Merrill Merchants Bancshares (MERB) 10-Q 2005 Q3 Quarterly report

FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2005

Commission File Number: 0-24715

MERRILL MERCHANTS BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

MAINE	01-0471507
(State or other jurisdiction of	(IRS Employer Identification No.)
incorporation or organization)

201 Main Street

Bangor, Maine 04401

(Address of principal executive offices)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: [ X ] No: [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-02 of the Exchange Act).  Yes: [  ] No: [ X ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes: [  ] No: [ X ]

The number of shares outstanding for the issuer's classes of common stock as of October 31, 2005 is 3,435,633.

MERRILL MERCHANTS BANCSHARES, INC.

INDEX TO FORM 10-Q

PART I FINANCIAL INFORMATION	Page
ITEM 1. FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm	3
Consolidated Statements of Financial Condition at September 30, 2005 and December 31, 2004	4
Consolidated Statements of Income for the Three and Nine Months Ended
September 30, 2005 and 2004	5
Consolidated Statements of Shareholders' Equity for the Three and Nine Months Ended
September 30, 2005 and 2004	6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004	7
Notes to Consolidated Financial Statements	8
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS	9
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	16
ITEM 4.  CONTROLS AND PROCEDURES	18
PART II OTHER INFORMATION
ITEM 1.  LEGAL PROCEEDINGS	18
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	18
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES	19
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	19
ITEM 5.  OTHER INFORMATION	19
ITEM 6.  EXHIBITS	19
SIGNATURE PAGE	20
EXHIBITS

Page 2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Merrill Merchants Bancshares, Inc.

We have reviewed the accompanying interim consolidated financial information of Merrill Merchants Bancshares, Inc. and Subsidiary as of September 30, 2005, and for the three- and nine-month periods ended September 30, 2005 and 2004. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is to express an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying financial statements for them to be in conformity with U. S. generally accepted accounting principles.

/s/ BERRY, DUNN, McNEIL & PARKER

Bangor, Maine

November 7, 2005

Page 3

MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Financial Condition

	September 30,			December 31,
	2005			2004
(in thousands, except number of shares and per share data)	(Unaudited)			(Audited)
ASSETS
Cash and due from banks	$	11,802		$	10,092
Federal funds sold		3,400			-
Interest-bearing deposits with banks		105			128
Total cash and cash equivalents		15,307			10,220
Investment securities - available for sale		70,168			66,099
Loans held for sale		1,393			617
Loans receivable		311,064			282,988
Less allowance for loan losses		4,083			3,866
Net loans receivable		306,981			279,122
Properties and equipment, net		4,669			3,850
Cash surrender value of life insurance		3,981			3,854
Deferred income tax benefit		1,326			1,079
Accrued income and other assets		4,206			3,849
Total assets	$	408,031		$	368,690
LIABILITIES AND SHAREHOLDERS’ EQUITY
Demand deposits	$	55,522		$	51,945
Savings and NOW deposits		152,858			142,614
Certificates of deposit		116,615			105,223
Total deposits		324,995			299,782
Securities sold under agreements to repurchase (term and demand)		20,105			16,486
Other borrowed funds		24,795			17,038
Accrued expenses and other liabilities		4,614			4,055
Total liabilities		374,509			337,361
Shareholders’ equity
Common stock, par value $1; authorized 4,000,000 shares, issued and outstanding 3,435,633 shares in 2005 and 3,340,310 shares in 2004		3,436			3,340
Capital surplus		24,182			22,037
Retained earnings		5,877			5,763
Accumulated other comprehensive (loss) income
Unrealized gain on securities available for sale, net of tax		89			203
Net unrealized depreciation on derivative instruments marked to market, net of tax		(62	)		(14	)
Total shareholders’ equity		33,522			31,329
Total liabilities and shareholders’ equity	$	408,031		$	368,690

See report of independent registered public accounting firm. The accompanying notes are

an integral part of these consolidated financial statements.

Page 4

MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income

(Unaudited)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands, except number of shares and per share data)		2005		2004		2005		2004
Interest and dividend income
Interest and fees on loans	$	5,297	$	4,261	$	14,757	$	12,183
Interest on investment securities		532		484		1,543		1,481
Dividends on investment securities		42		35		107		85
Interest on federal funds sold		80		2		106		2
Total interest and dividend income		5,951		4,782		16,513		13,751
Interest expense
Interest on deposits		1,569		1,047		4,051		2,907
Interest on borrowed funds		321		214		911		686
Total interest expense		1,890		1,261		4,962		3,593
Net interest income		4,061		3,521		11,551		10,158
Provision for loan losses		106		88		300		256
Net interest income after provision for loan losses		3,955		3,433		11,251		9,902
Non-interest income
Service charges on deposit accounts		387		345		1,092		1,043
Other service charges and fees		210		212		616		582
Trust fees		392		354		1,171		1,042
Net gain on sale of loans and properties and equipment		110		166		519		678
Net gain on investment securities		-		-		19		65
Other		116		91		393		281
Total non-interest income		1,215		1,168		3,810		3,691
Non-interest expense
Salaries and employee benefits		1,742		1,588		5,096		4,725
Occupancy expense		217		198		715		633
Equipment expense		154		128		474		428
Data processing		146		176		462		512
Other		704		629		2,144		1,911
Total non-interest expense		2,963		2,719		8,891		8,209
Income before income taxes		2,207		1,882		6,170		5,384
Income tax expense		745		648		2,086		1,832
Net income	$	1,462	$	1,234	$	4,084	$	3,552
Per share data
Basic earnings per common share	$	.43	$	.36	$	1.19	$	1.02
Diluted earnings per common share	$	.42	$	.36	$	1.18	$	1.01

See report of independent registered public accounting firm. The accompanying notes are

an integral part of these consolidated financial statements.

Page 5

MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

For the Nine Months Ended September 30, 2005 and 2004

(Unaudited)

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

										Unrealized  Gain (Loss) On Securities Available				Net  Unrealized  Depreciation  on Derivative						Total  Share-  holders’
		Common			Capital			Retained									Treasury
		Stock			Surplus			Earnings		for Sale				Instruments			Stock			Equity
Balance at December 31, 2003	$	3,335		$	21,762		$	5,305		$	366		$	-		$	(215	)	$	30,553
Net income		-			-			3,552			-			-			-			3,552
Unrealized loss on derivative instruments, net of deferred taxes of $17		-			-			-			-			(33	)		-			(33	)
Change in unrealized gain on securities available for sale, net of deferred taxes of ($15)		-			-			-			(29	)		-			-			(29	)
Total comprehensive income		-			-			3,552			(29	)		(33	)		-			3,490
Treasury stock purchased (72,592 shares at an average price of $24.80)		-			-			-			-			-			(1,801	)		(1,801	)
Common stock options exercised, 7,628 shares		2			9			(42	)		-			-			97			66
3% common stock dividend declared		100			2,422			(2,526	)		-			-			-			(4	)
Treasury stock retirement		(80	)		(561	)		(1,278	)		-			-			1,919			-
Common stock repurchased (17,000 shares at an average price of $20.88)		(17	)		(119	)		(218	)		-			-			-			(354	)
Common stock cash dividend declared, $0.41 per share		-			-			(1,374	)		-			-			-			(1,374	)
Balance at September 30, 2004	$	3,340		$	23,513		$	3,419		$	337		$	(33	)	$	-		$	30,576
Balance at December 31, 2004	$	3,340		$	22,037		$	5,763		$	203		$	(14	)	$	-		$	31,329
Net income		-			-			4,084			-			-			-			4,084
Unrealized loss on derivative instruments, net of deferred taxes of ($25)		-			-			-			-			(48	)		-			(48	)
Change in unrealized gain on securities available for sale, net of deferred taxes of ($56)		-			-			-			(114	)		-			-			(114	)
Total comprehensive income		-			-			4,084			(114	)		(48	)		-			3,922
Common stock options exercised, 787 shares		1			8			-			-			-			-			9
Common stock repurchased (5,500 shares at $21.70)		(5	)		(114	)		-			-			-			-			(119	)
3% common stock dividend declared		100			2,251			(2,355	)		-			-			-			(4	)
Common stock cash dividend declared, $0.47 per share		-			-			(1,615	)		-			-			-			(1,615	)
Balance at September 30, 2005	$	3,436		$	24,182		$	5,877		$	89		$	(62	)	$	-		$	33,522

See report of independent registered public accounting firm. The accompanying notes are

an integral part of these consolidated financial statements.

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MERRILL MERCHANTS BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2005 and 2004

(Unaudited)

(in thousands)		2005			2004
Cash flows from operating activities
Net income	$	4,084		$	3,552
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation		278			288
Amortization		238			374
Net amortization on investment securities		350			616
Deferred income taxes		(158	)		(96	)
Provision for loan losses		300			256
Net gain on sale of loans, investment securities and properties and equipment		(365	)		(450	)
Net change in:
Loans held for sale		(776	)		(381	)
Deferred loan fees, net		(78	)		30
Accrued income and other assets		(449	)		(445	)
Accrued expenses and other liabilities		559			565
Net cash provided by operating activities		3,983			4,309
Cash flows from investing activities
Net loans made to customers		(28,081	)		(29,856	)
Acquisition of properties and equipment and computer software		(1,152	)		(568	)
Purchase of investment securities available for sale		(45,243	)		(40,198	)
Proceeds from sales and maturities of investment securities available for sale		40,672			45,757
Net cash used by investing activities		(33,804	)		(24,865	)
Cash flows from financing activities
Net increase in demand, savings and NOW deposits		13,821			19,007
Net increase in certificates of deposit		11,392			15,837
Net increase (decrease) in securities sold under agreement to repurchase		3,619			(1,901	)
Net increase (decrease) in other borrowed funds		187			(9,885	)
Long-term advances from the Federal Home Loan Bank		10,000			3,290
Payments on long-term advances		(2,430	)		(2,305	)
Dividends paid on common stock		(1,571	)		(1,348	)
Repurchase of common stock		(119	)		(2,156	)
Proceeds from stock issuance		9			66
Net cash provided by financing activities		34,908			20,605
Net increase in cash and cash equivalents		5,087			49
Cash and cash equivalents, beginning of period		10,220			10,746
Cash and cash equivalents, end of period	$	15,307		$	10,795
Supplemental disclosures of cash flow information
Cash paid for interest	$	5,028		$	3,551
Income tax paid		2,089			1,975

See report of independent registered public accounting firm. The accompanying notes are

an integral part of these consolidated financial statements.

Page 7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

Merrill Merchants Bancshares, Inc. (the Company) is a financial holding company that owns all of the common stock of Merrill Merchants Bank (the Bank). The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions and balances are eliminated in consolidation. The income reported for the 2005 period is not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2004.

NOTE 2 - EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2005 and 2004:

	Three Months Ended				Nine Months Ended
		September 30,				September 30,
		2005		2004		2005		2004
(in thousands, except for number of shares and per-share data)
Net income, as reported	$	1,462	$	1,234	$	4,084	$	3,552
Weighted-average shares outstanding		3,435,126		3,450,105		3,437,724		3,482,946
Effect of dilutive stock options		29,877		28,776		29,106		30,900
Adjusted weighted-average shares outstanding		3,465,003		3,478,881		3,466,830		3,513,846
Basic earnings per share	$	0.43	$	0.36	$	1.19	$	1.02
Diluted earnings per share	$	0.42	$	0.36	$	1.18	$	1.01

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

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

Page 8

NOTE 3 - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123(R) - Share-Based Payment, which replaces SFAS No. 123 - Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25 - Accounting for Stock Issued to Employees. In March 2005, the Securities and Exchange (SEC) issued Staff Accounting Bulletin No. 107 - Share-Based Payment, which provides interpretive guidance related to SFAS No. 123(R). SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. SFAS No. 123(R) requires liability awards to be remeasured each reporting period and compensation costs to be recognized over the period that an employee provides service in exchange for the award. In April 2005, the SEC delayed the effective date of SFAS No. 123(R) to the beginning of the annual reporting period that begins after June 15, 2005, which is January 1, 2006 for the Company. The adoption of SFAS No. 123(R) is not expected to have a material effect on the Company’s consolidated financial statements.

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

The Company has interest rate protection agreements with notional amounts of $10 million at September 30, 2005. Under these agreements, the Company exchanges a variable rate asset for a fixed rate asset, thus protecting certain asset yields from falling interest rates. In accordance with SFAS No. 133, management designated these swap agreements as cash-flow hedges since they convert a portion of the loan portfolio from a variable rate based upon the Prime Rate to a fixed rate. The hedge relationship is estimated to be 100% effective; therefore, there is no impact on the statement of income resulting from changes in fair value. The fair values of the swap agreements are recorded in the statement of financial condition with the offset recorded in the statement of changes in shareholders’ equity.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

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

Page 9

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

CRITICAL ACCOUNTING POLICIES

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

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

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

Page 10

EXECUTIVE OVERVIEW

Net income increased 18% for the third quarter ended September 30, 2005 compared to the third quarter last year, an increase of $228,000. The following were significant factors related to the results to the third quarter of 2005 compared to the third quarter of 2004.

§   Net interest income increased $540,000 or 15% to $4.1 million. The increase was driven by an increase in average earning assets of 8% combined with an increase in the net interest margin of 31 basis points to 4.29%.

§   Non-interest income was $1.2 million for the third quarter of 2005, an increase of $47,000 or 4%, from the same period in 2004. Trust fees grew 11% and service charges on deposit accounts increased 12% while the gains on mortgage sales declined 34%.

§   Non-interest expense increased $244,000, or 9%, to $3.0 million for the third quarter of 2005 compared to the third quarter of 2004. The increase was the result of an increase in personnel costs of 10%, an increase in other expenses of 12%, and a decline in data processing expenses of 17%.

§   Comparing September 30, 2005 and 2004, total loans grew $34.8 million or 13%. Real estate lending was strong with growth in the commercial real estate portfolio of $13.6 million or 15% and home equity balances increasing $8.4 million or 25%. Residential and construction balances increased $6.1 million from a year ago and loans to small businesses were up $5.2 million.

§   Comparing September 30, 2005 and 2004, total deposits grew $31.3 million or 11% with savings account balances increasing $11.8 million or 27%.

RESULTS OF OPERATIONS

The Company reported net income of $4.1 million, or $1.18 per diluted share, for the first nine months of 2005. This is an increase of $532,000, or 15%, compared to net income of $3.6 million, or $1.01 per diluted share, for the comparable period of 2004. Net income for the third quarter of 2005 increased $228,000, or 18%, to $1.5 million compared with the third quarter of 2004 and earnings per diluted share increased to $0.42 compared to $0.36 for the same period.

The annualized return on average shareholders’ equity increased to 16.95% for the nine months in 2005 from 15.60% in 2004 and was 17.60% and 16.26% for the third quarter of 2005 and 2004, respectively. The annualized return on average assets for the first nine months of 2005 and 2004 was 1.42% and 1.33%, respectively, and for the third quarter of 2005 and 2004 was 1.45% and 1.33%, respectively.

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NET INTEREST INCOME

Net interest income is interest earned on interest-earning assets less interest incurred on interest-bearing liabilities. Interest-earning assets are categorized as loans, investment securities and other earning assets, which include federal funds sold and interest-bearing deposits in other financial institutions. Interest-bearing liabilities are categorized as customer deposits, time and savings deposits and borrowings including repurchase agreements, short-term borrowings and long-term debt. Net interest income depends on the volume of average interest-earning assets and average interest-bearing liabilities and the interest rates earned or incurred on them.

Net interest income totaled $11.6 million for the first nine months of 2005, an increase of $1.4 million compared to the same period in 2004. The 14% increase was driven by growth in average earning assets of $27.0 million combined with an increase in the Company’s net interest margin to 4.22% for the first nine months of 2005 compared to 3.99% for the same period last year.

Since June 2004, the Board of Governors of the Federal Reserve System has increased the Federal Funds targeted rate nine times from 1.00% to 3.75% at September 30, 2005.

The average rate earned on interest-earning assets increased to 6.04% from 5.41% for the nine months ended September 30, 2005 and 2004, respectively, on average interest-earning assets of $364.3 million and $337.3 million for the corresponding periods. The average interest rate incurred on interest-bearing liabilities also increased, to 2.24% from 1.76% for the nine months ended September 30, 2005 and 2004, respectively, on average interest-bearing liabilities of $295.6 million and $273.0 million for the corresponding periods.

Net interest income totaled $4.1 million for the third quarter of 2005, an increase of $540,000 or 15% over the same period in 2004. The net interest margin increased to 4.29% for the third quarter of 2005 as compared to 3.98% for the same period in 2004. The yield on average earning assets for the third quarter of 2005 and 2004 was 6.26% and 5.42%, respectively, and the average interest rate incurred on interest-bearing liabilities was 2.44% and 1.79%, respectively.

PROVISION FOR LOAN LOSSES

The provision for loan losses was $300,000 for the nine months ended September 30, 2005, as compared to $256,000 for the same period in 2004. The slight increase in the provision for loan losses was appropriate given the continued growth of the loan portfolio, the overall credit quality of the portfolio and the Company’s historical loan loss trends.

In originating loans, the Company recognizes that it will experience loan losses and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of collateralized loans, the quality of the collateral for the loan as well as general economic conditions. It is management's policy to attempt to maintain an appropriate allowance for loan losses based on, among other things, industry standards, management's experience, the Bank's historical loan loss experience, evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality.

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Provisions result from management’s continuing review of the loan portfolio as well as its judgment as to the adequacy of the reserves in light of the condition of the economy and the real estate market. Management believes that based on information currently available, the allowance for loan losses is appropriate and overall credit quality remains strong.

Management continues to actively monitor the Company's asset quality and to charge off loans against the allowance for loan losses when appropriate or to provide specific loan allowances when necessary. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ from the economic conditions in the assumptions used in making the final determinations. The Company’s allowance for loan losses amounted to $---4.1 million at September 30, 2005 (1.31% of total loans), an increase of $217,000 since year-end.

NON-INTEREST INCOME

Non-interest income was $3.8 million for the nine months ended September 30, 2005, an increase of $119,000 compared to the same period in 2004. The 3% increase in non-interest income was driven by increases in trust fees of $129,000, increases in other fees of $112,000 and a $106,000 gain on the sale of our credit card portfolio. Mortgage sale gains declined by $265,000 as residential loan refinancing volume is significantly lower this year and investment security gains decreased $46,000 from a year ago.

Non-interest income was $1.2 million for the third quarter of 2005, an increase of $47,000 or 4%, from the same period in 2004. Trust fees grew 11% and service charges on deposit accounts increased 12% while the gains on mortgage sales declined 34%.

NON-INTEREST EXPENSE

Non-interest expense totaled $8.9 million for the nine months ended September 30, 2005 compared to $8.2 million for the same period last year. The increase in non-interest expense of $682,000, or 8%, was due to increases in personnel costs of 8%, occupancy costs of 13% and other expenses of 12%.

Non-interest expense increased $244,000, or 9%, to $3.0 million for the third quarter of 2005 compared to the third quarter of 2004. The increase was the result of an increase in personnel costs of 10%, an increase in other expenses of 12%, and a decline in data processing expenses of 17%.

The Company’s efficiency ratio (non-interest expense divided by the sum of net interest income and other income) improved to 58.4% for the nine months of 2005 compared to 59.6% for the same period in 2004 and was 56.2% and 58.0% for the third quarter ended September 30, 2005 and 2004, respectively.

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FINANCIAL CONDITION

Total assets increased $39.3 million or 11% to $408.0 million during the first nine months of 2005. Since December 31, 2004, the loan portfolio increased $28.1 million or 10%. Comparing September 30, 2005 to December 31, 2004, small business loans increased 9%, commercial real estate balances grew 8%, home equity loans increased 21%, construction loans increased 24%, consumer loans grew 8% and residential loan balances increased 4%. The investment portfolio increased $4.1 million or 6% since year-end while cash and cash equivalents increased $5.1 million or 50%. Asset growth was funded by an increase in deposit balances and borrowed funds.

Total deposits increased 8% to $325.0 million for the first nine months of 2005. Since December 31, 2004, savings accounts increased 30% due to offering a premium interest rate savings product, certificates of deposit balances increased 17% and checking accounts grew 5%. Borrowed funds increased by $11.4 million to $44.9 million at September 30, 2005 primarily due to long-term advances from the Federal Home Loan Bank (“FHLB”) of $7.9 million.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity represents the ability to meet both asset growth and deposit withdrawals. Many factors affect a company’s ability to meet liquidity needs, including changes in the markets served, its asset-liability mix, its reputation and credit standing in the market and general economic conditions. In addition to traditional in-market deposit sources, the Company has other sources of liquidity, including proceeds from maturing investment securities and loans, the sale of investment securities, federal funds through correspondent bank relationships, brokered deposits and FHLB borrowings. Additional liquidity is available in the loan portfolio through sale of residential mortgages and the guaranteed portion of Small Business Administration loans. Management believes that the current level of liquidity is sufficient to meet current and future funding requirements.

The Company’s total shareholders’ equity was $33.5 million or 8.2% of total assets at September 30, 2005, compared with $31.3 million or 8.5% of total assets at December 31, 2004.  The net increase of $2.2 million in the first nine months of 2005 was attributable to net income of $4.1 million less cash dividends of $1.6 million, common stock acquired of $119,000 and changes in unrealized losses on investment securities and derivative instruments of $162,000, net of tax. In the third quarter of 2005, the Company declared a cash dividend of $.16 per share on the Company’s common stock. This was an increase of 18% over last year’s third quarter dividend.

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Under Federal Reserve Board guidelines, bank holding companies such as the Company are required to maintain capital based on “risk-adjusted” assets. These guidelines apply to the Company on a consolidated basis. Under the current guidelines, banking organizations must maintain a risk-based capital ratio of 8%. The Company’s risk-based capital ratios for Tier 1 and Tier 2 capital at September 30, 2005, of 11.12% and 12.37%, respectively, exceed regulatory guidelines for a “well capitalized” financial institution. The Company’s ratios at December 31, 2004 were 11.83% and 13.09%, respectively.

On June 17, 2004, the Board of Directors approved a fourth stock repurchase program authorizing the Company to repurchase up to 169,995, or 5%, of its outstanding shares of common stock. As of September 30, 2005, 22,137 shares had been repurchased under the program. The repurchases will be made from time to time at the discretion of Company management.

OFF-BALANCE-SHEET ITEMS

The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Bank follows the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments, including requiring collateral or other security to support financial instruments with credit risk. At September 30, 2005, the Company had the following levels of commitments to extend credit:

			Commitment Expires in:
(In thousands)		Total Amount Committed		Less than 1 year		1 - 3 years		4 - 5 years		After 5 years
Letters of Credit	$	1,946	$	1,692	$	-	$	254	$	-
Other Commitments to Extend Credit		72,090		37,603		3,441		1,203		29,843
Total	$	74,036	$	39,295	$	3,441	$	1,457	$	29,843

The Company is a party to several off-balance sheet contractual obligations through lease agreements on branch facilities. These commitments, borrowings and the related payments were made during the normal course of business. At September 30, 2005, the Company had the following levels of contractual obligations:

			Payments Due by Period:
(In thousands)		Total Amount of Obligation		Less than 1 year		1 - 3 years		4 - 5 years		After 5 years
Operating Leases	$	990	$	300	$	426	$	241	$	23
Federal Home Loan Bank Debt		23,240		3,225		11,017		7,132		1,866
Total	$	24,230	$	3,525	$	11,443	$	7,373	$	1,889

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In July 2004, the Bank acquired an historic building located at 183 Main Street, Bangor, Maine. This property is adjacent to the Bank’s headquarters property at 201 Main Street. The Bank has commenced a construction project to renovate the 183 Main Street property and link a three-story connecting corridor to its headquarters building. The $1.5 million project is targeted for completion in early 2006.

The Company uses derivative instruments as partial hedges against large fluctuations in interest rates. The Company uses interest rate swap instruments to partially hedge against potentially lower yields on the variable prime rate loan category in a declining rate environment. If rates were to decline, resulting in reduced income on the adjustable rate loans, there would be an increased income flow from the interest rate swap instruments. These financial instruments are factored into the Company’s overall interest rate risk position. The Company regularly reviews the credit quality of the counterparty from which the instruments have been purchased. At September 30, 2005, the Company had two two-year swap agreements with a notional amount of $10.0 million due to mature June 21, 2006 with cash flows for the following periods:

	Payments Due by Period:
(In thousands)		Less than 1 year			1 - 3 years		4 - 5 years		After 5 years
Fixed Payments from Counterparty	$	429		$	-	$	-	$	-
Payments based on Prime Rate		488			-		-		-
Net Cash Flow	$	(59	)	$	-	$	-	$	-

The net cash flow reflected on the table above is based on the current rate environment. The Company receives a fixed 5.93% on the notional amount during the contract period from the counterparty on the swap agreements and pays a variable rate based on the prime rate that is 6.75% at September 30, 2005. The cash flow will remain negative for the Company as long as the prime rate exceeds 5.93%. This derivative instrument was put into place to partially hedge against potential lower yields on the variable prime rate loan category in a declining rate environment. As the prime rate increases the Company experiences a net cash outflow from this derivative instrument that is offset by an increase in cash flow for the variable prime rate loans.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by the Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to its Asset/Liability Committee (“ALCO”). In this capacity, ALCO develops guidelines and strategies impacting the Company’s asset/liability management activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels/trends.

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

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

Estimated
Rate Change	Change in NII
+200bp	1.39%
-200bp	(4.25)%

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

When appropriate, the Company may utilize derivative financial instruments, such as interest rate floors, caps and swaps to hedge its interest rate risk position. The Board of Directors’ approved hedging policy statements govern the use of these instruments. As of September 30, 2005, the Company had a notional principal of $10 million in interest rate swap agreements. ALCO monitors derivative activities relative to its expectation and the Company’s hedging policy. These instruments are more fully described in Note 4-Derivative Financial Instruments within the “Notes to Consolidated Financial Statements” section.

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

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ITEM 4. CONTROLS AND PROCEDURES

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

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

PART II. OTHER INFORMATION

Item 1         LEGAL PROCEEDINGS

None

Item 2       UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the three months ended September 30, 2005, the Company repurchased the following shares of the common stock:

Period	(a) Total Number  of Shares  Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced  Plans or Programs		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July 1 - 31, 2005		-		-		-		147,858
August 1 - 31, 2005		-		-		-		147,858
September 1-30, 2005		-		-		-		147,858

On June 17, 2004, the Board of Directors approved a fourth stock repurchase program authorizing the Company to repurchase up to 169,995 shares of the Company’s common stock. The authority may be exercised from time to time and in such amounts as market conditions warrant. Shares are being repurchased for other corporate purposes. The program does not have an expiration date.

Item 3        DEFAULTS UPON SENIOR SECURITIES

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None

Item 4        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

Item 5        OTHER INFORMATION

            None

Item 6 EXHIBITS

Exhibits

3.1           Articles of Incorporation of Merrill Merchants Bancshares, Inc.*

3.2           By-laws of Merrill Merchants Bancshares, Inc.*

4            Specimen Stock Certificate of Merrill Merchants Bancshares, Inc.*

31          Rule 13a - 14(a) / 15d - 14(a) Certifications

32          Section 1350 Certifications

* Incorporated by reference to the Company’s Registration Statement on Form SB-2 (File No. 333-56197), and any amendments thereto filed with the Securities and Exchange Commission.

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SIGNATURES

In accordance with the requirements 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.

	MERRILL MERCHANTS BANCSHARES, INC.
Date: November 9, 2005	By: /s/ Edwin N. Clift
	Edwin N. Clift
	Chairman and Chief Executive
	Officer (Principal Executive Officer)
Date: November 9, 2005	By: /s/ Deborah A. Jordan
	Deborah A. Jordan
	Executive Vice President and
	Treasurer (Principal Financial and Accounting Officer)

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