated  other  comprehensive  loss)  net of tax was $2,895,000.  This  compares  to  an  unrealized  loss  net of tax of $723,000 at December  31,  2004.  The  Company monitors the market value fluctuations of its securities  portfolio on a monthly basis as well as associated credit ratings to determine  potential  impairment  of  a  security.  Federal Funds Sold - ------------------  There  were no  federal  funds sold at  December  31,  2005.  This  compares  to $2,271,000 at December 31, 2004.  This  represents a normal  operating  range of funds for daily cash needs.  Lending - -------  New business development during the year coupled with the loans acquired as part of the  previously  described  merger  resulted  in an  increase  in  net  loans outstanding to $215,989,000 at December 31, 2005, as compared to $201,978,000 at December 31, 2004.  This is an increase of  $14,011,000  or 6.94%.  Although the largest  dollar  volumes of loan  activity  continues  to be in the  residential mortgage  area,  the Company offers a wide variety of loan types and terms along with competitive pricing to customers. The Company's credit function is designed to ensure adherence to prudent credit standards despite competition for loans in the Company's market area.                                          23   The following table  represents the composition of the loan portfolio  comparing December 31, 2005 to December 31, 2004:                                                       December 31, 2005   December 31, 2004                                                    -----------------   -----------------                                                            (amounts in thousands)    Commercial, financial and agricultural                 $  15,354           $  15,127 Real Estate-construction and land development             18,814              14,290 Real Estate-residential                                  135,619             130,414 Real Estate-commercial                                    40,889              35,487 Consumer                                                   7,900               9,122 Other                                                         47                  69                                                        ---------           ---------                                                          218,623             204,509 Unearned income                                               (8)                (19) Allowance for loan losses                                 (2,626)             (2,512)                                                        ---------           --------- Loans, net                                             $ 215,989           $ 201,978                                                        =========           =========   Provisions and Allowance for Loan Losses - ----------------------------------------  Gross loans outstanding as of December 31, 2005 totaled $218,623,000 as compared to total gross loans of $204,509,000  as of December 31, 2004. This  represented an increase of  $14,114,000  or 6.90%.  Approximately  90% of the Company's loan portfolio is real estate  secured and  reflected a slight  increase from the 88% real estate  secured figure as of December 31, 2004. The increase in total gross loans was primarily the result of increases in residential  and commercial  real estate loans which included construction.  Credit risk is inherent in the business of extending loans. The Company monitors the loan portfolio to ensure that loan quality will not be sacrificed for growth or otherwise compromise the Company's objectives. Because of the risk associated with extending loans the Company  maintains an allowance or reserve for loan and lease losses through  charges to earnings.  The loan loss provision  expense for the year 2005 was $210,000 as compared to $250,000  for the year ended  December 31, 2004.  The Bank  evaluates the adequacy of the allowance on a monthly basis. No material changes have been made in the estimation methods or assumptions that the Bank used in making this  determination  during the year ending December 31, 2005.  Such  evaluations  are based on  assessments  of credit quality and "risk rating" of loans by senior  management,  which is reviewed by the Company's Loan Committee on a regular basis. Loans are initially risk rated when originated. If there is  deterioration  in the  credit  quality,  the risk  rating is  adjusted accordingly.  The allowance also includes a component  resulting  from the  application of the measurement  criteria of Statements of Financial  Accounting  Standards No. 114, Accounting by Creditors for  Impairment of a Loan ("SFAS 114").  Impaired  loans receive  individual  evaluation of the allowance  necessary on a monthly  basis. Loans to be considered  for  impairment are defined in the Company's Loan Policy as  commercial  loans  with  balances   outstanding  of  $100,000  or  more  and residential  real estate mortgages with balances of $300,000 or more. Such loans are considered impaired when it is probable that the Company will not be able to collect all principal and interest due according to the terms of the note.  Any such commercial loan and/or residential mortgage will be considered impaired under any of the following circumstances:       1.   Non-accrual status;      2.   Loans over 90 days delinquent;      3.   Troubled debt restructures consummated after December 31, 1994;      4.   Loans  classified as  "doubtful",  meaning that they have  weaknesses,           which  make  collection  or  liquidation  in  full,  on the  basis  of           currently existing facts, conditions,  and values, highly questionable           and improbable.  The  individual  allowance for any impaired loan is based upon the present value of expected future cash flows discounted at the loan's  effective  interest rate or the  fair  value  of the  collateral  if the  loan is  collateral  dependent. Specifically  identifiable and quantifiable  losses are immediately  charged off against the allowance.  In addition, a risk of loss factor is applied in evaluating  categories of loans as part of the periodic  analysis of the  Allowance  for Loan and Lease  Losses. This  analysis  reviews the  allocations  of the  different  categories of loans within the  portfolio  and  considers  historical  loan  losses and  delinquency balances as well as recent delinquent percentage trends.                                         24   The credit card delinquency and loss history is separately evaluated and given a special loan loss factor because management  recognizes the higher risk involved in such  loans.  Concentrations  of credit and local  economic  factors are also evaluated on a periodic  basis.  Historical  average net losses by loan type are examined as well as trends by type.  The Bank's loan mix over the same period of time is also  analyzed.  A loan  loss  allocation  is made for each type of loan multiplied by the loan mix  percentage  for each loan type to produce a weighted average factor.  Nonperforming  loans,  which include all loans that are on a non-accrual  status along  with  loans  that are 90 days or more  past due and  still  accruing  are closely monitored by management.  These  nonperforming loans totaled $773,000 or 0.35% of total loans outstanding as of December 31, 2005 and compares  favorably to the December  31, 2004 figures  which  totaled  $2,267,000  or 1.11% of total loans outstanding at that time.  Accordingly,  the overall quality of the Bank's loan portfolio is considered to be excellent.  The  Allowance  for  Loan  and  Lease Losses (ALLL) at December 31, 2005 totaled $2,626,000, representing 339.72% of the previously mentioned nonperforming loans of  $773,000 and 1.20% of total loans outstanding of $218,623,000. This compares to  an  ALLL  of  $2,512,000 which represented 110.81% of nonperforming loans of $2,267,000  and 1.23 % of total loans outstanding of $204,509,000 as of December 31,  2004. The Allowance for Off Balance Sheet Commitments for December 31, 2005 totaled $134,000. The December 31, 2004 balance of the Allowance for Off Balance Sheet  Commitments  was  $127,000. A total of $135,000 in loans were charged-off during  the  2005  year  compared  to $70,000 during 2004. A total of $39,000 of previously  charged-off  loans were recovered during the year ended December 31, 2005  compared  to  $28,000  in  recoveries  for the 2004 year. While management estimates loan losses using the best available information, no assurances can be given  that  future  additions  to  the allowance will not be necessary based on changes  in  economic  and  real  estate  market  conditions,  identification of additional  problem  loans or other factors. Additionally, despite the excellent overall  quality  of  the loan portfolio and with expectations of the Company to continue  to  grow its existing portfolio, future additions to the allowance may be necessary to maintain adequate reserve coverage. Management is of the opinion that  the  ALLL  is  adequate  as  of  December  31,  2005.  Deposits - --------  The Company offers a variety of deposit  accounts with a range of interest rates and  terms.   Deposits  at  year-end  2005  totaled  $287,271,000   compared  to $298,842,000   at  year-end   2004.   The  Company   continues  its  efforts  to competitively price products and develop and maintain  relationship banking with its  customers.  The flow of deposits  is  influenced  significantly  by general economic  conditions,  changes in money market rates,  prevailing interest rates and the aggressive competition from nonbanking entities.  During the year, there was an increase in demand,  NOW and  savings  accounts  that are lower cost core deposits.  The average  daily amount of deposits by category and the average  rates paid on such deposits are summarized in the following table:  (dollars in thousands)               Year ended December 31                         2005                 2004                   2003                --------------------------------------------------------------                  Average              Average               Average                 Balance     Rate     Balance      Rate     Balance      Rate                -------------------------------------------------------------- Demand         $ 65,591             $ 51,649              $ 38,998 NOW              27,767      .25%     23,797       .01%     20,030       31% Money Market     53,835     2.15%     38,884       .83%     39,491       76% Savings          59,466      .77%     54,596       .68%     45,975       98% Time             86,794     2.86%     75,241      2.64%     68,898      2.98%                --------             --------              --------                $293,453     1.42%   $244,167      1.12%   $213,392      1.34%                ========             ========              ========                                          25   Maturities of time  certificates of deposits of $100,000 or more  outstanding at December 31 are summarized as follows:  (dollars in thousands)                          December 31                                          2005      2004      2003                                        ---------------------------  Three months or less                   $ 9,763   $ 9,540   $ 5,575 Over three months through six months     1,057     1,011     1,343 Over six months through one year         8,774     7,517     5,591 Over one year                            8,069    14,887    11,080                                        -------   -------   -------  Total                                  $27,663   $32,955   $23,589                                        =======   =======   =======  Borrowings - ----------  As part of its  operating  strategy,  the  Company  utilizes  advances  from the Federal Home Loan Bank to supplement deposit growth and fund its asset growth, a strategy that is designed to increase  interest income.  These advances are made pursuant to various credit programs, each of which has its own interest rate and range of  maturities.  At December  31,  2005,  the Company had  $71,016,000  in outstanding  advances from the Federal Home Loan Bank compared to $79,213,000 at December 31, 2004.  Management  expects that it will  continue  this strategy of supplementing  deposit  growth  with  advances  from  Federal  Home Loan Bank of Boston.  Interest Rate Risk - ------------------  Interest rate risk is the most  significant  market risk  affecting the Company. Interest  rate risk is defined as an exposure  to a movement  in interest  rates that could have an adverse effect on net interest income. Net interest income is sensitive to interest rate risk to the degree that interest bearing  liabilities mature or reprice on a different basis than earning assets.  The Bank's  assets and  liabilities  are  managed in  accordance  with  policies established  and  reviewed  by  the  Bank's  Board  of  Directors.   The  Bank's Asset/Liability   Management   Committee  monitors  asset  and  deposit  levels, developments  and trends in interest  rates,  liquidity and capital.  One of the primary  financial  objectives  is to manage  interest rate risk and control the sensitivity  of  earnings  to changes in  interest  rates in order to  prudently improve  net  interest  income and  manage  the  maturities  and  interest  rate sensitivities of assets and liabilities.  To  quantify  the extent of these  risks  both in its  current  position  and in actions it might take in the future,  interest rate risk is monitored  using gap analysis which identifies the differences  between assets and liabilities  which mature or reprice during specific time frames and model simulation which is used to "rate shock" the Company's assets and liability  balances to measure how much of the Company's net interest income is "at risk" from sudden rate changes.  An interest rate sensitivity gap is defined as the difference between the amount of  interest-earning  assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same  period.  A gap is  considered  positive  when the amount of interest  rate sensitive  assets exceeds the amount of interest rate sensitive  liabilities.  A gap  is  considered   negative  when  the  amount  of  interest  rate  sensitive liabilities  exceeds the amount of interest rate sensitive  assets.  At December 31, 2005, the Company was slightly asset  sensitive  (positive  gap). This would suggest that the during a period of rising  interest  rates the Company would be in a better position to invest in higher yielding assets  resulting in growth in interest income.  To the contrary,  during a period of falling interest rates, a positive  gap would  result  in a  decrease  in  interest  income.  The level of interest  rate risk at December  31,  2005 is within the limits  approved by the Board of Directors.  Liquidity - ---------  Liquidity is the ability to raise funds on a timely basis at an acceptable  cost in  order  to meet  cash  needs.  Adequate  liquidity  is  necessary  to  handle fluctuation in deposit levels,  to provide for customers'  credit needs,  and to take advantage of investment  opportunities  as they are presented.  The Company manages  liquidity  primarily  with readily  marketable  investment  securities, deposits and loan repayments. The Company's subsidiary, Salisbury Bank and Trust Company  is a member of the  Federal  Home Loan Bank of Boston  that  provides a source of available borrowings for liquidity.  At  December  31,  2005,  the  Company  had  approximately  $47,966,000  in loan commitments outstanding. Management believes that the current level of liquidity is ample to meet the  Company's  needs  for  both the  present  and  foreseeable future.                                         26   Capital - -------  At  December  31,  2005,  the  Company  had  $41,442,000 in stockholders' equity compared  to  $40,700,000  at  December 31, 2004. This represents an increase of $742,000  or  1.82%. Several components contributed to the change since December 2004. Earnings for the year totaled $4,561,000. Securities in the portfolio that are  classified as available-for-sale are adjusted to fair value monthly and the unrealized  losses  or gains are not included in earnings, but are reported as a net  amount  (less  expected  tax)  as  a  separate  component  of capital until realized.  Then it is included in earnings. Market fluctuations of fair value at December  31,  2005 resulted in an accumulated other comprehensive loss totaling $2,895,000.The  Company  declared  dividends  in 2005 resulting in a decrease in capital  of  $1,683,000. The Company issued 940 new shares of common stock under the  terms of the Director Stock Retainer Plan during the second quarter of 2005 which  resulted  in  an increase in capital of $36,000. Under current regulatory definitions,  the  Company  and the Bank are considered to be "well capitalized" for  capital  adequacy  purposes.  As a result, the Bank pays the lowest federal deposit  insurance  deposit  premiums  possible.  One primary measure of capital adequacy  for regulatory purposes is based on the ratio of risk-based capital to risk  weighted  assets.  This  method  of  measuring  capital  adequacy helps to establish  capital  requirements  that  are sensitive to the differences in risk associated  with  various assets. It takes in account off-balance sheet exposure in  assessing capital adequacy and it minimizes disincentives to holding liquid, low risk assets. At year-end 2005, the Company had a risk-based capital ratio of 15.76%  compared  to  12.13% at December 31, 2004. Maintaining strong capital is essential  to  bank  safety  and soundness. However, the effective management of capital  resources  requires  generating  attractive  returns on equity to build value  for  stockholders while maintaining appropriate levels of capital to fund growth,  meet  regulatory  requirements  and be consistent with prudent industry practices.  Management  believes that the capital ratios of the Company and Bank are  adequate  to  continue  to  meet  the  foreseeable  capital  needs  of  the institution.  Impact of Inflation and Changing Prices - ---------------------------------------  The Company's  consolidated financial statements are prepared in conformity with accounting  principles  generally accepted in the United States of America which require the measurement of financial condition and operating results in terms of historical dollars without  considering changes in the relative purchasing power of money,  over  time,  due to  inflation.  Unlike  most  industrial  companies, virtually all of the assets and liabilities of the Company are monetary and as a result,  interest  rates  tend  to  have  a  greater  impact  on  the  Company's performance  than do the  effects  of  general  levels  of  inflation.  Although interest  rates do not  necessarily  move in the same direction or with the same magnitude as the prices of goods and services,  inflation  could impact earnings in future periods.  Recent Accounting Pronouncements - --------------------------------  In  January  2003,  the  Financial  Accounting  Standards  Board  (FASB)  issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), in an effort to expand upon and  strengthen  existing  accounting  guidance that addresses when a company should include in its financial  statements the assets, liabilities and activities of another entity. In December 2003, the FASB revised Interpretation  No. 46, also referred to as Interpretation 46 (R) ("FIN 46(R)"). The  objective  of this  interpretation  is not to restrict  the use of variable interest entities but to improve financial  reporting by companies involved with variable  interest  entities.  Until now,  one company  generally  has  included another entity in its  consolidated  financial  statements only if it controlled the entity  through  voting  interests.  This  interpretation  changes  that, by requiring a variable  interest  entity to be  consolidated  by a company only if that  company is subject  to a  majority  of the risk of loss from the  variable interest  entity's  activities or entitled to receive a majority of the entity's residual  returns or both.  The Company is required to apply FIN 46, as revised, to all  entities  subject  to it no later  than the end of the  first  reporting period ending after March 15, 2004. However,  prior to the required  application of FIN 46, as  revised,  the  Company  shall apply FIN 46 or FIN 46 (R) to those entities that are considered to be special-purpose entities as of the end of the first fiscal year or interim period ending after December 15, 2003. The adoption of this  interpretation  did not have an  impact on the  Company's  consolidated financial  statements  as the Company did not have any  financial  interests  in variable interest entities at December 31, 2005.  In December  2003,  the  American  Institute  of  Certified  Public  Accountants ("AICPA") issued Statement of Position 03-3 ("SOP 03-3") "Accounting for Certain Loans or Debt  Securities  Acquired  in a  Transfer."  SOP 03-3  requires  loans acquired  through a transfer,  such as a business  combination,  where there are differences  in expected  cash flows and  contractual  cash flows due in part to credit quality be recognized at their fair value. The excess of contractual cash flows over  expected  cash flows is not to be  recognized  as an  adjustment  of yield,  loss accrual,  or valuation  allowance.  Valuation  allowances cannot be created nor "carried  over" in the initial  accounting  for loans  acquired in a transfer on loans subject to SFAS 114,  "Accounting  by Creditors for Impairment of a Loan." This SOP is effective for loans  acquired in fiscal years  beginning after  December 15, 2004,  with early adoption  encouraged.  The adoption                                         27   of SOP  03-3 did not have an  impact  on the  Company's  financial  position  or results of  operations  since the Company  acquired no loans subject to SFAS 114 since the effective date of SOP 03-3.  In December  2004,  the FASB issued SFAS No. 123  (revised  2004),  "Share-Based Payment"  ("SFAS  123R").   This  Statement  revises  FASB  Statement  No.  123, "Accounting  for Stock Based  Compensation"  and  supersedes APB Opinion No. 25, "Accounting  for Stock  Issued to  Employees,"  and its  related  implementation guidance.  SFAS  123R  requires  that the cost  resulting  from all  share-based payment transactions be recognized in the consolidated financial statements.  It establishes   fair  value  as  the  measurement   objective  in  accounting  for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity  instruments held by employee share ownership plans. This  Statement  is effective  for the Company as of the  beginning of the first annual  reporting  period that begins after  December 15, 2005.  The adoption of this  Statement is not  anticipated  to have a material  impact on the Company's financial  position or results of operations as there is no share-based  payment arrangements  with  employees  and  the  compensation  expense  related  to  the Directors Stock Retainer Plan is not anticipated to be material.  Off-Balance Sheet Arrangements - ------------------------------  The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing  needs of its customers.  In the opinion of management,  these off-balance  sheet  arrangements are not likely to have a  material  effect  on  the  Company's  financial  condition,  results  of operations, or liquidity. (See Note 11 to the Financial Statements).  Forward Looking Statements - --------------------------  This Annual  Report and future  filings made by the Company with the  Securities and Exchange  Commission,  as well as other filings,  reports and press releases made or  issued  by the  Company  and the  Bank,  and  oral  statements  made by executive  officers  of the Company  and the Bank,  may include  forward-looking statements relating to such matters as:  (a)  assumptions  concerning  future economic and business  conditions and their      effect on the  economy in general  and on the  markets in which the Company      and the Bank do business, and (b)  expectations  for increased  revenues and earnings for the Company and Bank      through growth resulting from  acquisitions,  attraction of new deposit and      loan customers and the introduction of new products and services.  Such forward-looking  statements are based on assumptions rather than historical or current facts and, therefore,  are inherently  uncertain and subject to risk. For those  statements,  the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Act of 1995.  The Company  notes that a variety of factors  could cause the actual  results or experience  to  differ   materially  from  the  anticipated   results  or  other expectations described or implied by such forward-looking  statements. The risks and uncertainties  that may effect the operation,  performance,  development and results of the Company's and Bank's business include the following:  (a)  the risk of adverse changes in business  conditions in the banking industry      generally and in the specific markets in which the Bank operates; (b)  changes in the  legislative  and  regulatory  environment  that  negatively      impact the Company and Bank through increased operating expenses; (c)  increased competition from other financial and non-financial institutions; (d)  the impact of technological advances; and (e)  other risks  detailed from time to time in the  Company's  filings with the      Securities and Exchange Commission.  Such  developments  could have an adverse impact on the Company's and the Bank's financial position and results of operations.  Statement of Management's Responsibility - ----------------------------------------  Management is responsible for the integrity and objectivity of the  consolidated financial  statements  and other  information  appearing in this Form 10-K.  The consolidated  financial  statements  were prepared in accordance with accounting principles generally accepted in the United States of America applying estimates and management's best judgment as required.  To fulfill their  responsibilities, management establishes and maintains accounting systems and practices adequately supported by internal accounting controls.  These controls include the selection and training of management and supervisory personnel;  an organization                                         28   structure   providing  for   delegation  of  authority  and   establishment   or responsibilities;  communication  of  requirements  for compliance with approved accounting, control and business practices throughout the organization; business planning and review;  and a program of internal audit.  Management  believes the internal accounting controls in use provide reasonable assurance that assets are safeguarded,  that  transactions  are executed in accordance  with  management's authorization  and that  financial  records  are  reliable  for the  purpose  of preparing financial  statements.  Shatswell,  MacLeod and Company, P.C. has been engaged to provide an  independent  opinion on the fairness of the  consolidated financial statements. Their report appears in this Annual Report on Form 10-K.
The  main  components  of  market risk for the Company are credit risk, interest rate  risk  and  liquidity  risk.  The  Company  manages  interest rate risk and liquidity  risk  through  an  ALCO  Committee comprised of outside Directors and senior   management.   The  committee  monitors   compliance  with   the  Bank's Asset/Liability  Policy  which establishes guidelines to meet various applicable regulatory  rules  and statutes, measures the various risks facing the bank on a consistent  basis  and  coordinates  the  management  of  the  bank's  financial position.  Model  simulation  is  used to measure earnings volatility under both rising and falling interest rate scenarios. The Company's interest rate risk and liquidity  position  has  not  significantly  changed  from  year-end  2005.                                         29
Index to Consolidated Financial Statements - ------------------------------------------  Report of Independent Registered Public   Accounting Firm, January 19, 2006 ....................................   F-1  Consolidated Balance Sheets at December 31, 2005 and 2004 ..............   F-2  Consolidated Statements of Income for the Years Ended  December 31, 2005, 2004 and 2003 ......................................   F-3  Consolidated Statements of Changes in Stockholders' Equity  for the Years Ended December 31, 2005, 2004 and 2003 ..................   F-4  Consolidated Statements of Cash Flows for the Years Ended  December 31, 2005, 2004 and 2003 ......................................   F-5  Notes to Consolidated Financial Statements for the  Years Ended December 31, 2005, 2004 and 2003 ..........................   F-7  Salisbury Bancorp, Inc. (parent company only)  Balance Sheet at December 31, 2005 and 2004 ...........................   F-27   Statements of Income for the Years Ended    December 31, 2005, 2004 and 2003 ....................................   F-27   Statements of Cash Flows for the Years Ended    December 31, 2005, 2004 and 2003 ....................................   F-28  Quarterly Results of Operations (unaudited) ............................   F-29                                          30                          SHATSWELL, MACLEOD & COMPANY, P.C.                        ----------------------------------                           CERTIFIED PUBLIC ACCOUNTANTS  To the Board of Directors Salisbury Bancorp, Inc. Lakeville, Connecticut               REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM              -------------------------------------------------------  We have  audited  the  accompanying  consolidated  balance  sheets of  Salisbury Bancorp,  Inc. and  Subsidiary  as of December 31, 2005 and 2004 and the related consolidated  statements  of income,  changes in  stockholders'  equity and cash flows for each of the years in the  three-year  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 consolidated financial statements are free of material misstatement. The Company is not  required  to  have,  nor were we  engaged  to  perform,  an audit of its internal control over financial reporting.  Our audit included  consideration of internal  control  over  financial  reporting  as a basis  for  designing  audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the  effectiveness  of the Company's  internal  control over  financial  reporting.  Accordingly,  we express no such opinion.  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 consolidated  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 Salisbury Bancorp, Inc. and Subsidiary as of December 31, 2005 and 2004, and the consolidated  results of their  operations  and their cash flows for each of the years in the  three-year  period ended  December 31, 2005,  in  conformity  with accounting principles generally accepted in the United States of America.                                             /S/ SHATSWELL, MacLEOD & COMPANY, P.C.                                           SHATSWELL, MacLEOD & COMPANY, P.C. West Peabody, Massachusetts January 19, 2006                                         F-1                                          SALISBURY BANCORP, INC. AND SUBSIDIARY                                      --------------------------------------                                            CONSOLIDATED BALANCE SHEETS                                           ---------------------------                                            December 31, 2005 and 2004                                           --------------------------  ASSETS                                                                                2005             2004                                                                                  -------------    -------------    Cash and due from banks                                                          $   8,431,844    $   7,283,667 Interest bearing demand deposits with other banks                                      652,807        1,180,937 Money market mutual funds                                                            1,119,724          941,890 Federal funds sold                                                                                    2,271,000                                                                                  -------------    -------------            Cash and cash equivalents                                                10,204,375       11,677,494 Investments in available-for-sale securities (at fair value)                       145,608,297      178,654,748 Investments in held-to-maturity securities (fair values of $147,202 as of    December 31, 2005 and $219,623 as of December 31, 2004)                             146,856          218,374 Federal Home Loan Bank stock, at cost                                                5,413,200        5,413,200 Loans held-for-sale                                                                    375,000 Loans, less allowance for loan losses of $2,626,170 and $2,511,546 as of    December 31, 2005 and 2004, respectively                                        215,989,149      201,978,499 Investment in real estate                                                               75,000           75,000 Premises and equipment                                                               6,451,979        5,933,978 Goodwill                                                                             9,509,305        9,509,305 Core deposit intangible                                                              1,657,715        1,822,131 Accrued interest receivable                                                          2,362,924        2,256,499 Cash surrender value of life insurance policies                                      3,424,186        3,293,548 Other assets                                                                         2,079,307        1,893,029                                                                                  -------------    -------------            Total assets                                                          $ 402,922,293    $ 423,100,805                                                                                  =============    =============  LIABILITIES AND STOCKHOLDERS' EQUITY Deposits:    Noninterest-bearing                                                           $  63,995,665    $  65,017,207    Interest-bearing                                                                223,275,537      233,824,639                                                                                  -------------    -------------            Total deposits                                                          287,271,202      298,841,846 Federal Home Loan Bank advances                                                     71,015,614       79,213,283 Due to broker                                                                        1,083,331 Other liabilities                                                                    3,193,154        3,262,745                                                                                  -------------    -------------            Total liabilities                                                       361,479,970      382,401,205                                                                                  -------------    ------------- Stockholders' equity:    Common stock, par value $.10 per share; authorized 3,000,000 shares; issued      and outstanding, 1,683,341 shares in 2005 and 1,682,401 shares in 2004            168,334          168,240    Paid-in capital                                                                  13,068,045       13,031,573    Retained earnings                                                                31,100,702       28,222,466    Accumulated other comprehensive loss                                             (2,894,758)        (722,679)                                                                                  -------------    -------------            Total stockholders' equity                                               41,442,323       40,699,600                                                                                  -------------    -------------            Total liabilities and stockholders' equity                            $ 402,922,293    $ 423,100,805                                                                                  =============    =============                                     The accompanying notes are an integral part of these                                              consolidated financial statements.                                                                F-2                                              SALISBURY BANCORP, INC. AND SUBSIDIARY                                          --------------------------------------                                             CONSOLIDATED STATEMENTS OF INCOME                                            ---------------------------------                                       Years Ended December 31, 2005, 2004 and 2003                                      --------------------------------------------                                                                             2005          2004          2003                                                                        -----------   -----------   -----------     Interest and dividend income:    Interest and fees on loans                                          $13,319,930   $ 9,592,478   $ 9,226,484    Interest on debt securities:      Taxable                                                             4,814,993     4,499,725     4,186,368      Tax-exempt                                                          2,329,414     2,293,706     2,086,134    Dividends on equity securities                                          282,534       112,008       112,340    Other interest                                                           69,512        53,101        38,496                                                                        -----------   -----------   -----------          Total interest and dividend income                             20,816,383    16,551,018    15,649,822                                                                        -----------   -----------   ----------- Interest expense:    Interest on deposits                                                  4,171,360     2,738,680     2,866,495    Interest on Federal Home Loan Bank advances                           3,180,591     2,920,316     2,746,975                                                                        -----------   -----------   -----------          Total interest expense                                          7,351,951     5,658,996     5,613,470                                                                        -----------   -----------   -----------          Net interest and dividend income                               13,464,432    10,892,022    10,036,352 Provision for loan losses                                                  210,000       250,000       312,500                                                                        -----------   -----------   -----------          Net interest and dividend income after provision for            loan losses                                                  13,254,432    10,642,022     9,723,852                                                                        -----------   -----------   ----------- Noninterest income:    Trust department income                                               1,571,311     1,410,814     1,252,000    Loan commissions                                                        260,997       239,139       225,958    Service charges on deposit accounts                                     642,268       620,771       560,291    Gain on sales and writedown of available-for-sale securities, net     1,209,724     1,489,905     1,058,140    Gain on sales of loans held-for-sale                                    270,061       304,354       261,418    Other income                                                            910,743       690,198       626,292                                                                        -----------   -----------   -----------          Total noninterest income                                        4,865,104     4,755,181     3,984,099                                                                        -----------   -----------   ----------- Noninterest expense:    Salaries and employee benefits                                        7,355,316     5,970,639     4,833,913    Occupancy expense                                                       728,302       435,983       359,458    Equipment expense                                                       776,729       600,127       579,395    Trust department expense                                                398,130       339,069       408,433    Data processing                                                         782,556       710,950       575,441    Conversion expense                                                      464,484         1,139    Insurance                                                               148,317       121,959       114,806    Printing and stationery                                                 251,882       253,725       183,970    Professional fees                                                       301,239       272,426       300,209    Legal expense                                                           173,761       106,134       127,772    Amortization of core deposit intangible                                 164,416       101,109        68,355    Other expense                                                         1,363,134     1,226,708     1,047,008                                                                        -----------   -----------   -----------          Total noninterest expense                                      12,443,782    10,603,313     8,599,899                                                                        -----------   -----------   -----------          Income before income taxes                                      5,675,754     4,793,890     5,108,052 Income taxes                                                             1,114,413       774,948     1,267,950                                                                        -----------   -----------   -----------          Net income                                                    $ 4,561,341   $ 4,018,942   $ 3,840,102                                                                        ===========   ===========   ===========  Earnings per common share                                              $      2.71   $      2.67   $      2.70                                                                        ===========   ===========   ===========                              The accompanying notes are an integral part of these                                    consolidated financial statements.                                                       F-3                                                  SALISBURY BANCORP, INC. AND SUBSIDIARY                                             --------------------------------------                                    CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY                                   ----------------------------------------------------------                                           Years Ended December 31, 2005, 2004 and 2003                                          --------------------------------------------                                                 Number                                              Accumulated                                                  of                                                    Other                                                Shares        Common       Paid-in      Retained    Comprehensive                                                Issued        Stock        Capital      Earnings    (Loss) Income      Total                                             ------------  ------------  ------------  ------------  ------------   ------------        Balance, December 31, 2002                     1,423,238  $    142,324  $  2,303,547  $ 23,164,693  $  1,734,382   $ 27,344,946 Comprehensive income:    Net income                                                                            3,840,102    Other comprehensive loss, net of tax      effect                                                                                           (1,048,565)        Comprehensive income                                                                            2,791,537 Issuance of 840 shares for Directors' fees           840            84        23,604                                     23,688 Dividends declared ($.92 per share)                                                     (1,309,959)                  (1,309,959)                                             ------------  ------------  ------------  ------------  ------------   ------------ Balance, December 31, 2003                     1,424,078       142,408     2,327,151    25,694,836       685,817     28,850,212 Comprehensive income:    Net income                                                                            4,018,942    Other comprehensive loss, net of tax      effect                                                                                           (1,408,496)        Comprehensive income                                                                            2,610,446 Shares issued for merger                         257,483        25,748    10,672,670                                 10,698,418 Issuance of 840 shares for Directors' fees           840            84        31,752                                     31,836 Dividends declared ($.96 per share)                                                     (1,491,312)                  (1,491,312)                                             ------------  ------------  ------------  ------------  ------------   ------------ Balance, December 31, 2004                     1,682,401       168,240    13,031,573    28,222,466      (722,679)    40,699,600 Comprehensive income:    Net income                                                                            4,561,341    Other comprehensive loss, net of tax      effect                                                                                           (2,172,079)        Comprehensive income                                                                                           2,389,262 Issuance of 940 shares for Directors' fees           940            94        36,472                                     36,566 Dividends declared ($1.00 per share)                                                    (1,683,105)                  (1,683,105)                                             ------------  ------------  ------------  ------------  ------------   ------------ Balance, December 31, 2005                     1,683,341  $    168,334  $ 13,068,045  $ 31,100,702  $ (2,894,758)  $ 41,442,323                                             ============  ============  ============  ============  ============   ============     Reclassification disclosure for the years ended December 31:                                                                                   2005          2004          2003                                                                              -----------   -----------   -----------     Unrealized holding losses on available-for-sale securities    Net unrealized holding losses on available-for-sale securities            $(1,547,214)  $(1,106,610)  $  (370,016)    Reclassification adjustment for net realized gains in net income           (1,209,724)   (1,489,905)   (1,058,140)                                                                              -----------   -----------   -----------                                                                               (2,756,938)   (2,596,515)   (1,428,156) Income tax benefit                                                               878,763     1,011,343       556,267                                                                              -----------   -----------   -----------      Unrealized holding losses on available-for-sale securities, net of tax   (1,878,175)   (1,585,172)     (871,889)                                                                              -----------   -----------   ----------- Minimum pension liability adjustment                                            (445,309)      289,396      (289,396) Income tax benefit (expense)                                                     151,405      (112,720)      112,720                                                                              -----------   -----------   -----------      Minimum pension liability, net of tax                                      (293,904)      176,676      (176,676)                                                                              -----------   -----------   -----------      Other comprehensive loss, net of tax                                    $(2,172,079)  $(1,408,496)  $(1,048,565)                                                                              ===========   ===========   ===========  Accumulated  other  comprehensive  (loss) income consists of the following  as of December 31:                                                                                      2005          2004          2003                                                                              -----------   -----------   ----------- Net unrealized holding (losses) gains on available-for-sale securities,  net of taxes                                                                $(2,600,854) $   (722,679)  $   862,493 Minimum pension liability adjustment, net of taxes                              (293,904)                   (176,676)                                                                              -----------   -----------   ----------- Accumulated other comprehensive (loss) income                                $(2,894,758)  $  (722,679)  $   685,817                                                                              ===========   ===========   ===========                                     The accompanying notes are an integral part of these                                            consolidated financial statements.                                                               F-4                                              SALISBURY BANCORP, INC. AND SUBSIDIARY                                           --------------------------------------                                            CONSOLIDATED STATEMENTS OF CASH FLOWS                                           -------------------------------------                                        Years Ended December 31, 2005, 2004 and 2003                                       --------------------------------------------                                                                                  2005             2004             2003                                                                            -------------    -------------    -------------     Cash flows from operating activities:    Net income                                                              $   4,561,341    $   4,018,942    $   3,840,102    Adjustments to reconcile net income to net cash provided by      operating activities:        Amortization of securities, net                                           302,781          289,214          395,030        Gain on sales and writedown of available-for-sale securities, net      (1,209,724)      (1,489,905)      (1,058,140)        Gain on sales of other real estate owned                                  (52,151)        Provision for loan losses                                                 210,000          250,000          312,500        Change in loans held-for-sale                                             375,000         (100,000)        (275,000)        (Decrease) increase in unearned income on loans                           (10,473)          18,529        Net decrease (increase) in mortgage servicing rights                       83,471          (41,253)         (67,250)        Write-off of equipment                                                      9,399        Depreciation and amortization                                             529,238          357,645          335,672        Amortization of core deposit intangible                                   164,416          101,109           68,355        Amortization of fair value adjustment on loans                            184,256          266,986        Accretion of fair value adjustments on deposits and borrowings           (154,287)         (51,429)         (11,450)        (Increase) decrease in interest receivable                               (110,482)          84,056           57,668        Deferred tax expense                                                       67,273          143,691          137,341        Decrease (increase) in prepaid expenses                                    14,242          270,965         (124,330)        Increase in cash surrender value of insurance policies                   (130,638)        (139,607)         (49,585)        Decrease (increase) in income tax receivable                              336,288          (53,889)        (154,792)        Increase in other assets                                                  (53,742)         (71,917)        (205,831)        (Decrease) increase in accrued expenses                                  (268,051)        (750,246)         197,428        Increase (decrease) in interest payable                                    42,822           57,465          (80,151)        Increase in other liabilities                                              59,445          367,956           20,000        Issuance of shares for Directors' fees                                     36,566           31,836           23,688                                                                            -------------    -------------    -------------     Net cash provided by operating activities                                   5,029,742        3,569,547        3,309,104                                                                            -------------    -------------    ------------- Cash flows from investing activities:    Redemption of Federal Reserve Bank stock                                                        56,300    Purchases of Federal Home Loan Bank stock                                                     (351,000)        (825,800)    Purchases of available-for-sale securities                                (87,783,193)    (124,520,785)     (89,014,647)    Proceeds from sales of available-for-sale securities                       83,572,466       98,347,353       49,353,780    Proceeds from maturities of available-for-sale securities                  34,328,155       32,998,864       31,044,359    Proceeds from maturities of held-to-maturity securities                        71,272           10,968           91,497    Loan originations and principal collections, net                          (12,432,343)      (8,191,577)      (4,157,060)    Purchases of loans                                                         (2,001,184)    Recoveries of loans previously charged off                                     39,094           28,302           48,508    Other real estate owned - expenditures capitalized                                                               (8,511)    Capital expenditures                                                       (1,017,056)      (1,003,263)        (475,024)    Proceeds from sale of equipment                                                                    436    Purchase of life insurance policies                                                                          (3,000,000)    Cash and cash equivalents acquired from Canaan National      Bancorp, Inc. net of expenses paid of $309,419                                             2,487,705    Cash paid to Canaan National Bancorp, Inc. shareholders                                     (6,020,163)                                                                            -------------    -------------    -------------     Net cash provided by (used in) investing activities                        14,777,211       (6,156,860)     (16,942,898)                                                                            -------------    -------------    -------------                                                                      F-5                                                 SALISBURY BANCORP, INC. AND SUBSIDIARY                                             --------------------------------------                                              CONSOLIDATED STATEMENTS OF CASH FLOWS                                             -------------------------------------                                           Years Ended December 31, 2005, 2004 and 2003                                          --------------------------------------------                                                           (continued)                                                           -----------                                                                                          2005            2004             2003                                                                                    -------------   -------------    -------------     Cash flows from financing activities:    Net (decrease) increase in demand deposits, NOW and      savings accounts                                                                 (8,516,596)      6,920,818        9,642,776    Net decrease in time deposits                                                      (3,029,964)     (2,141,902)      (2,211,280)    Federal Home Loan Bank advances                                                    10,000,000       5,000,000    Principal payments on advances from Federal Home Loan Bank                         (1,346,521)     (6,140,973)     (10,993,296)    Net change in short-term advances from Federal Home Loan Bank                     (16,720,945)                      20,000,000    Decrease in other borrowed funds                                                                      (86,863)    Dividends paid                                                                     (1,666,046)     (1,415,074)      (1,295,533)                                                                                    -------------   -------------    -------------     Net cash (used in) provided by financing activities                               (21,280,072)      2,136,006       15,142,667                                                                                    -------------   -------------    -------------  Net (decrease) increase in cash and cash equivalents                                  (1,473,119)       (451,307)       1,508,873 Cash and cash equivalents at beginning of year                                        11,677,494      12,128,801       10,619,928                                                                                    -------------   -------------    ------------- Cash and cash equivalents at end of year                                           $  10,204,375   $  11,677,494    $  12,128,801                                                                                    =============   =============    =============  Supplemental disclosures:    Interest paid                                                                   $   7,463,416   $   5,652,960    $   5,705,071    Income taxes paid                                                                     710,852         685,000        1,285,401    Transfer from equipment to other assets                                                                 2,815  Canaan National Bancorp, Inc. merger:    Cash and cash equivalents acquired                                                              $   2,797,124    Available-for-sale securities                                                                      42,776,284    Federal Home Loan Bank stock                                                                        1,291,200    Federal Reserve Bank stock                                                                             56,300    Net loans acquired                                                                                 54,787,421    Fixed assets acquired                                                                               2,355,970    Accrued interest receivable                                                                           460,550    Other assets acquired                                                                               1,173,549    Core deposit intangible                                                                             1,191,279                                                                                                    -------------                                                                                                      106,889,677     Deposits assumed                                                                                   75,613,508    Federal Home Loan Bank borrowings assumed                                                          19,500,346    Other borrowings assumed                                                                               86,863    Other liabilities assumed                                                                           1,812,381                                                                                                    -------------                                                                                                       97,013,098     Net assets acquired                                                                                 9,876,579     Merger costs                                                                                       17,028,000                                                                                                    -------------       Goodwill                                                                                      $   7,151,421                                                                                                    =============                                            The accompanying notes are an integral part of these                                                  consolidated financial statements.                                                                        F-6                        SALISBURY BANCORP, INC. AND SUBSIDIARY                      --------------------------------------                     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                    ------------------------------------------                    Years Ended December 31, 2005, 2004 and 2003                   --------------------------------------------  NOTE 1 - NATURE OF OPERATIONS - -----------------------------  Salisbury  Bancorp,  Inc.  (Bancorp)  is  a  Connecticut  corporation  that  was organized on April 24, 1998 to become a holding  company,  under which Salisbury Bank and Trust Company (Bank) operates as its wholly-owned subsidiary.  (Bancorp and the Bank are referred to together as the (Company).  The  Bank is a state  chartered  bank  which  was  incorporated  in 1874  and is headquartered  in  Lakeville,  Connecticut.  The Bank operates its business from four banking  offices  located in Connecticut and two banking offices located in Massachusetts.  The Bank is engaged  principally  in the business of  attracting deposits from the general public and investing those deposits in residential and commercial real estate,  consumer and small business loans. The Bank also offers a full complement of trust and investment services.  As described in Note 15, on September  10, 2004 Canaan  National  Bancorp,  Inc. merged with and into the Company.  NOTE 2 - ACCOUNTING POLICIES - ----------------------------  The  accounting  and  reporting  policies of the Company  conform to  accounting principles  generally  accepted in the United States of America and  predominant practices within the banking  industry.  The consolidated  financial  statements were prepared using the accrual basis of accounting.  The significant accounting policies are summarized below to assist the reader in better  understanding  the consolidated financial statements and other data contained herein.       USE OF ESTIMATES:       The  preparation  of financial  statements  in conformity  with  accounting      principles  generally  accepted  in the United  States of America  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 the estimates.       BASIS OF PRESENTATION:       The consolidated  financial  statements include the accounts of Bancorp and      its  wholly-owned  subsidiary,   the  Bank,  and  the  Bank's  wholly-owned      subsidiaries,  SBT Realty,  Inc.,  SBT Mortgage  Service  Corporation  (the      "PIC"), and CNB Insurance Agency,  Inc. SBT Realty,  Inc. holds and manages      bank owned real estate  situated in New York state.  The PIC  operates as a      passive  investment  company  and  services  residential   mortgages.   CNB      Insurance  Agency,  Inc. was formed to sell  insurance and was dissolved in      April 2005. All significant  intercompany  accounts and  transactions  have      been eliminated in the consolidation.       CASH AND CASH EQUIVALENTS:       For purposes of reporting  cash flows,  cash and cash  equivalents  include      cash on hand, cash items, due from banks,  interest bearing demand deposits      with other banks, money market mutual funds and federal funds sold.       Cash and due from banks as of December 31, 2005 and 2004 includes  $649,000      which is subject  to  withdrawals  and usage  restrictions  to satisfy  the      reserve requirements of the Federal Reserve Bank.                                        F-7        SECURITIES:       Investments in debt  securities are adjusted for  amortization  of premiums      and accretion of discounts so as to approximate the interest method.  Gains      or losses on sales of  investment  securities  are  computed  on a specific      identification basis.       The  Company  classifies  debt  and  equity  securities  into  one of three      categories: held-to-maturity, available-for-sale or trading. These security      classifications  may be  modified  after  acquisition  only  under  certain      specified  conditions.   In  general,   securities  may  be  classified  as      held-to-maturity only if the Company has the positive intent and ability to      hold them to maturity.  Trading  securities are defined as those bought and      held  principally  for the  purpose of selling  them in the near term.  All      other securities must be classified as available-for-sale.            --   Held-to-maturity  securities are carried at amortized cost in the                consolidated balance sheets.  Unrealized holding gains and losses                are not  included  in  earnings  or in a  separate  component  of                capital.   They  are  merely   disclosed  in  the  notes  to  the                consolidated financial statements.            --   Available-for-sale  securities  are  carried at fair value on the                consolidated balance sheets.  Unrealized holding gains and losses                are not  included  in earnings  but are  reported as a net amount                (less  expected  tax) in a separate  component  of capital  until                realized.            --   Trading  securities are carried at fair value on the consolidated                balance sheets.  Unrealized  holding gains and losses for trading                securities are included in earnings. During the three years ended                December 31, 2005 the Company did not classify any  securities as                trading.       Declines  in the fair  value  of  held-to-maturity  and  available-for-sale      securities  below their cost that are deemed to be other than temporary are      reflected in earnings as realized losses.       LOANS:       Loans  receivable  that management has the intent and ability to hold until      maturity or payoff,  are reported at their outstanding  principal  balances      adjusted  for any  charge-offs,  the  allowance  for  loan  losses  and any      deferred  fees or costs on  originated  loans or  unamortized  premiums  or      discounts on purchased loans.       Interest on loans is recognized on a simple interest basis.       Residential  real estate  loans are  generally  placed on  nonaccrual  when      reaching 90 days past due or in process of foreclosure.  Any equity line 90      days past due or in the  process  of  foreclosure  is placed on  nonaccrual      status.  Secured  consumer  loans are written down to realizable  value and      unsecured consumer loans are charged-off upon reaching 120 or 180 days past      due  depending  on the type of  loan.  Commercial  real  estate  loans  and      commercial business loans and leases which are 90 days or more past due are      generally placed on nonaccrual status, unless secured by sufficient cash or      other assets  immediately  convertible to cash. When a loan has been placed      on  nonaccrual  status,  previously  accrued  and  uncollected  interest is      reversed  against  interest  on loans.  A loan can be  returned  to accrual      status when  collectibility of principal is reasonably assured and the loan      has performed for a period of time, generally six months.       Cash  receipts  of  interest  income  on  impaired  loans are  credited  to      principal  to  the  extent   necessary   to  eliminate   doubt  as  to  the      collectibility  of the net carrying  amount of the loan. Some or all of the      cash  receipts  of  interest  income on  impaired  loans is  recognized  as      interest  income if the remaining net carrying amount of the loan is deemed      to be fully collectible. When recognition of interest income on an impaired      loan  on a cash  basis  is  appropriate,  the  amount  of  income  that  is      recognized  is  limited to that  which  would have been  accrued on the net      carrying  amount of the loan at the  contractual  interest  rate.  Any cash      interest payments received in excess of the limit and not applied to reduce      the  net  carrying  amount  of the  loan  are  recorded  as  recoveries  of      charge-offs until the charge-offs are fully recovered.                                        F-8        ALLOWANCE FOR LOAN LOSSES:       The  allowance  for loan losses is  established  as losses are estimated to      have occurred through a provision for loan losses charged to earnings. Loan      losses are charged  against the  allowance  when  management  believes  the      uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if      any, are credited to the allowance.       The allowance for loan losses is evaluated on a regular basis by management      and is based upon management's periodic review of the collectibility of the      loans in light of historical experience,  the nature and volume of the loan      portfolio,  adverse  situations  that may affect the borrower's  ability to      repay,  the estimated  value of any  underlying  collateral  and prevailing      economic  conditions.  This  evaluation  is  inherently  subjective  as  it      requires  estimates that are  susceptible  to significant  revision as more      information becomes available.       A loan is  considered  impaired  when,  based on  current  information  and      events,  it is  probable  that the  Bank  will be  unable  to  collect  the      scheduled  payments of  principal  or interest  when due  according  to the      contractual terms of the loan agreement.  Factors  considered by management      in determining impairment include payment status, collateral value, and the      probability of collecting  scheduled  principal and interest  payments when      due.  Loans  that  experience  insignificant  payment  delays  and  payment      shortfalls generally are not classified as impaired.  Management determines      the significance of payment delays and payment shortfalls on a case-by-case      basis,  taking into consideration all of the circumstances  surrounding the      loan and the borrower,  including the length of the delay,  the reasons for      the delay,  the  borrower's  prior  payment  record,  and the amount of the      shortfall in relation to the  principal  and interest  owed.  Impairment is      measured on a loan by loan basis for commercial and  construction  loans by      either the present  value of expected  future cash flows  discounted at the      loan's effective  interest rate, the loan's obtainable market price, or the      fair value of the collateral if the loan is collateral dependent.       Large  groups  of  smaller  balance   homogeneous  loans  are  collectively      evaluated  for  impairment.  Accordingly,  the  Bank  does  not  separately      identify   individual   consumer  and  residential   loans  for  impairment      disclosures.       PREMISES AND EQUIPMENT:       Premises and equipment are stated at cost,  less  accumulated  depreciation      and  amortization.   Cost  and  related  allowances  for  depreciation  and      amortization of premises and equipment retired or otherwise disposed of are      removed  from the  respective  accounts  with any gain or loss  included in      income or expense. Depreciation and amortization are calculated principally      on the straight-line  method over the estimated useful lives of the assets.      Estimated  lives  are 3 to 99 years  for  buildings  and 2 to 20 years  for      furniture and equipment.       OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:       Other real estate owned includes  properties  acquired through  foreclosure      and properties  classified as in-substance  foreclosures in accordance with      Statement of Financial  Accounting  Standards (SFAS) No. 15, "Accounting by      Debtors and Creditors for Troubled Debt  Restructuring."  These  properties      are  carried at the lower of cost or  estimated  fair value less  estimated      costs to sell.  Any writedown from cost to estimated fair value required at      the time of foreclosure or  classification  as in-substance  foreclosure is      charged to the allowance for loan losses.  Expenses  incurred in connection      with  maintaining  these assets and  subsequent  writedowns are included in      other expense.       In accordance with SFAS No. 114, "Accounting by Creditors for Impairment of      a  Loan,"  the  Bank  classifies  loans  as  in-substance   repossessed  or      foreclosed if the Bank or its subsidiaries  receives physical possession of      the debtor's assets  regardless of whether formal  foreclosure  proceedings      take place. As of December 31, 2005 and December 31, 2004, the Company does      not have any other real estate owned.       ADVERTISING:       The Bank directly  expenses costs  associated with  advertising as they are      incurred.                                        F-9        INCOME TAXES:       The Company  recognizes  income taxes under the asset and liability method.      Under this method,  deferred tax assets and liabilities are established for      the temporary differences between the accounting basis and the tax basis of      the Company's assets and liabilities at enacted tax rates expected to be in      effect when the amounts related to such temporary  differences are realized      or settled.       FAIR VALUES OF FINANCIAL INSTRUMENTS:       SFAS No.  107,  "Disclosures  About Fair Value of  Financial  Instruments,"      requires that the Company  disclose  estimated fair value for its financial      instruments.  Fair value  methods  and  assumptions  used by the Company in      estimating its fair value disclosures are as follows:       Cash and cash  equivalents:  The carrying  amounts  reported in the balance      sheets for cash and cash equivalents approximate those assets' fair values.       Securities  (including   mortgage-backed   securities):   Fair  values  for      securities are based on quoted market prices,  where  available.  If quoted      market  prices are not  available,  fair values are based on quoted  market      prices of comparable instruments.       Loans held-for-sale:  Fair values of mortgage loans held-for-sale are based      on commitments on hand from investors or prevailing market prices.       Loans receivable:  For variable-rate loans that reprice frequently and with      no  significant  change in credit  risk,  fair values are based on carrying      values. The fair values for other loans are estimated using discounted cash      flow analyses,  using interest rates currently being offered for loans with      similar terms to borrowers of similar credit quality.       Accrued  interest  receivable:  The  carrying  amount of  accrued  interest      receivable approximates its fair value.       Deposit   liabilities:   The  fair  values   disclosed   for  interest  and      non-interest  checking,  passbook savings and money market accounts are, by      definition,  equal to the amount  payable on demand at the  reporting  date      (i.e., their carrying amounts).  Fair values for fixed-rate certificates of      deposit are estimated using a discounted cash flow calculation that applies      interest rates  currently  being offered on  certificates  to a schedule of      aggregated expected monthly maturities on time deposits.       Federal  Home Loan Bank  Advances:  Fair values for Federal  Home Loan Bank      advances are estimated  using a discounted cash flow technique that applies      interest  rates  currently  being  offered on  advances  to a  schedule  of      aggregated expected monthly maturities on Federal Home Loan Bank advances.       Due to broker:  The carrying amount of due to broker  approximates its fair      value.       Off-balance sheet  instruments:  The fair value of commitments to originate      loans is  estimated  using  the fees  currently  charged  to enter  similar      agreements,  taking into account the remaining  terms of the agreements and      the present  creditworthiness  of the  counterparties.  For fixed-rate loan      commitments and the unadvanced  portion of loans, fair value also considers      the difference  between  current levels of interest rates and the committed      rates.  The fair  value of  letters  of credit  is based on fees  currently      charged for similar  agreements or on the estimated  cost to terminate them      or otherwise settle the obligation with the counterparties at the reporting      date.       STOCK BASED COMPENSATION:       Bancorp has a  stock-based  plan to compensate  non-employee  directors for      their services.  This plan is more fully described in Note 14. Compensation      cost for these  services is  reflected  in net income in an amount equal to      the fair  value of the  shares  of  Bancorp  common  stock  payable  to the      directors.                                        F-10        EARNINGS PER SHARE:       Basic EPS excludes dilution and is computed by dividing income available to      common  stockholders  by  the  weighted-average  number  of  common  shares      outstanding for the period. Weighted average common shares outstanding were      1,683,031  in 2005,  1,503,373 in 2004 and  1,423,815 in 2003.  Diluted EPS      reflects the  potential  dilution  that could occur if  securities or other      contracts  to issue common  stock were  exercised or converted  into common      stock or resulted in the  issuance of common  stock that then shared in the      earnings of the entity.  Diluted EPS is not presented because there were no      common stock equivalents in the three year period ended December 31, 2005.       RECENT ACCOUNTING PRONOUNCEMENTS:       In January 2003,  the Financial  Accounting  Standards  Board (FASB) issued      Interpretation No. 46,  "Consolidation of Variable Interest Entities" ("FIN      46"),  in an effort  to  expand  upon and  strengthen  existing  accounting      guidance  that  addresses  when a company  should  include in its financial      statements the assets,  liabilities  and activities of another  entity.  In      December 2003, the FASB revised  Interpretation No. 46, also referred to as      Interpretation 46 (R) ("FIN 46(R)").  The objective of this  interpretation      is not to restrict  the use of variable  interest  entities  but to improve      financial  reporting by companies involved with variable interest entities.      Until  now,  one  company  generally  has  included  another  entity in its      consolidated  financial statements only if it controlled the entity through      voting interests. This interpretation changes that, by requiring a variable      interest  entity to be  consolidated  by a company  only if that company is      subject  to a  majority  of the  risk of loss  from the  variable  interest      entity's  activities  or  entitled  to receive a majority  of the  entity's      residual  returns  or both.  The  Company is  required  to apply FIN 46, as      revised,  to all entities  subject to it no later than the end of the first      reporting  period  ending  after  March  15,  2004.  However,  prior to the      required  application of FIN 46, as revised, the Company shall apply FIN 46      or FIN 46 (R) to those entities that are  considered to be  special-purpose      entities as of the end of the first  fiscal year or interim  period  ending      after December 15, 2003. The adoption of this  interpretation  did not have      an impact on the Company's consolidated financial statements as the Company      did not have any  financial  interests  in  variable  interest  entities at      December 31, 2005.       In December 2003, the American  Institute of Certified  Public  Accountants      ("AICPA")  issued  Statement of Position 03-3 ("SOP 03-3")  "Accounting for      Certain Loans or Debt Securities Acquired in a Transfer." SOP 03-3 requires      loans acquired through a transfer,  such as a business  combination,  where      there are differences in expected cash flows and contractual cash flows due      in part to credit quality be recognized at their fair value.  The excess of      contractual  cash flows over expected cash flows is not to be recognized as      an adjustment of yield,  loss accrual,  or valuation  allowance.  Valuation      allowances  cannot be created nor "carried over" in the initial  accounting      for loans acquired in a transfer on loans subject to SFAS 114,  "Accounting      by Creditors  for  Impairment  of a Loan." This SOP is effective  for loans      acquired in fiscal years  beginning  after  December  15, 2004,  with early      adoption encouraged. The adoption of SOP 03-3 did not have an impact on the      Company's  financial  position or results of  operations  since the Company      acquired no loans subject to SFAS 114 since the effective date of SOP 03-3.       In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based      Payment"  ("SFAS  123R").  This  Statement  revises FASB Statement No. 123,      "Accounting  for Stock Based  Compensation"  and supersedes APB Opinion No.      25,   "Accounting   for  Stock  Issued  to  Employees,"   and  its  related      implementation  guidance.  SFAS 123R requires that the cost  resulting from      all  share-based  payment  transactions  be recognized in the  consolidated      financial  statements.   It  establishes  fair  value  as  the  measurement      objective in accounting for share-based  payment  arrangements and requires      all entities to apply a fair-value based  measurement  method in accounting      for  share-based  payment  transactions  with  employees  except for equity      instruments  held by employee  share  ownership  plans.  This  Statement is      effective for the Company as of the beginning of the first annual reporting      period that begins after  December 15, 2005. The adoption of this Statement      is not  anticipated  to have a material  impact on the Company's  financial      position  or  results  of  operations  as there is no  share-based  payment      arrangements  with employees and the  compensation  expense  related to the      Directors Stock Retainer Plan is not anticipated to be material.                                        F-11   NOTE 3 - INVESTMENTS IN SECURITIES - ----------------------------------  Debt and equity  securities  have been  classified in the  consolidated  balance sheets  according to management's  intent.  The amortized cost of securities and their approximate fair values are as follows as of December 31:                                                         Amortized          Gross           Gross                                                        Cost          Unrealized       Unrealized        Fair                                                        Basis            Gains           Losses          Value                                                    -------------    -------------   -------------   -------------      Available-for-sale securities:    December 31, 2005:      Equity securities                             $       3,031    $     145,058   $               $     148,089      U.S. government agencies preferred stock         13,292,628           99,660         946,300      12,445,988      Debt securities issued by the U.S. Treasury        and other U. S. government corporations        and agencies                                   52,390,332                        1,874,694      50,515,638      Debt securities issued by states of the        United States and political subdivisions        of the states                                  41,550,010           75,980         293,765      41,332,225      Money market mutual funds                         1,119,724        1,119,724      Mortgage-backed securities                       42,312,984           15,325       1,161,952      41,166,357                                                    -------------    -------------   -------------   -------------                                                      150,668,709          336,023       4,276,711     146,728,021      Money market mutual funds included in        cash and cash equivalents                      (1,119,724)                                      (1,119,724)                                                    -------------    -------------   -------------   -------------                                                    $ 149,548,985    $     336,023   $   4,276,711   $ 145,608,297                                                    =============    =============   =============   =============     December 31, 2004:      Equity securities                             $       3,031    $     142,727   $               $     145,758      U.S. government agencies preferred stock         13,488,364            1,490       1,280,752      12,209,102      Debt securities issued by the U.S. Treasury        and other U. S. government corporations        and agencies                                   53,771,554           53,170         408,766      53,415,958      Debt securities issued by states of the        United States and political subdivisions        of the states                                  58,052,206          630,317         230,178      58,452,345      Money market mutual funds                           941,890          941,890      Mortgage-backed securities                       54,523,343          209,599         301,357      54,431,585                                                    -------------    -------------   -------------   -------------                                                      180,780,388        1,037,303       2,221,053     179,596,638      Money market mutual funds included in        cash and cash equivalents                        (941,890)                                        (941,890)                                                    -------------    -------------   -------------   -------------                                                    $ 179,838,498    $   1,037,303   $   2,221,053   $ 178,654,748                                                    =============    =============   =============   =============  Held-to-maturity securities:    December 31, 2005:      Mortgage-backed securities                    $     146,856    $         346   $               $     147,202                                                    =============    =============   =============   =============     December 31, 2004:      Mortgage-backed securities                    $     218,374    $       1,249   $               $     219,623                                                    =============    =============   =============   =============                                         F-12   The scheduled  maturities of debt  securities were as follows as of December 31, 2005:                                          Available-For-Sale         Held-To-Maturity                                       ------------------    ---------------------------                                                               Amortized                                               Fair              Cost           Fair                                              Value              Basis          Value                                          ------------       ------------   ------------     Due after five years through ten years   $ 17,555,100       $              $ Due after ten years                        74,292,763 Mortgage-backed securities                 41,166,357            146,856        147,202                                          ------------       ------------   ------------                                          $133,014,220       $    146,856   $    147,202                                          ============       ============   ============   During 2005,  proceeds from sales of  available-for-sale  securities amounted to $83,572,466.  Gross  realized  gains and gross  realized  losses on those  sales amounted to $1,427,881  and $35,657,  respectively.  During 2004,  proceeds from sales of available-for-sale  securities amounted to $98,347,353.  Gross realized gains and gross  realized  losses on those  sales  amounted  to  $1,577,110  and $87,205,  respectively.  During 2003, proceeds from sales of  available-for-sale securities  amounted to  $49,353,780.  Gross  realized  gains and gross realized losses on those sales amounted to $1,136,732 and $78,592,  respectively. The tax provision applicable to these net realized gains amounted to $473,356,  $580,318 and $412,146,  respectively. In 2005, a writedown of $182,500 was recorded on an available-for-sale security.  The amortized  cost basis and fair value of securities of issuers which exceeded 10% of stockholders' equity were as follows as of December 31, 2005:                                                            Amortized                                                              Cost        Fair                                                              Basis       Value                                                           ----------  ---------- Federal National Mortgage Association Preferred Stock     $5,759,052  $5,603,706 Federal Home Loan Mortgage Corporation Preferred Stock     7,533,576   6,842,282  Total carrying  amounts of $38,612,787  and $4,712,905 of debt  securities  were pledged to secure Federal Home Loan Bank advances, public deposits, treasury tax and loan and for other  purposes as required by law as of December  31, 2005 and 2004, respectively.  The aggregate fair value and unrealized losses of securities that have been in a continuous  unrealized  loss position for less than twelve months and for twelve months or more, and are temporarily impaired,  are as follows as of December 31, 2005:                                                     Less than 12 Months           12 Months or Longer                  Total                                              ---------------------------   ---------------------------   ---------------------------                                                 Fair         Unrealized       Fair         Unrealized       Fair         Unrealized                                                 Value          Losses         Value          Losses         Value          Losses                                              ------------   ------------   ------------   ------------   ------------   ------------        U.S. government agencies preferred    stock                                     $              $              $  9,983,488   $    946,300   $  9,983,488   $    946,300 Debt securities issued by the U.S.    Treasury and other U. S. government    corporations and agencies                   30,132,339      1,192,830     20,383,299        681,864     50,515,638      1,874,694 Debt securities issued by states of the    United States and political    subdivisions of the states                  17,931,437        245,720      2,774,361         48,045     20,705,798        293,765 Mortgage-backed securities                     23,808,282        605,473     13,416,890        556,479     37,225,172      1,161,952                                              ------------   ------------   ------------   ------------   ------------   ------------      Total temporarily impaired securities   $ 71,872,058   $  2,044,023   $ 46,558,038   $  2,232,688   $118,430,096   $  4,276,711                                              ============   ============   ============   ============   ============   ============                                         F-13   Securities  exhibiting  unrealized  losses are  analyzed to  determine  that the impairments  are not  other-than-temporary  and  the  following  information  is considered.  U.S. Government  securities are backed by the full faith and credit of the United States and therefore bear no credit risk. U.S. Government agencies securities,  which have a significant impact in financial markets,  have minimal credit risk.  All  investments  maintain a credit rating of at least  investment grade  by one of the  nationally  recognized  rating  agencies.  Mortgage-backed securities are issued by federal government  agencies or by private issuers with minimum security ratings of AAA.  NOTE 4 - LOANS - --------------  Loans consisted of the following as of December 31:                                                         2005            2004                                                   -------------   ------------- Commercial, financial and agricultural            $  15,354,328   $  15,126,711 Real estate - construction and land development      18,814,408      14,289,715 Real estate - residential                           135,618,937     130,414,119 Real estate - commercial                             40,889,007      35,486,897 Consumer                                              7,899,912       9,121,747 Other                                                    46,783          69,385                                                   -------------   -------------                                                     218,623,375     204,508,574 Unearned income                                          (8,056)        (18,529) Allowance for loan losses                            (2,626,170)     (2,511,546)                                                   -------------   -------------            Net loans                              $ 215,989,149   $ 201,978,499                                                   =============   =============  Certain  directors and executive  officers of the Company and companies in which they have significant ownership interest were customers of the Bank during 2005. Total  loans to such  persons  and their  companies  amounted  to $735,130 as of December 31, 2005.  During 2005,  principal  advances of $528,868  were made and repayments totaled $605,027.  Changes in the  allowance  for loan  losses  were as follows for the years ended December 31:                                                     2005           2004           2003                                              -----------    -----------    -----------     Balance at beginning of period               $ 2,511,546    $ 1,664,274    $ 1,458,359 Provision for loan losses                        210,000        250,000        312,500 Recoveries of loans previously charged off        39,094         28,302         48,508 Loans charged off                               (134,470)       (69,742)      (155,093) Allowance related to business combination                       638,712                                              -----------    -----------    ----------- Balance at end of period                     $ 2,626,170    $ 2,511,546    $ 1,664,274                                              ===========    ===========    ===========   The  following  table  sets forth  information  regarding  nonaccrual  loans and accruing loans 90 days or more overdue as of December 31:                                                                  2005       2004                                                                ------     ------                                                                  (in thousands) Total nonaccrual loans                                         $  694     $1,739                                                                ======     ======  Accruing loans which are 90 days or more overdue               $   79     $  528                                                                ======     ======                                        F-14   Information  about  loans  that  meet  the  definition  of an  impaired  loan in Statement of Financial Accounting Standards No. 114 is as follows as of December 31:                                                                                 2005                          2004                                                                   ---------------------------   ---------------------------                                                                   Recorded       Related        Recorded       Related                                                                   Investment     Allowance      Investment     Allowance                                                                   In Impaired    For Credit     In Impaired    For Credit                                                                   Loans          Losses         Loans          Losses                                                                   ------------   ------------   ------------   ------------      Loans for which there is a related allowance for credit losses    $          0   $          0   $    183,317   $          0  Loans for which there is no related allowance for credit losses                                                                   ------------   ------------   ------------   ------------             Totals                                                 $          0   $          0   $    183,317   $          0                                                                   ============   ============   ============   ============  Average recorded investment in impaired loans during the    year ended December 31                                         $     73,133                  $     73,327                                                                   ============                  ============  Related amount of interest income  recognized during the time,  in the year ended December 31, that the loans were impaired             Total recognized                                       $      6,665                  $      5,843                                                                   ============                  ============            Amount recognized using a cash-basis method of               accounting                                          $      6,665                  $      5,843                                                                   ============                  ============   In 2005, 2004 and 2003 the Bank capitalized  mortgage  servicing rights totaling $73,849, $112,187 and $69,844, respectively, and amortized $164,178, $66,019 and $1,924,  respectively.  The balance of  capitalized  mortgage  servicing  rights included  in other  assets  at  December  31,  2005 and  2004 was  $414,900  and $498,371,  respectively.  On  September  10,  2004  the Bank  acquired  mortgage servicing  rights of  $392,256,  exclusive  of $2,388  in  valuation  allowance, through the acquisition of Canaan National Bancorp, Inc.  Following is an analysis of the aggregate changes in the valuation allowance for mortgage servicing rights for the years ended December 31:                                                             2005          2004                                                          --------      -------- Balance, beginning of year                               $  7,973      $    670 Additions                                                  16,077         5,621 Valuation allowance from business combination               2,388 Reductions                                                (22,935)         (706)                                                          --------      -------- Balance, end of year                                     $  1,115      $  7,973                                                          ========      ========  The fair value of the mortgage  servicing rights was $525,209 and $516,322 as of December 31, 2005 and 2004, respectively.  Loans  serviced  for others are not  included in the  accompanying  consolidated balance  sheets.  The unpaid  principal  balance  of  mortgage  and other  loans serviced for others was  $49,567,721  and  $49,026,331  at December 31, 2005 and 2004, respectively.                                        F-15   NOTE 5 - PREMISES AND EQUIPMENT - -------------------------------  The following is a summary of premises and equipment as of December 31:                                                         2005             2004                                                    -----------      ----------- Land                                               $   775,844      $   483,344 Buildings                                            5,629,513        5,338,726 Furniture and equipment                              2,696,510        2,364,380                                                    -----------      -----------                                                      9,101,867        8,186,450 Accumulated depreciation and amortization           (2,649,888)      (2,252,472)                                                    -----------      -----------                                                    $ 6,451,979      $ 5,933,978  NOTE 6 - DEPOSITS - -----------------  The aggregate  amount of time deposit  accounts in  denominations of $100,000 or more  as of  December  31,  2005  and  2004  was  $27,662,727  and  $32,955,388, respectively.  For time deposits as of December 31, 2005,  the scheduled  maturities  for years ended December 31 are as follows:                2006                                  $59,576,491               2007                                   19,944,040               2008                                    3,196,204               2009                                    2,358,793               2010                                    3,328,339               Fair value adjustment                       4,014                                                     -----------                                                     $88,407,881                                                     ===========  Certain  directors and executive  officers of the Company and companies in which they have a significant  ownership  interest  were  customers of the Bank during 2005. Total deposits of such persons and their companies  amounted to $1,739,823 and $1,672,885 as of December 31, 2005 and 2004, respectively.  NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES - ----------------------------------------  Advances  consist of funds  borrowed  from the Federal  Home Loan Bank of Boston (FHLB).  Maturities  of advances  from the FHLB for the five fiscal  years  ending  after December 31, 2005, and thereafter, are summarized as follows:                 2006                                 $ 9,942,009                2007                                   1,589,044                2008                                  11,577,699                2009                                   1,320,213                2010                                  22,202,309                Thereafter                            23,939,479                Fair value adjustment                    444,861                                                     -----------                                                     $71,015,614                                                     ===========                                        F-16   As of December 31, 2005, the following advances from the FHLB were redeemable at par at the option of the FHLB:  MATURITY DATE                 OPTIONAL REDEMPTION DATE                  AMOUNT - -------------                 ------------------------               -----------   4/27/2009              1/26/2006 and quarterly thereafter          $   500,000   4/27/2009              1/26/2006 and quarterly thereafter              500,000   1/25/2010              1/25/2006 and quarterly thereafter           19,000,000   2/8/2010               2/7/2006 and quarterly thereafter               600,000   12/15/2010             3/15/2006 and quarterly thereafter              800,000   12/20/2010             3/20/2006 and quarterly thereafter              500,000   12/27/2010             3/27/2006 and quarterly thereafter            1,000,000   1/24/2011              1/23/2006 and quarterly thereafter            1,000,000   2/28/2011              2/27/2006 and quarterly thereafter           10,000,000   2/28/2011              2/27/2006 and quarterly thereafter              850,000   3/1/2011               3/1/2006 and quarterly thereafter               500,000   3/7/2011               3/6/2006 and quarterly thereafter             1,000,000   12/16/2013             3/15/2006 and quarterly thereafter           10,000,000  The  advances  also  include  $400,000  borrowed  in 2002 at  4.37%  which  is a Knock-out  Advance  with a Strike  Rate of 7%. If the  three  month  LIBOR  rate exceeds the Strike Rate of 7% on January 9, 2006 and quarterly  thereafter,  the FHLB will require that this  borrowing  become due  immediately  upon the Strike Date as defined in the Contract.  As of December 31, 2005, the three month LIBOR was 4.54%. The maturity date is April 9, 2007.  Amortizing  advances  are being repaid in equal  monthly  payments and are being amortized  from  the  date of the  advance  to the  maturity  date  on a  direct reduction basis.  Borrowings from the FHLB are secured by a blanket lien on qualified  collateral, consisting primarily of loans with first mortgages secured by one to four family properties,  certain  unencumbered  investment  securities  and other  qualified assets.  At December  31,  2005,  the interest  rates on FHLB  advances  ranged from 1.55 percent to 6.30 percent.  At December 31, 2005,  the weighted  average  interest rate on FHLB advances was 4.90 percent.  NOTE 8 - EMPLOYEE BENEFITS - --------------------------  The  Bank  has  an  insured  noncontributory  defined  benefit  retirement  plan available to all  employees  eligible as to age and length of service.  Benefits are based on a covered  employee's  final average  compensation,  primary social security benefit and credited service. The Bank makes annual contributions which meet the Employee Retirement Income Security Act minimum funding requirements.                                        F-17   The following tables set forth  information about the plan as of December 31 and the years then ended, using a measurement date of December 31:                                                                      2005           2004           2003                                                               -----------    -----------    -----------     Change in projected benefit obligation:    Benefit obligation at beginning of year                    $ 4,108,971    $ 2,762,015    $ 2,019,027    Adjustment                                                     960,236    Actuarial loss (gain)                                          783,390        (12,650)       489,531    Service cost                                                   466,570        259,513        188,104    Interest cost                                                  290,825        220,533        148,033    Benefits paid                                                 (154,050)       (80,676)       (82,680)                                                               -----------    -----------    -----------        Benefit obligation at end of year                        5,495,706      4,108,971      2,762,015                                                               -----------    -----------    -----------  Change in plan assets:    Plan assets at estimated fair value at beginning of year     2,839,515      1,787,563      1,396,711    Actual return on plan assets                                    94,489        140,306        205,463    Contributions                                                  591,000        992,322        268,069    Benefits paid                                                 (154,050)       (80,676)       (82,680)                                                               -----------    -----------    -----------        Fair value of plan assets at end of year                 3,370,954      2,839,515      1,787,563                                                               -----------    -----------    -----------  Funded status (2,124,752)                                      (1,269,456)      (974,452) Unrecognized net loss                                           2,330,482      1,503,149        560,356 Unrecognized prior service cost                                     2,696          3,589         93,653 Unamortized net obligation existing at date of adoption of    SFAS No. 87                                                                     2,771         58,364 Additional minimum liability                                     (448,005)                                                               -----------    -----------    -----------        (Accrued) prepaid benefit cost included in the          balance sheet                                        $  (239,579)   $   240,053    $  (262,079)                                                               ===========    ===========    ===========   The $960,236  adjustment  made to the 2004 beginning of year  projected  benefit obligation  is a result of a change in  calculation  methodology  from the prior actuary to the current actuary,  hired by the Bank in April 2004,  including the effect of reflecting salary increases in the  determination of liabilities.  The adjustment  also  includes   liability  gains  and  losses  due  to  demographic experience.  Net periodic cost for the year ended  December 31, 2004 of $490,190 includes  additional  amortization  of the transition  obligation and additional amortization  of prior  service  cost in the  amounts  of $46,921  and  $89,172, respectively,  as a result of this  adjustment.  Net  income  for the year ended December 31, 2004 was reduced by $83,085, net of tax benefit of $53,008, related to this adjustment.  Amounts  recognized  in the  balance  sheets as of  December  31,  2005 and 2004 consist of:                                                          2005            2004                                                     ------------    ------------ (Accrued) prepaid benefit cost                      $   (239,579)   $    240,053 Additional minimum liability                            (448,005) Intangible asset                                           2,696 Accumulated other comprehensive loss                     445,309                                                     ------------    ------------        Net amount recognized                        $   (239,579)   $    240,053                                                     ============    ============  The accumulated  benefit  obligation for the Bank's defined benefit pension plan was $3,610,533 and $2,824,624 at December 31, 2005 and 2004, respectively.  The  discount  rate  used in  determining  the  actuarial  present  value of the projected benefit obligation was 6.0% for 2005 and 2004. The rate of increase in future  compensation levels was based on the following graded table for 2005 and 2004:                             AGE                     RATE                            ---                     ----                             25                     4.75%                             35                     4.25                             45                     3.75                             55                     3.25                             65                     3.00                                        F-18   Components of net periodic cost are as follows for the years ended December 31:                                                 2005         2004         2003                                             ---------    ---------    --------- Service cost                                $ 466,570    $ 259,513    $ 188,104 Interest cost on benefit obligation           290,825      220,533      148,033 Expected return on assets                    (236,062)    (196,448)    (107,010) Amortization of transition obligation           2,771       55,593        8,672 Amortization of prior service cost                893       90,064          892 Amortization of net loss                       97,630       60,935                                             ---------    ---------    ---------        Net periodic cost                    $ 622,627    $ 490,190    $ 238,691                                             =========    =========    =========  The discount  rate used to determine  the net periodic  cost was 6.00% for 2005, 2004 and 2003;  and the  expected  return on plan  assets was 7.50% for 2005 and 7.25% for 2004 and 2003.  The  graded  table  was  also  used  for the rate of  compensation  increase  in determining  the net  periodic  benefit  cost in 2005  and  2004  and no rate of increase was used in 2003.  Pension  expense is  calculated  based upon a number of  actuarial  assumptions, including an expected  long-term  rate of return on pension plan assets of 7.50% for 2005. In developing the expected long-term rate of return assumption,  asset class  return  expectations  were  evaluated  as  well  as  long-term  inflation assumptions,   and  historical   returns  based  on  the  current  target  asset allocations of 60% equity and 40% fixed income.  The Bank regularly  reviews the asset  allocations  and  periodically  rebalances  investments  when  considered appropriate.  While all future  forecasting  contains  some level of  estimation error, the Bank believes that 7.50% falls within a range of reasonable long-term rate of return  expectations for pension plan assets.  The Bank will continue to evaluate the actuarial assumptions,  including expected rate of return, at least annually, and will adjust as necessary.  Plan Assets  The pension plan  investments  are managed by the Trust  Department of the Bank. The  investments  in the plan are reviewed and approved by the Trust  Committee. The asset allocation of the plan is a balanced  allocation.  Debt securities are timed to mature when employees are due to retire.  Debt  securities are laddered for  coupon  and  maturity.  Equities  are put in the plan to achieve a balanced allocation  and to provide  growth of the  principal  portion of the plan and to provide  diversification.  The Trust Committee reviews the policies of the plan. The  prudent  investor  rule  and  applicable  ERISA  regulations  apply  to the management of the funds and investment selections.  The Bank's pension plan asset allocations by asset category are as follows:                                                        December 31, 2005          December 31, 2004                                                  -----------------------    -----------------------                 Asset Category                   Fair Value    Percent      Fair Value     Percent - ----------------------------------------------   ----------   ----------    ----------   ----------      Equity securities                                $  987,888         29.4%   $1,054,531         37.1% U.S. Government treasury and agency securities    1,319,226         39.1       991,537         34.9 Corporate bonds                                      23,632           .7        24,032           .9 Mutual funds                                        583,354         17.3       462,875         16.3 Money market mutual funds                           344,620         10.2       306,540         10.8 Certificates of deposit                             112,234          3.3                                                  ----------   ----------    ----------   ----------          Total                                   $3,370,954        100.0%   $2,839,515        100.0%                                                  ==========   ==========    ==========   ==========   There were no  securities  of the Bancorp and related  parties  included in plan assets as of December 31, 2005 and 2004.                                        F-19   Based on current data and assumptions, the following benefits are expected to be paid for each of the following five years and, in the aggregate,  the five years thereafter:                    2006                            $   119,000                   2007                                167,000                   2008                                 88,000                   2009                                126,000                   2010                                193,000                   2011 - 2015                       3,685,000  The Bank  contributed  $671,000 to its  pension  plan in January of 2006 for the 2005 plan year and does not expect to make other contributions in 2006.  The Bank  adopted a 401(k)  Plan  effective  in 2000.  Under  the Plan  eligible participants   may  contribute  a  percentage  of  their  pay,  subject  to  IRS limitations.  The Bank may make  discretionary  contributions  to the Plan.  The Bank's contribution  expense in the years ended December 31, 2005, 2004 and 2003 amounted  to   approximately   $91,212,   $60,000  and  $46,000,   respectively. Discretionary contributions vest in full after five years.  Fourteen  of  the  Company's  executives  have a  change  in  control  agreement ("agreement")  with the  Company.  The  agreements  provide  that if following a "change-in-control"  of the Company or Bank, an Executive  Officer is terminated under certain defined circumstances, or is reassigned, within a period of twelve (12) months  following  the change in control,  such  Executive  Officer will be entitled  to a  lump  sum  payment  equal  to  six  or 12  months  of his or her compensation  based  upon the most  recent  aggregate  base  salary  paid to the Executive Officer in the twelve (12) month period immediately preceding the date of change in control.  NOTE 9 - INCOME TAXES - ---------------------  The components of income tax expense are as follows for the years ended December 31:                                           2005         2004         2003                                    ----------   ----------   ---------- Current:    Federal                         $  986,976   $  631,007   $  708,089    State                               60,164          250      422,520                                    ----------   ----------   ----------                                     1,047,140      631,257    1,130,609                                    ----------   ----------   ---------- Deferred:    Federal                             12,873      131,788      126,996    State                                            11,903       10,345    Change in valuation allowance       54,400                                    ----------   ----------   ----------                                        67,273      143,691      137,341                                    ----------   ----------   ----------      Total income tax expense      $1,114,413   $  774,948   $1,267,950                                    ==========   ==========   ==========  The reasons for the  differences  between the statutory  federal income tax rate and the  effective  tax rates are  summarized  as  follows  for the years  ended December 31:                                                 2005       2004       2003                                                ----       ----       ----                                                % of       % of       % of                                               Income     Income     Income Federal income tax at statutory rate           34.0%      34.0%      34.0% Increase (decrease) in tax resulting from:    Tax-exempt income                           (15.8)     (18.2)     (15.8)    Other items                                  (.3)        .2        1.0 State tax, net of federal tax benefit            .7         .2        5.6 Change in valuation allowance                   1.0                                                ----       ----       ----        Effective tax rates                     19.6%      16.2%      24.8%                                                ====       ====       ====                                         F-20   The Company had gross deferred tax assets and gross deferred tax  liabilities as follows as of December 31:                                                                          2005           2004                                                                   -----------    -----------    Deferred tax assets:    Allowance for loan losses                                      $   704,341    $   662,814    Interest on non-performing loans                                     8,385         24,611    Accrued deferred compensation                                       22,429         18,810    Post-retirement benefits                                            27,880         27,880    Other real estate owned property writedown                          22,101         22,101    Capital loss carryforward                                           89,250         27,200    Mark to market purchase accounting adjustments                     323,515        318,244    Preferred stock amortization                                         3,991          3,991    Minimum pension liability                                          151,405    Net unrealized holding loss on available-for-sale securities     1,339,834        461,071                                                                   -----------    -----------            Gross deferred tax assets                                2,693,131      1,566,722            Valuation allowance                                        (81,600)       (27,200)                                                                   -----------    -----------                                                                     2,611,531      1,539,522  Deferred tax liabilities:    Core deposit intangible asset                                     (633,725)      (621,035)    Accelerated depreciation                                          (998,515)    (1,030,994)    Discount accretion                                                    (189)        (5,299)    Mortgage servicing rights                                         (141,067)      (169,446)    Prepaid pension                                                   (244,011)       (81,619)                                                                   -----------    -----------            Gross deferred tax liabilities                          (2,017,507)    (1,908,393)                                                                   -----------    ----------- Net deferred tax asset (liability)                                $   594,024    $  (368,871)                                                                   ===========    ===========   Included in the net deferred  tax  liabilities  activity  during the year ending December 31, 2004 is a $704,560  deferred tax liability  recorded related to the Canaan National Bancorp, Inc. merger.  As of  December  31,  2005,  the Company  had no  operating  loss and tax credit carryovers for tax purposes.  NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES - ------------------------------------------------  The Bank entered  into an agreement  with a third party in which the third party is to provide the Bank with account processing  services and other miscellaneous services.  Under the agreement,  the Bank is obligated to pay monthly processing fees  through  August  5,  2010.  In the event the Bank  chooses  to cancel  the agreement  prior to the end of the contract term a lump sum termination fee will have to be paid.  The fee shall be  calculated as the average  monthly  billing, exclusive of pass through  costs for the past twelve  months,  multiplied by the number of months and any portion of a month remaining in the contract term.  NOTE 11 - FINANCIAL INSTRUMENTS - -------------------------------  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.  These financial instruments include commitments to originate loans, standby letters of credit  and  unadvanced  funds on loans.  The  instruments  involve,  to varying degrees,  elements  of credit  risk in excess of the  amount  recognized  in the balance sheets. The contract amounts of those instruments  reflect the extent of involvement the Bank has in particular classes of financial instruments.  The Bank's exposure to credit loss in the event of  nonperformance  by the other party to the financial  instrument for loan  commitments  and standby letters of credit is represented by the contractual amounts of those instruments.  The Bank uses the same credit policies in making commitments and conditional  obligations as it does for on-balance sheet instruments.                                        F-21   Commitments  to originate  loans are  agreements to lend to a customer  provided there is no violation of any condition established in the contract.  Commitments generally  have fixed  expiration  dates or other  termination  clauses  and may require  payment of a fee. Since many of the  commitments are expected to expire without  being  drawn  upon,  the total  commitment  amounts do not  necessarily represent  future  cash   requirements.   The  Bank  evaluates  each  customer's creditworthiness on a case-by-case basis. The amount of collateral obtained,  if deemed necessary by the Bank upon extension of credit,  is based on management's credit  evaluation  of the  borrower.  Collateral  held varies,  but may include secured interests in mortgages, accounts receivable,  inventory, property, plant and equipment and income producing properties.  Standby  letters of credit  are  conditional  commitments  issued by the Bank to guarantee  the  performance  by a customer  to a third  party.  The credit  risk involved in issuing  letters of credit is essentially  the same as that involved in extending loan facilities to customers. As of December 31, 2005 and 2004, the maximum  potential  amount of the Bank's  obligation  was $21,900  and  $31,900, respectively,   for  financial  and  standby  letters  of  credit.   The  Bank's outstanding  letters of credit generally have a term of less than one year. If a letter  of  credit  is  drawn  upon,  the Bank may  seek  recourse  through  the customer's  underlying line of credit.  If the customer's line of credit is also in default, the Bank may take possession of the collateral, if any, securing the line of credit.  The estimated fair values of the Bank's financial instruments,  all of which are held or issued for purposes  other than  trading,  are as follows as of December 31:                                                   2005                         2004                                    ---------------------------   ---------------------------                                       Carrying         Fair         Carrying         Fair                                       Amount          Value         Amount          Value                                    ------------   ------------   ------------   ------------      Financial assets:    Cash and cash equivalents       $ 10,204,375   $ 10,204,375   $ 11,677,494   $ 11,677,494    Available-for-sale securities    145,608,297    145,608,297    178,654,748    178,654,748    Held-to-maturity securities          146,856        147,202        218,374        219,623    Federal Home Loan Bank stock       5,413,200      5,413,200      5,413,200      5,413,200    Loans held-for-sale                  375,000        381,347    Loans, net                       215,989,149    215,652,000    201,978,499    201,271,000    Accrued interest receivable        2,362,924      2,362,924      2,256,499      2,256,499  Financial liabilities:    Deposits                         287,271,202    287,598,000    298,841,846    299,977,000    FHLB advances                     71,015,614     71,362,000     79,213,283     79,167,886    Due to broker                                                    1,083,331      1,083,331   The  carrying  amounts of  financial  instruments  shown in the above  table are included  in the  consolidated  balance  sheets  under the  indicated  captions. Accounting policies related to financial instruments are described in Note 2.  The amounts of financial  instrument  liabilities with off-balance  sheet credit risk are as follows as of December 31:                                                         2005              2004                                                    -----------       ----------- Commitments to originate loans                     $ 3,242,137       $ 7,681,700 Standby letters of credit                               21,900            31,900 Unadvanced portions of loans:    Home equity                                      24,847,998        23,085,518    Commercial lines of credit                        8,495,283         9,136,426    Construction                                      4,521,483         4,913,228    Consumer                                          6,837,017         7,260,206                                                    -----------       -----------                                                    $47,965,818       $52,108,978  There is no material  difference  between the notional amounts and the estimated fair values of the off-balance sheet liabilities.                                        F-22   NOTE 12 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK - ---------------------------------------------------------  Most of the Bank's business  activity is with customers  located in northwestern Connecticut  and  bordering  New  York and  Massachusetts  towns.  There  are no concentrations   of   credit   to   borrowers   that   have   similar   economic characteristics. The majority of the Bank's loan portfolio is comprised of loans collateralized by real estate located in northwestern  Connecticut and bordering New York and Massachusetts towns.  NOTE 13 - REGULATORY MATTERS - ----------------------------  Bancorp and its  subsidiary the 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's and the Bank's  financial  statements. Under  capital  adequacy  guidelines  and the  regulatory  framework  for prompt corrective  action,  the  Company  and  the  Bank  must  meet  specific  capital guidelines that involve quantitative  measures of their assets,  liabilities and certain  off-balance-sheet  items  as  calculated  under  regulatory  accounting practices.  Their  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 the Bank to  maintain  minimum  amounts and ratios (set forth in the  table  below)  of total  and Tier 1  capital  (as  defined  in the regulations)  to  risk-weighted  assets (as defined),  and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005,  that the Company and the Bank meet all capital  adequacy  requirements to which they are subject.  As of December 31, 2005, the most recent  notification  from the Federal Deposit Insurance  Corporation  categorized  the  Bank as  well  capitalized  under  the regulatory  framework for prompt  corrective  action.  To be categorized as well capitalized the Bank must maintain minimum total  risk-based,  Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management  believes have changed the Bank's category.  The  Company's  and the  Bank's  actual  capital  amounts  and  ratios  are also presented in the table.                                                                                                       To Be Well                                                                                                    Capitalized Under                                                                           For Capital              Prompt Corrective                                                         Actual            Adequacy Purposes        Action Provisions                                                    ----------------       -----------------        -----------------                                                    Amount     Ratio       Amount       Ratio       Amount       Ratio                                                    ------     -----       ------       -----       ------       -----                                                                              (Dollar amounts in thousands) As of December 31, 2005:    Total Capital (to Risk Weighted Assets)      Consolidated                                  $34,058    15.76%      $17,801       >8.0%          N/A                                                                                         -      Salisbury Bank and Trust Company               34,492    15.53        17,771       >8.0       $22,213      >10.0%                                                                                         -                       -     Tier 1 Capital (to Risk Weighted Assets)      Consolidated                                   32,432    14.58         8,900       >4.0           N/A                                                                                         -      Salisbury Bank and Trust Company               31,732    14.29         8,885       >4.0        13,328       >6.0                                                                                         -                        -     Tier 1 Capital (to Average Assets)      Consolidated                                   32,432     8.27        15,687       >4.0           N/A                                                                                         -      Salisbury Bank and Trust Company               31,732     8.11        15,649       >4.0        19,562       >5.0                                                                                         -                        -                                         F-23                                                                                                       To Be Well                                                                                                    Capitalized Under                                                                           For Capital              Prompt Corrective                                                         Actual            Adequacy Purposes        Action Provisions                                                    ----------------       -----------------        -----------------                                                    Amount     Ratio       Amount       Ratio       Amount       Ratio                                                    ------     -----       ------       -----       ------       -----                                                                              (Dollar amounts in thousands) As of December 31, 2004:    Total Capital (to Risk Weighted Assets)      Consolidated                                  $31,579    12.13%      $20,825       >8.0%          N/A                                                                                         -      Salisbury Bank and Trust Company               31,008    11.90        20,840       >8.0       $26,050      >10.0%                                                                                         -                       -     Tier 1 Capital (to Risk Weighted Assets)      Consolidated                                   28,940    11.12        10,412       >4.0           N/A                                                                                         -      Salisbury Bank and Trust Company               28,369    10.89        10,420       >4.0        15,630       >6.0                                                                                         -                        -     Tier 1 Capital (to Average Assets)      Consolidated                                   28,940     7.22        16,042       >4.0           N/A                                                                                         -      Salisbury Bank and Trust Company               28,369     7.09        16,016       >4.0        20,020       >5.0                                                                                         -                        -   The declaration of cash dividends is dependent on a number of factors, including regulatory  limitations,  and the  Company's  operating  results  and  financial condition.  The stockholders of Bancorp will be entitled to dividends only when, and if,  declared  by the  Bancorp's  Board of  Directors  out of funds  legally available  therefore.  The  declaration  of future  dividends will be subject to favorable operating results, financial conditions, tax considerations, and other factors.  Under  Connecticut law, the Bank may pay dividends only out of net profits.  The Connecticut  Banking  Commissioner's  approval is required for dividend payments which  exceed the current  year's net profits and  retained net profits from the preceding  two years.  As of December  31,  2005,  the Bank is  restricted  from declaring dividends to Bancorp in an amount greater than $1,682,846.  NOTE 14 - DIRECTORS STOCK RETAINER PLAN - ---------------------------------------  At the 2001 annual  meeting  the  stockholders  of Bancorp  voted to approve the "Directors Stock Retainer Plan of Salisbury Bancorp, Inc. (the Plan)." This plan provides  non-employee  directors of the Company with shares of restricted stock of Bancorp as a component of their  compensation for services as directors.  The maximum  number of shares of stock  that may be issued  pursuant  to the plan is 15,000. The first grant date under this plan preceded the 2002 annual meeting of stockholders.  Each director whose term of office begins with or continues after the date the Plan was approved by the  stockholders  is issued an "annual  stock retainer"  consisting of 120 shares of fully vested  restricted  common stock of Bancorp.  In 2005,  2004 and 2003, 940, 840 and 840 shares,  respectively,  were issued under the Plan and the related  compensation expense amounted to $36,566, $31,836 and $23,688, respectively.  NOTE 15 - MERGER - ----------------  On September 10, 2004, Canaan National Bancorp,  Inc. ("Canaan National") merged (the  "Merger")  with and into the Company.  Under the terms of the Merger,  the shareholders  of Canaan  National  received  a total of  $6,020,163  in cash and 257,483  shares of Bancorp  common  stock in  exchange  for all shares of Canaan National  Bancorp,  Inc.  stock.  The value of the  257,483  shares  issued  was $10,698,418  and was  determined  based on the September 10, 2004 closing market price of $41.55 of Bancorp's common stock.                                        F-24   The  Merger  was  accounted  for  using  the  purchase   method  of  accounting. Accordingly,  the assets acquired and liabilities  assumed have been recorded by the Company at their fair values at the consummation  date. During the appraisal process,  an identifiable  intangible  asset of $1,191,279 was calculated and is being amortized to expense over a period of 12 years.  Goodwill recorded totaled $7,151,421  and will be analyzed  for  impairment  on at least an annual  basis. Financial  statement  amounts for Canaan  National are included in the Company's consolidated  financial  statements beginning on the acquisition date. A summary of net assets acquired is included in the  supplemental  disclosures in the cash flow statement.  The following (unaudited) pro forma consolidated results of operations have been prepared as if the  acquisition  of Canaan  National  had occurred at January 1, 2003:                                                       Year Ended December 31,                                                  -------------------------------                                                      2004                2003                                                  -----------         ----------- Gross revenues                                   $25,291,875         $26,027,000 Net income                                       $ 4,870,000         $ 4,683,000 Net income per share                             $      2.89         $      2.78  The pro forma  information is presented for  informational  purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the  acquisition  been  consummated as of that time, nor is it intended to be a projection of future results.  NOTE 16 - GOODWILL AND INTANGIBLE ASSETS - ----------------------------------------  The  Company's  assets as of  December  31,  2005 and 2004  include  goodwill of $2,357,884  relating to the purchase of a branch of a bank in 2001.  In 2004 the Company recorded  $7,151,421 of additional  goodwill from the merger with Canaan National Bancorp,  Inc. Goodwill recognized in the 2004 merger is not deductible for tax purposes.  The Company evaluated its goodwill as of December 31, 2005 and 2004 and found no impairment.  A summary of acquired amortized intangible assets is as follows:                                                             As of December 31, 2005                                                  ------------------------------------                                                     Gross                      Net                                                   Carrying   Accumulated    Carrying                                                    Amount    Amortization    Amount                                                  ----------   ----------   ----------     Core deposit intangible-branch purchase          $  888,606   $  293,354   $  595,252  Core deposit intangible-Canaan National merger    1,191,279      128,816    1,062,463                                                  ----------   ----------   ----------             Total                                 $2,079,885   $  422,170   $1,657,715                                                  ==========   ==========   ==========                                                           As of December 31, 2004                                                  ------------------------------------                                                     Gross                      Net                                                   Carrying   Accumulated    Carrying                                                    Amount    Amortization    Amount                                                  ----------   ----------   ----------  Core deposit intangible-branch purchase         $  888,606   $  225,000   $  663,606  Core deposit intangible-Canaan National merger    1,191,279       32,754    1,158,525                                                  ----------   ----------   ----------             Total                                 $2,079,885   $  257,754   $1,822,131                                                  ==========   ==========   ==========   Aggregate amortization expense was $164,416,  $101,109 and $68,355 in 2005, 2004 and 2003,  respectively.  Amortization  is being  calculated on a  straight-line basis.                                        F-25   Estimated  amortization expense for each of the five years succeeding 2005 is as follows:             2006                                        $164,216            2007                                         164,216            2008                                         164,216            2009                                         164,216            2010                                         164,216                                                        --------                                                        $821,080                                                        ========  NOTE 17 - RECLASSIFICATION - --------------------------  Certain amounts in the prior years have been  reclassified to be consistent with the current year's statement presentation.  NOTE 18 - PARENT COMPANY ONLY FINANCIAL STATEMENTS - --------------------------------------------------  The following  condensed  financial  statements are for Salisbury Bancorp,  Inc. (Parent  Company Only) and should be read in conjunction  with the  Consolidated Financial Statements of Salisbury Bancorp, Inc. and Subsidiary.                                        F-26                                SALISBURY BANCORP, INC.                              -----------------------                                (Parent Company Only)                                   BALANCE SHEETS                                  --------------                             December 31, 2005 and 2004                            --------------------------  ASSETS                                                     2005          2004 - ------                                                 -----------   ----------- Checking account in Salisbury Bank and Trust Company   $             $       630 Money market mutual funds                                1,119,724       941,890                                                        -----------   -----------            Cash and cash equivalents                     1,119,724       942,520 Investment in subsidiary                                40,741,857    40,129,049 Other assets                                                 1,577        35,484                                                        -----------   -----------            Total assets                                $41,863,158   $41,107,053                                                        ===========   ===========  LIABILITIES AND STOCKHOLDERS' EQUITY Dividends payable                                      $   420,835   $   403,776 Other liabilities                                                          3,677                                                        -----------   -----------            Total liabilities                               420,835       407,453 Total stockholders' equity                              41,442,323    40,699,600                                                        -----------   -----------            Total liabilities and stockholders' equity  $41,863,158   $41,107,053                                                        ===========   ===========                               SALISBURY BANCORP, INC.                              -----------------------                                (Parent Company Only)                                STATEMENTS OF INCOME                               --------------------                    Years Ended December 31, 2005, 2004 and 2003                   --------------------------------------------                                                                         2005           2004           2003                                                                  -----------    -----------    -----------     Dividend income from subsidiary                                  $ 1,780,000    $ 7,510,000    $ 1,540,000 Taxable interest on securities                                        24,068          4,375          2,873                                                                  -----------    -----------    -----------                                                                    1,804,068      7,514,375      1,542,873                                                                  -----------    -----------    -----------  Legal expense                                                         10,500         26,823 Supplies and printing                                                  1,632          2,042          6,873 Other expense                                                         27,559         24,167         63,405                                                                  -----------    -----------    -----------                                                                       29,191         36,709         97,101                                                                  -----------    -----------    ----------- Income before income tax benefit and equity in undistributed    (distributed) net income of subsidiary                          1,774,877      7,477,666      1,445,772 Income tax benefit                                                    (1,577)        (5,647)       (32,000)                                                                  -----------    -----------    ----------- Income before equity in undistributed (distributed) net    income of subsidiary                                            1,776,454      7,483,313      1,477,772 Equity in undistributed (distributed) net income of subsidiary     2,784,887     (3,464,371)     2,362,330                                                                  -----------    -----------    -----------            Net income                                            $ 4,561,341    $ 4,018,942    $ 3,840,102                                                                  ===========    ===========    ===========                                         F-27                                                  SALISBURY BANCORP, INC.                                               -----------------------                                                 (Parent Company Only)                                               STATEMENTS OF CASH FLOWS                                              ------------------------                                       Years Ended December 31, 2005, 2004 and 2003                                      --------------------------------------------                                                                                2005           2004           2003                                                                         -----------    -----------    -----------     Cash flows from operating activities:    Net income                                                           $ 4,561,341    $ 4,018,942    $ 3,840,102    Adjustments to reconcile net income to net cash provided      by operating activities:        Equity in (undistributed) distributed net income of subsidiary    (2,784,887)     3,464,371     (2,362,330)        Deferred tax expense                                                                                 1,000        Decrease (increase) in taxes receivable                                4,070         (5,647)        Decrease (increase) in due from subsidiary                                           33,000        (23,547)        Decrease (increase) in other assets                                   29,837        189,807       (219,644)        Decrease in other liabilities                                         (3,677)       (78,323)        Issuance of shares for Director's fees                                36,566         31,836         23,688                                                                         -----------    -----------    -----------     Net cash provided by operating activities                              1,843,250      7,653,986      1,259,269                                                                         -----------    -----------    -----------  Cash flows from investing activities:    Cash paid to Canaan National Bancorp, Inc. shareholders                              (6,020,163)    Cash and cash equivalents acquired from Canaan National      Bancorp, Inc., net of expenses paid of $309,419                                       222,868                                                                         -----------    -----------    -----------     Net cash used in investing activities                                                (5,797,295)                                                                         -----------    -----------    -----------  Cash flows from financing activities:    Dividends paid                                                        (1,666,046)    (1,415,074)    (1,295,533)                                                                         -----------    -----------    -----------     Net cash used in financing activities                                 (1,666,046)    (1,415,074)    (1,295,533)                                                                         -----------    -----------    -----------  Net increase (decrease) in cash and cash equivalents                        177,204        441,617        (36,264) Cash and cash equivalents at beginning of year                              942,520        500,903        537,167                                                                         -----------    -----------    ----------- Cash and cash equivalents at end of year                                $ 1,119,724    $   942,520    $   500,903                                                                         ===========    ===========    ===========  Supplemental disclosure:        Liability assumed in merger with Canaan National Bancorp, Inc.                  $    82,000                                                               F-28   NOTE 19 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) - -----------------------------------------------------  Summarized quarterly financial data for 2005 and 2004 follows:                                      (In thousands, except earnings per share)                                                 2005 Quarters Ended                                      ---------------------------------------                                      March 31   June 30  Sept. 30    Dec. 31                                      --------   -------  --------    -------  Interest and dividend income         $  5,034  $  5,069  $  5,272   $  5,441 Interest expense                        1,645     1,744     1,906      2,057                                      --------  --------  --------   --------    Net interest and dividend income     3,389     3,325     3,366      3,384 Provision (benefit) for loan losses        90        90        90        (60) Other income                            1,389     1,226     1,275        975 Other expense                           3,026     2,965     3,068      3,385                                      --------  --------  --------   --------    Income before income taxes           1,662     1,496     1,483      1,034 Income tax expense                        333       188       352        241                                      --------  --------  --------   --------    Net income                        $  1,329  $  1,308  $  1,131   $    793                                      ========  ========  ========   ========  Earnings per common share            $    .79  $    .78  $    .67   $    47                                      ========  ========  ========   ========                                      (In thousands, except earnings per share)                                                 2004 Quarters Ended                                      ---------------------------------------                                      March 31   June 30  Sept. 30    Dec. 31                                      --------   -------  --------    ------- Interest and dividend income         $  3,755  $  3,815  $  4,105   $  4,876 Interest expense                        1,269     1,273     1,390      1,727                                      --------  --------  --------   --------    Net interest and dividend income     2,486     2,542     2,715      3,149 Provision for loan losses                  60        60        60         70 Other income                            1,092     1,122     1,124      1,417 Other expense                           2,077     2,260     2,985      3,281                                      --------  --------  --------   --------    Income before income taxes           1,441     1,344       794      1,215 Income tax expense (benefit)              369       248        (2)       160                                      --------  --------  --------   --------    Net income                        $  1,072  $  1,096  $    796   $  1,055                                      ========  ========  ========   ========  Earnings per common share            $    .74  $    .77  $    .54   $    63                                      ========  ========  ========   ========                                        F-29
During the two (2) most recent fiscal  years,  the Company and the Bank have had no changes in or disagreements  with  independent  accountants on accounting and financial disclosure matters.
The Company's Chief  Executive  Officer and Chief  Financial  Officer  concluded that, based upon an evaluation as of December 31, 2005, the Company's disclosure controls and procedures are effective to ensure that information  required to be disclosed  by the  Company  in  reports  that it  files  or  submits  under  the Securities Exchange Act of 1934 is recorded, processed,  summarized and reported within the time periods  specified  in the SEC rules and forms.  During the year ended December 31, 2005, there were no changes in the Company's internal control over financial reporting that has materially  affected,  or is reasonably likely to materially affect, the Company's internal control over financial reporting.
None.  PART III
Information  regarding  Directors  and Executive  Officers of the  Registrant is omitted  from  this  report  on Form  10-K  and is  contained  in the  Company's Definitive  Proxy Statement for the Annual Meeting of Stockholders to be held on May 10,  2006 to be filed  within  120 days  after  the end of the  fiscal  year covered by this Form 10-K, and the information  included therein is incorporated by reference.  Code of Ethics - --------------  The Company has adopted a Code of Ethics  that  applies to the  Company's  Chief Executive Officer and Chief Financial  Officer. A copy of such Code of Ethics is available  upon  request to any person,  without  charge,  by writing to John F. Foley, Chief Financial Officer, Salisbury Bancorp, Inc., 5 Bissell Street, P. O. Box 1868, Lakeville, CT 06039.
Information regarding Executive Compensation is omitted from this report on Form 10-K and is contained in the Company's Definitive Proxy Statement for the Annual Meeting of  Stockholders  to be held on May 10, 2006 to be filed within 120 days after the end of the fiscal year covered by this Form 10-K, and the  information included therein is incorporated by reference.
Information  regarding  Security  Ownership  of  Certain  Beneficial  Owners and Management and Related  Stockholder  Matters is omitted from this report on Form 10-K and is contained in the Company's Definitive Proxy Statement for the Annual Meeting of  Stockholders  to be held on May 10, 2006 to be filed within 120 days after the end of the fiscal year covered by this Form 10-K, and the  information included therein is incorporated by reference.
Information  regarding Certain Relationships and Related Transactions is omitted from this report on Form 10-K and is contained in the Company's Definitive Proxy Statement for the Annual Meeting of  Stockholders  to be held on May 10, 2006 to be filed  within 120 days after the end of the fiscal year  covered by this Form 10-K, and the information included therein is incorporated by reference.                                         31
Information  regarding  Principal  Accountant  Fees and Services is omitted from this report on Form 10-K and is  contained  in the  Company's  Definitive  Proxy Statement for the Annual Meeting of  Stockholders  to be held on May 10, 2006 to be filed  within 120 days after the end of the fiscal year  covered by this Form 10-K, and the information included therein is incorporated by reference.  PART IV
(a)  The following documents are filed as part of this report on Form l0-K.       1. Financial Statements:            The  financial  statements  filed as part of this report are listed in           the index appearing at Item 8.       2. Financial Statement Schedules:            Such  schedules  are  omitted  because  they are  inapplicable  or the           information is included in the  consolidated  financial  statements or           notes thereto.       3. Exhibits Required by Item 601 of Regulation S-K:            Exhibit No.    Description         ----------     -----------              3.1         Certificate of Incorporation of Salisbury Bancorp, Inc. (1)            3.2         Bylaws of Salisbury Bancorp, Inc., as amended (2)            10          Pension Supplement Agreement with John F. Perotti (3)            10.2        Form of Change in Control Agreement with Executive Officers (4)            10.3        Director Stock Retainer Plan (5)            11          Computation of Earnings per Share            21          Subsidiaries of the Company            31.1        Rule 13a-15(e) Certification            31.2        Rule 13a-15(e) Certification            32          Section 1350 Certifications    (1)  Exhibit  was  filed  on  April  23,  1998  as  Exhibit  3.1  to   Company's      Registration  Statement  on Form S-4 (No.  333-50857)  and is  incorporated      herein by reference. (2)  Exhibit was filed on February  10,  2005 as Exhibit 3.2 to  Company's  Form      8-K/A and is  incorporated  herein by  reference.  (3) Exhibit was filed on      April 23, 1998 as Exhibit 10 to  Company's  Registration  Statement on Form      S-4 (No. 333-50857) and is      incorporated herein by reference. (4)  Exhibit was filed on May 8, 2002, as Exhibit 10.2 to the  Company's  Annual      Report on Form 10-KSB/A for the fiscal year ended  December 31, 2002 and is      incorporated herein by reference. (5)  Exhibit was filed on May 8, 2002, as Exhibit 10.3 to the  Company's  Annual      Report on Form 10KSB for the fiscal  year ended  December  31,  2002 and is      incorporated herein by reference.                                         32   SIGNATURES  Pursuant to the requirements of Section 13 and 15(d) of the Securities  Exchange Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its behalf by the undersigned,  thereunto duly authorized, in Lakeville, Connecticut on March 27, 2006.                                               SALISBURY BANCORP, INC.                                               By: /s/ John F. Perotti                                                  -----------------------                                                  John F. Perotti                                                  Chairman and                                                  Chief Executive Officer                                               By: /s/ John F. Foley                                                  -----------------------                                                  John F. Foley                                                  Chief Financial Officer                                                  and Treasurer  Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following  persons on behalf of the  Registrant and in the capacities and on the dates indicated:  Signature                          Title                             Date - ---------                          -----                             ----   /s/ John F. Perotti               Chairman,                    March 27, 2006 - ----------------------------       Chief Executive Officer  (John F. Perotti)                                    and Director   /s/ Louis E. Allyn, II            Director                     March 27, 2006 - ---------------------------- (Louis E. Allyn, II)   /s/ John R. H. Blum               Director                     March 27, 2006 - ---------------------------- (John R. H. Blum)   /s/ Louise F. Brown               Director                     March 27, 2006 - ---------------------------- (Louise F. Brown)   /s/ Richard J. Cantele, Jr.       Director                     March 27, 2006 - ---------------------------- (Richard J. Cantele, Jr.)   /s/ Robert S. Drucker             Director                     March 27, 2006 - ---------------------------- (Robert S. Drucker)  /s/ Nancy F. Humphreys             Director                     March 27, 2006 - ---------------------------- (Nancy F. Humphreys)  /s/ Holly J. Nelson                Director                     March 27, 2006 - ---------------------------- (Holly J. Nelson)   /s/ Michael A. Varet              Director                     March 27, 2006 - ---------------------------- (Michael A. Varet)                                         33      EX-11 2 ex11.txt EX-11                                     EXHIBIT 11                         COMPUTATION OF EARNINGS PER SHARE  The Company has computed and presented  earnings per share ("EPS") in accordance with Statement of Financial Accounting Standards No. 128.  Reconciliation of the numerators and the  denominators of the basic and diluted per share  computation for net income are as follows:                                                                 (amounts in thousands, except per share data)                                                                             (unaudited)                                                                Income         Shares            Per-Share                                                               (Numerator)    (Denominator)     Amount                                                               -----------    -------------     ------     Twelve months ended December 31, 2005    Basic EPS       Net income and income available to common stockholders   $4,561           1,683          $ 2.71       Effect of dilutive securities, options                                        0                                                                ------          ------    Diluted EPS       Income available to common stockholders and assumed          conversions                                           $4,561           1,683          $ 2.71                                                                ======          ======  Twelve months ended December 31, 2004    Basic EPS       Net income and income available to common stockholders   $4,019           1,503          $ 2.67       Effect of dilutive securities, options                                        0                                                                ------          ------    Diluted EPS       Income available to common stockholders and assumed          conversions                                           $4,019           1,503          $ 2.67                                                                ======          ======                                                                 (amounts in thousands, except per share data)                                                                             (unaudited)                                                                Income         Shares            Per-Share                                                               (Numerator)    (Denominator)     Amount                                                               -----------    -------------     ------     Three months ended December 31, 2005    Basic EPS       Net income and income available to common stockholders   $  793           1,683          $  .47       Effect of dilutive securities, options                        0               0                                                                ------          ------    Diluted EPS       Income available to common stockholders and assumed          conversions                                                                $  793           1,683          $  .47                                                                ======          ====== Three months ended December 31, 2004    Basic EPS       Net income and income available to common stockholders   $1,055           1,682          $  .63       Effect of dilutive securities, options                        0               0                                                                ------          ------    Diluted EPS       Income available to common stockholders and assumed          conversions                                           $1,055           1,682          $  .63                                                                ======          ======      EX-21 3 ex21.txt EX-21                                      Exhibit 21                                    ----------                            Subsidiaries of the Company                                                                  Percent owned Subsidiary                          State of Incorporation       by Company - ----------                          ----------------------       ----------  Salisbury Bank and Trust Company        Connecticut                 100%        EX-31.1 4 ex31-1.txt EX-31.1                                     Exhibit 31.1                                   ------------                           RULE 13a-15(e) CERTIFICATION                           ----------------------------  I, John F. Perotti, certify that:  1. I have reviewed this annual report on Form 10-K of Salisbury Bancorp, Inc.;  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact  necessary to make the statements made, in light of the  circumstances  under which such statements were made, not misleading with respect to the period covered by this report;  3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial information included in this report, fairly present in all material respects the financial  condition,  results of operations and cash flows of the registrant as of, and for, the periods presented in this report;  4.  The  registrant's  other  certifying  officer  and  I  are  responsible  for establishing and maintaining  disclosure  controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:       a)   designed  such  disclosure  controls  and  procedures,  or caused such           disclosure   controls  and   procedures  to  be  designed   under  our           supervision,  to ensure  that  material  information  relating  to the           registrant,  including its consolidated subsidiaries, is made known to           us by others within those entities,  particularly during the period in           which this report is being prepared;       b)   evaluated the  effectiveness of the registrant's  disclosure  controls           and procedures and presented in this report our conclusions  about the           effectiveness of the disclosure controls and procedures, as of the end           of the period covered by this report based on such evaluation; and       c)   disclosed  in this  report  any  change in the  registrant's  internal           control over financial reporting that occurred during the registrant's           most  recent  fiscal  quarter  that  has  materially  affected,  or is           reasonably  likely to materially  affect,  the  registrant's  internal           control over financial reporting; and  5. The registrant's other certifying officer and I have disclosed,  based on our most recent  evaluation of internal  control over  financial  reporting,  to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):       a)   all significant  deficiencies  and material  weakness in the design or           operation  of internal  control  over  financial  reporting  which are           reasonably  likely to  adversely  affect the  registrant's  ability to           record, process, summarize and report financial information; and       b)   any fraud, whether or not material,  that involves management or other           employees who have a  significant  role in the  registrant's  internal           control over financial reporting.    Date: March 27, 2006  By:   /s/ John F. Perotti       -------------------       Chairman and CEO     EX-31.2 5 ex31-2.txt EX-31.2                                     Exhibit 31.2                                   ------------                            RULE 13a-15(e) CERTIFICATION                            ----------------------------  I, John F. Foley, certify that:  1. I have reviewed this annual report on Form 10-K of Salisbury Bancorp, Inc.;  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact  necessary to make the statements made, in light of the  circumstances  under which such statements were made, not misleading with respect to the period covered by this report;  3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial information included in this report, fairly present in all material respects the financial  condition,  results of operations and cash flows of the registrant as of, and for, the periods presented in this report;  4.  The  registrant's  other  certifying  officer  and  I  are  responsible  for establishing and maintaining  disclosure  controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:       a)   designed  such  disclosure  controls  and  procedures,  or caused such           disclosure   controls  and   procedures  to  be  designed   under  our           supervision,  to ensure  that  material  information  relating  to the           registrant,  including its consolidated subsidiaries, is made known to           us by others within those entities,  particularly during the period in           which this report is being prepared;       b)   evaluated the  effectiveness of the registrant's  disclosure  controls           and procedures and presented in this report our conclusions  about the           effectiveness of the disclosure controls and procedures, as of the end           of the period covered by this report based on such evaluation; and       c)   disclosed  in this  report  any  change in the  registrant's  internal           control over financial reporting that occurred during the registrant's           most  recent  fiscal  quarter  that  has  materially  affected,  or is           reasonably  likely to materially  affect,  the  registrant's  internal           control over financial reporting; and  5. The registrant's other certifying officer and I have disclosed,  based on our most recent  evaluation of internal  control over  financial  reporting,  to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):       a)   all significant  deficiencies  and material  weakness in the design or           operation  of internal  control  over  financial  reporting  which are           reasonably  likely to  adversely  affect the  registrant's  ability to           record, process, summarize and report financial information; and       b)   any fraud, whether or not material,  that involves management or other           employees who have a  significant  role in the  registrant's  internal           control over financial reporting.    Date: March 27, 2006  By:   /s/ John F. Foley       -----------------       Chief Financial Officer       and Treasurer     EX-32 6 ex32.txt EX-32                                      EXHIBIT 32                 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,                        AS ADOPTED PURSUANT TO SECTION 906                         OF THE SARBANES-OXLEY ACT OF 2002       In  connection  with the Annual  Report of  Salisbury  Bancorp,  Inc.  (the "Company") on Form 10-K for the period  ending  December 31, 2005, as filed with the Securities  and Exchange  Commission on the date hereof (the  "Report"),  I, John F. Perotti,  Chairman and Chief  Executive  Officer of the Company,  and I, John F. Foley,  Chief Financial  Officer and Treasurer of the Company,  certify, pursuant to 18 U.S.C.  Section 1350,  as adopted  pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:       (1)  The Report fully  complies with the  requirements  of section 13(a) or           15(d) of the Securities Exchange Act of 1934; and       (2)  The  information  contained  in the  Report  fairly  presents,  in all           material respects, the financial condition and result of operations of           the Company.  /s/  John F. Perotti                            /s/  John F. Foley - ----------------------------                    ----------------------------      John F. Perotti                                 John F. Foley      Chairman and                                    Chief Financial Officer      Chief Executive Officer                         and Treasurer      -----END PRIVACY-ENHANCED MESSAGE-----