The First Bancorp, Inc. (the "Company") was incorporated in the State of Maine on January 15, 1985, and is the parent holding company of The First, N.A. (the "Bank"). At the Company's Annual Meeting of Shareholders on April 30, 2008, the Company's name was changed to The First Bancorp, Inc. from First National Lincoln Corporation.

The Company generates almost all of its revenues from the Bank, which was chartered as a national bank under the laws of the United States on May 30, 1864. The Bank, which has fourteen offices along coastal Maine, emphasizes personal service to the communities it serves, concentrating primarily on small businesses and individuals.

The Bank offers a wide variety of traditional banking services and derives the majority of its revenues from net interest income - the spread between what it earns on loans and investments and what it pays for deposits and borrowed funds. While net interest income typically increases as earning assets grow, the spread can vary up or down depending on the level and direction of movements in interest rates. Management believes the Bank has modest exposure to changes in interest rates, as discussed in "Interest Rate Risk Management" elsewhere in Management's Discussion. In addition, the banking business in the Bank's market area historically has been seasonal with lower deposits in the winter and spring and higher deposits in the summer and fall. This seasonal swing is fairly predictable and has not had a materially adverse effect on the Bank.

Non-interest income is the Bank's secondary source of revenue and includes fees and service charges on deposit accounts, fees for processing merchant credit card receipts, income from the sale and servicing of mortgage loans, and income from investment management and private banking services through First Advisors, a division of the Bank.

Critical Accounting Policies

Management's discussion and analysis of the Company's financial condition and results of operations is based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States of America. 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, the valuation of mortgage servicing rights, goodwill and the valuation of stock options. 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 are likely to differ from the amounts derived from Management's estimates and assumptions, and such differences could be substantial.

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. The allowance for loan losses is discussed in more detail in the Assets and Asset Quality section of this report.

The valuation of mortgage servicing rights is a critical accounting policy which requires significant estimates and assumptions. The Bank often sells mortgage loans it originates and retains the ongoing servicing of such loans, receiving a fee for these services, generally 0.25% of the outstanding balance of the loan per annum. Mortgage servicing rights are recognized when they are acquired through the sale of loans, and are reported in other assets. They are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Management uses an independent firm which specializes in the valuation of mortgage servicing rights to determine the fair value which is recorded on the balance sheet. This includes an evaluation for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. The use of different assumptions could produce a different valuation.

The valuation of goodwill is a critical accounting policy. Intangible assets include the excess of the purchase price over the fair value of net assets acquired (goodwill) from the acquisition of FNB Bankshares in 2005 as well as the core deposit intangible related to the same acquisition. The core deposit intangible is amortized on a straight-line basis over ten years. The straight-line basis is used because the Company does not expect significant run off in the core deposits which were acquired. The Company periodically evaluates intangible assets for impairment on the basis of whether these assets are fully recoverable from projected, undiscounted net cash flows of the acquired company.

The value of stock options is a critical accounting policy. The Company established a shareholder-approved stock option plan in 1995, under which the Company may grant options to its employees for up to 600,000 shares of common stock. Only incentive stock options may be granted under the plan. The option price of each option grant is determined by the Options Committee of the Board of Directors, and in no instance shall be less than the fair market value on the date of the grant. An option's maximum term is ten years from the date of grant, with 50% of the options granted vesting two years from the date of grant and the remaining 50% vesting five years from date of grant. As of January 16, 2005, all options under this plan had been granted. The Company applies the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised 2004), "Share-Based Payment", to stock-based employee compensation for fiscal years beginning on or after January 1, 2006.

Companies are required to perform periodic reviews of individual securities in their investment portfolios to determine whether decline in the value of a security is other than temporary. A review of other-than-temporary impairment requires companies to make certain judgments regarding the materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery and the company's intent and ability to hold the security. Pursuant to these requirements, Management assesses valuation declines to determine the extent to which such changes are attributable to fundamental factors specific to the issuer, such as financial condition, business prospects or other factors or market-related factors, such as interest rates. Declines in the fair value of securities below their cost that are deemed to be other than temporary are recorded in earnings as realized losses.

Results of Operations

The First Bancorp posted record earnings of $14.0 million in 2008, despite the weakening economy and recession. Lower interest rates and good asset growth resulted in our net interest margin increasing to 3.33% in 2008 from 3.13% in 2007. This, in turn, led to a $5.9 million or 18.4% increase in net interest income to $37.7 million in 2008 compared to $31.8 million in 2007.

Earning assets grew nearly $100 million in 2008, which Management views as especially good given current economic conditions. The Company's loan portfolio increased $59.1 million during the year, with the majority of this in commercial loans, which are typically the highest earning assets. We also saw modest growth in mortgages, consumer loans and municipal loans. The Company's investment portfolio also posted good growth in 2008, up $40.7 million or 18.4%, with the increase coming in municipal and U.S. Government Agency securities. The asset growth was funded entirely with deposits, which were up $144.5 million or 18.5%. Low-cost deposits increased $10.5 million or 4.2%, while the majority of growth was in certificates of deposit - primarily from wholesale or national market sources - which were up $128.6 million or 31.5%. As a result, borrowed funds declined $44.6 million or 14.1%.

Net Interest Income

Net interest income in 2008 was $37.7 million, an increase of $5.9 million or 18.4% from the $31.8 million posted by the Company in 2007. The primary factor for the increase in net interest income during 2008 compared to 2007 was the $99.3 million or 8.7% growth in earning assets in 2008, with total loans increasing $59.1 million or 6.4% and investments increasing $40.7 million or 18.4%. At the same time, lower interest rates resulted in our net interest margin increasing, which in turn, led to an increase in net interest income.

The following tables present changes in interest income and expense attributable to changes in interest rates, volume, and rate/volume1 for interest-earning assets and interest-bearing liabilities. Tax-exempt income is calculated on a tax-equivalent basis, using a 35.0% tax rate.

Year ended December 31, 2008 compared to 2007

Dollars in thousands           Volume    Rate   Rate/Volume1  Total
Interest on earning assets
Interest-bearing deposits          $ -      $ -          $ 3     $ 3
Investment securities            2,592    (305)         (63)   2,224
Loans held for sale                  6       22           47      75
Loans                            5,338  (7,251)        (632) (2,545)
Total interest income            7,936  (7,534)        (645)   (243)
Interest expense
Deposits                         1,272  (7,688)        (329) (6,745)
Borrowings                       3,688  (2,317)        (842)     529
Total interest expense           4,960 (10,005)      (1,171) (6,216)
Change in net interest income  $ 2,976  $ 2,471        $ 526 $ 5,973

Year ended December 31, 2007 compared to 2006

Dollars in thousands            Volume   Rate   Rate/Volume1  Total
Interest on earning assets
Interest-bearing deposits        $ (64)  $ (64)         $ 64  $ (64)
Investment securities             1,044     482           46   1,572
Loans held for sale                   5      15           31      51
Loans                             4,165   1,761          133   6,059
Total interest income             5,150   2,194          274   7,618
Interest expense
Deposits                          1,067   2,760          114   3,941
Borrowings                        1,897     368           90   2,355
Total interest expense            2,964   3,128          204   6,296
Change in net interest income   $ 2,186 $ (934)         $ 70 $ 1,322

1 Represents the change attributable to a combination of change in rate and change in volume.

The following table presents, for the years ended December 31, 2008, 2007, and 2006, the interest earned on or paid for each major asset and liability category, respectively, the average yield for each major asset and liability category, and the net yield between assets and liabilities. Tax-exempt income has been calculated on a tax-equivalent basis using a 35% rate. Unrecognized interest on non-accrual loans is not included in the amount presented, but the average balance of non-accrual loans is included in the denominator when calculating yields.

                                           2008                 2007                 2006
                                   Amount of  Average   Amount of  Average   Amount of  Average
Dollars in thousands               interest  Yield/Rate interest  Yield/Rate interest  Yield/Rate
Interest on earning assets
Interest-bearing deposits                $ 3      1.65%       $ -      0.00%      $ 64      5.41%
Investment securities                 14,806      6.07%    12,582      5.98%    11,010      5.73%
Loans held for sale                       78      4.05%        53      8.43%        14      6.93%
Loans                                 58,672      6.16%    61,167      7.01%    55,096      6.79%
Total interest-earning assets         73,559      6.14%    73,802      6.81%    66,184      6.58%
Interest-bearing liabilities
Deposits                              23,000      2.90%    29,745      3.93%    25,804      3.55%
Borrowings                            10,669      3.62%    10,140      4.71%     7,785      4.49%
Total interest-bearing liabilities    33,669      3.10%    39,885      4.10%    33,589      3.73%
Net interest income                 $ 39,890             $ 33,917             $ 32,595
Interest rate spread                              3.04%                2.71%                2.85%
Net interest margin                               3.33%                3.13%                3.24%

Tax-exempt interest income amounted to $4.1 million for the year ended December 31, 2008, $3.9 million for the year ended December 31, 2007, and $3.7 million for the year ended December 31, 2006. The following table presents the effect of tax-exempt income on the calculation of the net interest margin, using a 35.0% tax rate in 2008, 2007 and 2006.

                                     For the Years Ended December 31,
Dollars in thousands                   2008        2007        2006
Net interest income as presented        $37,703     $31,836     $30,615
Effect of tax-exempt income               2,187       2,081       1,980
Net interest income, tax equivalent     $39,890     $33,917     $32,595

Non-Interest Income

Non-interest income decreased $0.5 million or 4.9% from $10.1 million in 2007 to $9.6 million in 2008. The decrease in non-interest income was due to lower mortgage origination and servicing income, which decreased by 75.4% and lower investment management and fiduciary income, which decreased by 15.1%. The decrease in mortgage origination and servicing income was due to a $338,000 impairment charge for mortgage-servicing rights.

Non-Interest Expense

Non-interest expense increased $0.8 million or 3.7% in 2008 from $22.2 million in 2007 to $23.0 million in 2008. During 2008, the Company aggressively sought to control operating expense. The Company saw a modest increase in salaries and benefits as well as in other operating expense.

Provision to the Allowance for Loan Losses

The Company's provision to the allowance for loan losses was $4.7 million in 2008 compared to $1.4 million in 2007. The amount of provision made during 2008 and 2007 was to maintain the allowance for loan losses at an adequate level given continued growth in our loan portfolio as well as current deterioration in asset quality. While the weakness in the national economy has not hit coastal Maine as hard as many other parts of the country, the Company has seen an increase in the level of past-due and non-performing loans. Net chargeoffs were $2.7 million in 2008 - with $1.1 million coming from one borrowing relationship
- compared to net chargeoffs of $1.0 million in 2007. As a result, our provision for loan losses was increased by $3.3 million in 2008 compared to 2007. Given the number of economic uncertainties at this time, Management views it prudent to continue to increase the allowance for loan losses. A further discussion of asset and credit quality can be found in "Assets and Asset Quality".

Net Income

Net income for 2008 was $14.0 million - a 7.1% or $0.9 million increase from net income of $13.1 million that was posted in 2007. Earnings per share on a fully diluted basis were $1.44, up $0.10 or 7.5% from the $1.34 reported for the year ended December 31, 2007. Higher net interest income was the primary factor for the increase in net income.

Key Ratios

Return on average assets in 2008 was 1.10%, down from the 1.13% posted in 2007. Return on average tangible equity was 15.75% in 2008, compared to 15.89% in 2007 and 15.75% in 2006, while return on average equity was 12.02% in 2008, compared to 11.89% in 2007 and 11.63% in 2006. The substantial difference between return on average tangible equity and average equity is due to the addition of goodwill related to acquisitions. In 2008, the Company's dividend payout ratio (dividends declared divided by net income) was 52.76%, compared to 51.49% in 2007 and 48.8% in 2006.

The Company's efficiency ratio - a benchmark measure of the amount spent to generate a dollar of income - was 46.07% in 2008 compared to 64.72% for the Bank's peer group, on average. In 2007, the Bank's efficiency ratio was 50.16% compared to 59.47% for the Bank's peer group, on average. The improvement in 2008 was the result of the growth in net interest income while controlling operating expenses. The efficiency ratio is calculated by dividing the Company's operating expenses (which excludes the provision for loan losses) by the total of net interest income on a tax-equivalent basis before provision for loan losses and other operating income (which excludes securities gains).

Investment Management and Fiduciary Activities

As of December 31, 2008, First Advisors, the Bank's private banking and investment management division, had assets under management with a market value of $223.8 million, consisting of 1,015 trust accounts, estate accounts, agency accounts, and self-directed individual retirement accounts. This compares to December 31, 2007, when 1,020 accounts with a market value of $261.0 million were under management. The decline in market value was due to decline in equity markets that impacted the value of assets under management.

Assets and Asset Quality

Asset growth was strong in 2008, with the loan portfolio increasing by $59.1 million or 6.4%, while the investment portfolio increased $40.7 million or 18.4% over December 31, 2007. Total assets increased by 8.4% or $102.5 million from $1.22 billion at December 31, 2007, to $1.33 billion at December 31, 2008. This increase in earning assets contributed to net interest income increasing $5.9 million or 18.4% during 2008 when compared to 2007.

While the weaknesses in the national and global economies have not impacted coastal Maine as much as other parts of the country, we nevertheless experienced a deterioration in asset quality in our loan portfolio. Non-performing assets to total assets stood at 1.31% at December 31, 2008, a significant increase over 0.56% at December 31, 2007. This increase is attributable to the impact that the weakened economy is having on our borrowers. Small businesses are seeing revenue/sales decreases and some are struggling to meet their obligations with a declining revenue base. A number of consumers have lost their jobs or seen a reduction in hours worked and/or overtime, thereby creating strained finances resulting in payment issues on their loans. In Management's opinion, the Company's long-standing approach to working with borrowers and ethical loan underwriting standards helps alleviate some of the payment problems on customers' loans and in the end minimizes actual loan losses.

Net charge offs in 2008 were $2.7 million compared to $1.0 million in 2007, with $1.1 million of the loan losses in 2008 coming from one borrowing relationship. This $2.7 million in net losses is 0.28% of average outstanding loans in 2008, which is relatively low compared to most banks across the country but higher than our results for the past 20 years with average chargeoffs of 0.22% per year. We manage our loan portfolio to minimize losses and have shown an excellent track record. The last time loan losses were at this level was during the late 1980s and early 1990s. Without the $1.1 million attributable to the one relationship, the loss ratio would have been 0.17%, which is in line with our ten-year historical average.

Residential real estate loans represent 46.6% of the total loan portfolio, and this loan category has a low level of losses in comparison to other loan types. In 2008, the loss ratio for residential mortgages was 0.04% compared to 0.28% for the entire loan portfolio. We have not written subprime mortgages or "no documentation loans" - the type of loans that are currently defaulting on a large scale nationwide. The Company does not have a credit card portfolio or offer dealer consumer loans which generally carry more risk and therefore higher losses.

The allowance for loan losses ended the year at $8.8 million and stood at 0.90% of total loans outstanding. A $4.7 million provision was made to the allowance for loan losses in 2008, resulting in a $2.0 million net increase in the allowance after $2.7 million in net chargeoffs. With a weakening economy and an increase in the level of non-performing loans, we felt it prudent to add to the reserve. Given all of the above factors management feels comfortable with the $8.8 million level as of December 31, 2008.

Investment Activities

During 2008, the investment portfolio increased 18.4% to end the year at $262.5 million, compared to $221.8 million on December 31, 2007. The Company's investment securities are classified into two categories: securities available for sale and securities to be held to maturity. Securities available for sale consist primarily of debt securities which Management intends to hold for indefinite periods of time. They may be used as part of the Company's funds management strategy, and may be sold in response to changes in interest rates, prepayment risk and liquidity needs, to increase capital ratios, or for other similar reasons. Securities to be held to maturity consist primarily of debt securities that the Company has acquired solely for long-term investment purposes, rather than for trading or future sale. For securities to be categorized as held to maturity, Management must have the intent and the Company must have the ability to hold such investments until their respective maturity dates. The Company does not hold trading account securities.

All investment securities are managed in accordance with a written investment policy adopted by the Board of Directors. It is the Company's general policy that investments for either portfolio be limited to government debt obligations, time deposits, banker's acceptances, corporate bonds and commercial paper with one of the three highest ratings given by a nationally recognized rating agency. The portfolio is primarily in U.S. Government agency securities and tax-exempt obligations of states and political subdivisions. The individual securities have been selected to enhance the portfolio's overall yield while not materially adding to the Company's level of interest rate risk. The following table sets forth the Company's investment securities at their carrying amounts as of December 31, 2008, 2007, and 2006.

Dollars in thousands                   2008      2007      2006
Securities available for sale
U.S. Treasury and agency                $ -       $ -   $ 4,967
Mortgage-backed securities              922     1,322     1,571
State and political subdivisions      8,910    10,855    11,073
Corporate securities                  2,977    14,727    18,349
Federal Home Loan Bank stock         14,031    12,569     7,586
Federal Reserve Bank stock              662       662       662
Other equity securities                 263       326       607
                                   $ 27,765  $ 40,461  $ 44,815
Securities to be held to maturity
U.S. Treasury and agency          $ 110,513  $ 95,009  $ 46,192
Mortgage-backed securities           60,774    30,786    33,379
State and political subdivisions     62,330    53,914    47,549
Corporate securities                  1,150     1,645     8,614
                                    234,767   181,354   135,734
Total securities                  $ 262,532 $ 221,815 $ 180,549

The following table sets forth certain information regarding the yields and expected maturities of the Company's investment securities as of December 31, 2008. Yields on tax-exempt securities have been computed on a tax-equivalent basis using a tax rate of 35%. Mortgage-backed securities are presented according to their final contractual maturity date, while the calculated yield takes into effect the intermediate cashflows from repayment of principal which results in a much shorter average life.

                                 Available For Sale         Held to Maturity
                                  Fair      Yield to                   Yield to
Dollars in thousands              Value     maturity   Amortized Cost  maturity
U.S. Treasury & Agency
Due in 1 year or less                  $ -       0.00%            $ -       0.00%
Due in 1 to 5 years                      -       0.00%              -       0.00%
Due in 5 to 10 years                     -       0.00%          5,000       5.00%
Due after 10 years                       -       0.00%        105,513       6.42%
Total                                    -       0.00%        110,513       6.35%
Mortgage-Backed Securities
Due in 1 year or less                    -       0.00%              -       0.00%
Due in 1 to 5 years                    165       1.61%          2,612       3.92%
Due in 5 to 10 years                    86       7.00%          1,857       5.09%
Due after 10 years                     671       3.04%         56,305       5.66%
Total                                  922       3.15%         60,774       5.57%
State & Political Subdivisions
Due in 1 year or less                    -       0.00%            785       8.50%
Due in 1 to 5 years                  2,834       6.97%          4,598       6.73%
Due in 5 to 10 years                 6,076       7.47%         13,999       6.60%
Due after 10 years                       -       0.00%         42,948       6.43%
Total                                8,910       7.31%         62,330       6.52%
Corporate Securities
Due in 1 year or less                  935       7.71%            150       1.50%
Due in 1 to 5 years                  1,409       7.50%              -       0.00%
Due in 5 to 10 years                     -       0.00%          1,000       5.12%
Due after 10 years                     633       4.60%              -       0.00%
Total                                2,977       6.95%          1,150       4.65%
Equity Securities                   14,956       5.95%
                                   $27,765       6.40%       $234,767       6.19%

During 2008, the Company sold the majority of the corporate debt securities in the investment portfolio in order to reduce the level of credit risk in the portfolio. As a result, a net security loss of $58,000 was recorded, net of taxes.

As of December 31, 2008, corporate debt securities which were rated below investment grade totaled $2.4 million, with an estimated fair value of $1.4 million. Management has evaluated these securities for other-than-temporary impairment, and in the Company's opinion, none of these holdings warranted other-than-temporary classification as of December 31, 2008. Management considered several factors in making this determination, including:

• All three companies were current on their interest payments to bondholders.

• The securities are issued by auto-related companies: the U.S. Government and President Obama have publicly stated the importance of helping the U.S. auto industry and preserving jobs.

• The Company has the both the intent and the ability to continue to hold these securities.

• The securities are in the available-for-sale portfolio, and the decline in market value is recognized on the Company's balance sheets as an unrealized loss to equity in accordance with SFAS 115.

Lending Activities

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