4c535cc197c6438

ITEM 1. Financial Statements

Merchants Bancshares, Inc.

Consolidated Balance Sheets

(unaudited)



	September 30,		December 31,
(In thousands except share and per share data)	2012		2011
ASSETS
Cash and due from banks	$	30,097	$	10,392
Interest earning deposits with banks and other short-term investments		22,935		27,420
Total cash and cash equivalents		53,032		37,812
Investments:
Securities available for sale, at fair value		526,257		511,751
Securities held to maturity (fair value of $498 and $624)		443		558
Total investments		526,700		512,309
Loans		1,072,879		1,027,626
Less: Allowance for loan losses		11,444		10,619
Net loans		1,061,435		1,017,007
Federal Home Loan Bank stock		8,145		8,630
Bank premises and equipment, net		15,221		14,232
Investment in real estate limited partnerships		5,338		5,189
Other assets		15,965		16,690
Total assets	$	1,685,836	$	1,611,869
LIABILITIES
Deposits:
Demand (noninterest bearing)	$	227,879	$	197,522
Savings, interest bearing checking and money market accounts		687,267		632,110
Time deposits $100 thousand and greater		126,095		127,303
Other time deposits		211,722		220,945
Total deposits		1,252,963		1,177,880
Short-term borrowings		55,600		0
Securities sold under agreements to repurchase		227,996		262,527
Other long-term debt		2,503		22,562
Junior subordinated debentures issued to unconsolidated subsidiary trust		20,619		20,619
Other liabilities		8,126		18,744
Total liabilities		1,567,807		1,502,332
Commitments and contingencies (Note 8)
SHAREHOLDERS' EQUITY
Preferred stock
Class A non-voting shares authorized - 200,000, none outstanding		0		0
Class B voting shares authorized - 1,500,000, none outstanding		0		0
Common stock, $.01 par value		67		67
Authorized 10,000,000 shares; issued 6,651,760 at September 30, 2012 and December 31, 2011
Outstanding: 5,955,111 at September 30, 2012 and 5,907,080 at December 31, 2011
Capital in excess of par value		36,700		36,544
Retained earnings		85,497		79,393
Treasury stock, at cost: 696,649 shares at September 30, 2012 and 744,680 shares at December 31, 2011		(14,837)		(15,817)
Deferred compensation arrangements		6,232		6,248
Accumulated other comprehensive income		4,370		3,102
Total shareholders' equity		118,029		109,537
Total liabilities and shareholders' equity	$	1,685,836	$	1,611,869

See accompanying notes to interim unaudited consolidated financial statements

Merchants Bancshares, Inc.

Consolidated Statements of Income

(Unaudited)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands except per share data)	2012		2011		2012		2011
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$	11,278	$	11,641	$	33,860	$	33,830
Investment income:
Interest and dividends on investment securities		2,942		3,187		9,005		9,717
Interest on interest earning deposits with banks and other short-term investments		9		37		29		81
Total interest and dividend income		14,229		14,865		42,894		43,628
INTEREST EXPENSE
Savings, interest bearing checking and money market accounts		176		298		603		914
Time deposits $100 thousand and greater		271		288		852		896
Other time deposits		413		525		1,293		1,634
Securities sold under agreement to repurchase and other short-term debt		341		518		1,454		1,682
Long-term debt		364		492		1,253		1,513
Total interest expense		1,565		2,121		5,455		6,639
Net interest income		12,664		12,744		37,439		36,989
Provision for credit losses		250		250		700		500
Net interest income after provision for credit losses		12,414		12,494		36,739		36,489
NONINTEREST INCOME
Changes in fair value on impaired securities		0		(10)		0		(20)
Non-credit related (gain) losses on securities not expected to be sold (recognized in other comprehensive income)		0		10		0		20
Net impairment losses		0		0		0		0
Net (losses) gains on investment securities		(26)		920		422		1,047
Trust division income		670		639		2,000		1,894
Service charges on deposits		1,033		1,161		3,001		3,195
Equity in losses of real estate limited partnerships		(370)		(441)		(1,189)		(1,324)
Gain on sale of other assets		749		0		1,083		0
Other		1,143		1,133		3,406		3,253
Total noninterest income		3,199		3,412		8,723		8,065
NONINTEREST EXPENSE
Compensation and benefits		4,809		5,251		14,756		15,544
Occupancy expense		946		935		2,843		2,927
Equipment expense		891		848		2,684		2,450
Legal and professional fees		677		721		1,954		2,098
Marketing		360		475		1,264		1,259
State franchise taxes		321		321		965		951
FDIC insurance		217		194		644		740
Prepayment penalty on long-term debt		677		861		1,363		861
Other Real Estate Owned ("OREO") expenses		65		47		129		128
Other		1,486		1,392		4,595		4,404
Total noninterest expense		10,449		11,045		31,197		31,362
Income before provision for income taxes		5,164		4,861		14,265		13,192
Provision for income taxes		1,159		680		2,911		2,281
NET INCOME	$	4,005	$	4,181	$	11,354	$	10,911

Basic earnings per common share	$	0.64	$	0.67	$	1.82	$	1.76
Diluted earnings per common share	$	0.64	$	0.67	$	1.81	$	1.76

See accompanying notes to interim unaudited consolidated financial statements

Merchants Bancshares, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands)	2012		2011		2012		2011
Net income	$	4,005	$	4,181	$	11,354	$	10,911
Other comprehensive (loss) income, net of tax:
Change in net unrealized (loss) gain on securities available for sale, net of taxes of $564, $674, $682 and $1,543		1,047		1,251		1,266		2,865
Reclassification adjustments for net securities gain included in net income, net of taxes of $9, $(322), $(148) and $(367)		17		(598)		(274)		(681)
Change in net unrealized loss on interest rate swaps, net of taxes of $19, $(113), $63 and $(110)		35		(209)		117		(204)
Pension liability adjustment, net of taxes of $29, $25, $86 and $74		53		46		159		137
Other comprehensive income		1,152		490		1,268		2,117
Comprehensive income	$	5,157	$	4,671	$	12,622	$	13,028

See accompanying notes to unaudited interim consolidated financial statements

Merchants Bancshares, Inc.

Consolidated Statements of Cash Flows

(Unaudited)



	Nine Months Ended Sept 30,
(In thousands)	2012		2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	11,354	$	10,911
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		700		500
Depreciation and amortization		1,464		1,396
Amortization of investment security premiums and accretion of discounts, net		1,794		3,185
Stock option expense		127		128
Net gains on sales of investment securities		(422)		(1,047)
Net gains on sale of loans		0		(28)
Net (gains) losses on sale of premises, equipment and other assets		(1,083)		16
Gains on sale of other real estate owned		(7)		(33)
Equity in losses of real estate limited partnerships, net		1,189		1,324
Changes in assets and liabilities:
Increase in interest receivable		545		274
Increase in other assets		(870)		(2,794)
Increase (decrease) in interest payable		2,345		(91)
(Decrease) increase in other liabilities		(12,440)		9,636
Net cash provided by operating activities		4,696		23,377
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment securities available for sale		64,336		132,025
Proceeds from maturities of investment securities available for sale		146,762		146,328
Proceeds from maturities of investment securities held to maturity		115		192
Proceeds from redemption of Federal Home Loan Bank stock		485		0
Purchases of investment securities available for sale		(225,450)		(229,110)
Loan originations in excess of principal payments		(45,366)		(97,839)
Proceeds from sales of loans, net		0		80
Proceeds from sale of other assets		334		0
Proceeds from sale of premises and equipment		788		51
Proceeds from sales of other real estate owned		505		224
Real estate limited partnership investments		(1,299)		(1,310)
Purchases of bank premises and equipment		(2,522)		(1,173)
Net cash used in investing activities		(61,312)		(50,532)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		75,083		73,363
Net increase in short-term borrowings		55,600		49
Net decrease in securities sold under agreement to repurchase, short-term		(34,531)		(9,855)
Principal payments on long-term debt		(20,059)		(8,558)
Cash dividends paid		(4,730)		(4,652)
Sale of treasury stock		15		12
Increase in deferred compensation arrangements		160		153
Proceeds from exercise of stock options, net of withholding taxes		278		0
Tax benefit from exercise of stock options		20		0
Net cash provided by financing activities		71,836		50,512
Increase in cash and cash equivalents		15,220		23,357
Cash and cash equivalents beginning of period		37,812		74,026
Cash and cash equivalents end of period	$	53,032	$	97,383

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Total interest payments	$	3,110	$	6,730
Total income tax payments		4,350		850
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Distribution of stock under deferred compensation arrangements	$	391	$	432
Distribution of treasury stock in lieu of cash dividend		518		517
Transfer of loans to other real estate owned		140		340
(Decrease) increase in payable for investments purchased		(9,461)		10,056

See accompanying notes to unaudited interim consolidated financial statements

Notes To Interim Unaudited Consolidated Financial Statements

For additional information, see the Merchants Bancshares, Inc. (“Merchants,” “we,” “us,” “our”) Annual Report on Form 10-K for the fiscal year ended December 31, 2011, filed with the Securities and Exchange Commission (the “SEC”) on March 8, 2012.

Note 1: Financial Statement Presentation

Principles of Consolidation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. All adjustments necessary for a fair presentation of our interim consolidated financial statements as of September 30, 2012 and December 31, 2011 and for the three and nine months ended September 30, 2012 and 2011 have been included. The information was prepared from our unaudited financial statements and the unaudited financial statements of our subsidiaries, Merchants Bank and MBVT Statutory Trust I. Amounts reported for prior periods are reclassified, where necessary, to be consistent with the current period presentation.

Management’s Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us 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 income and expenses during the reporting periods. The most significant estimates include those used in determining the allowance for loan losses, income taxes, interest income recognition on loans and investments and analysis of other-than-temporary impairment of investment securities. Operating results in the future may vary from the amounts derived from our estimates and assumptions.

Note 2: Recent Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The amendments in this ASU affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. We do not expect that this update will have a material impact on our financial condition or results of operations.

In August 2012, the FASB issued ASU 2012-03, “Technical Amendments and Corrections to SEC Sections – Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22.” The amendments in ASU 2012-03 that have no transition guidance are effective immediately for public and private entities. Amendments that are subject to transition guidance will be effective for public companies for fiscal periods beginning after December 15, 2012, and for nonpublic entities for fiscal periods beginning after December 15, 2013. We do not expect that this update will have a material impact on our financial condition or results of operations.

Note 3: Investment Securities

Investments in securities are classified as available for sale or held to maturity as of September 30, 2012. The amortized cost and fair values of the securities classified as available for sale and held to maturity as of September 30, 2012 are as follows:



			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(In thousands)	Cost		Gains		Losses		Value
Available for Sale:
U.S. Treasury Obligations	$	100	$	0	$	0	$	100
U.S. Agency Obligations		53,392		841		0		54,233
Federal Home Loan Bank ("FHLB") Obligations		4,563		55		0		4,618
Residential Real Estate Mortgage-backed Securities ("Agency MBSs")		175,353		8,351		0		183,704
Collateralized Mortgage Backed Securities ("Agency CMBSs")		5,090		0		66		5,024
Agency Collateralized Mortgage Obligations ("Agency CMOs")		270,792		2,825		198		273,419
Non-agency Collateralized Mortgage Obligations ("Non-agency CMOs")		4,749		9		20		4,738
Asset Backed Securities ("ABSs")		357		64		0		421
Total Available for Sale	$	514,396	$	12,145	$	284	$	526,257
Held to Maturity:
Agency MBSs	$	443	$	55	$	0	$	498
Total Held to Maturity	$	443	$	55	$	0	$	498

The amortized cost and fair values of the securities classified as available for sale and held to maturity as of December 31, 2011 are as follows:



			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(In thousands)	Cost		Gains		Losses		Value
Available for Sale:
U.S. Treasury Obligations	$	250	$	0	$	0	$	250
U.S. Agency Obligations		89,597		828		6		90,419
FHLB Obligations		16,545		134		3		16,676
Agency MBSs		176,756		7,100		18		183,838
Agency CMOs		211,749		2,976		245		214,480
Non-agency CMOs		5,346		2		493		4,855
ABSs		1,172		61		0		1,233
Total Available for Sale	$	501,415	$	11,101	$	765	$	511,751
Held to Maturity:
Agency MBSs	$	558	$	66	$	0	$	624
Total Held to Maturity	$	558	$	66	$	0	$	624

The contractual final maturity distribution of the debt securities classified as available for sale and held to maturity as of September 30, 2012 are as follows:



			After One		After Five
	Within		But Within		But Within		After Ten
(In thousands)	One Year		Five Years		Ten Years		Years		Total
Available for Sale (at fair value):
U.S. Treasury Obligations	$	0	$	100	$	0	$	0	$	100
U.S. Agency Obligations		0		10,056		44,177		0		54,233
FHLB Obligations		0		0		4,618		0		4,618
Agency MBSs		398		3,573		28,335		151,398		183,704
Agency CMBs		0		0		5,024		0		5,024
Agency CMOs		0		11		5,752		267,656		273,419
Non-agency CMOs		0		0		0		4,738		4,738
ABSs		0		0		0		421		421
Total Available for Sale	$	398	$	13,740	$	87,906	$	424,213	$	526,257
Held to Maturity (at amortized cost):
Agency MBSs	$	16	$	84	$	0	$	343	$	443
Total Held to Maturity	$	16	$	84	$	0	$	343	$	443

The contractual final maturity distribution of the debt securities classified as available for sale and held to maturity as of December 31, 2011, are as follows:



			After One		After Five
	Within		But Within		But Within		After Ten
(In thousands)	One Year		Five Years		Ten Years		Years		Total
Available for Sale (at fair value):
U.S. Treasury Obligations	$	250	$	0	$	0	$	0	$	250
U.S. Agency Obligations		3,023		12,567		69,823		5,006		90,419
FHLB Obligations		3,389		0		13,287		0		16,676
Agency MBSs		20		6,118		32,897		144,803		183,838
Agency CMOs		0		0		3,056		211,424		214,480
Non-agency CMOs		0		0		50		4,805		4,855
ABSs		0		0		0		1,233		1,233
Total Available for Sale	$	6,682	$	18,685	$	119,113	$	367,271	$	511,751
Held to Maturity (at amortized cost):
Agency MBSs	$	0	$	158	$	0	$	400	$	558
Total Held to Maturity	$	0	$	158	$	0	$	400	$	558

Actual maturities will differ from contractual maturities because borrowers may have rights to call or prepay obligations. Maturities of Agency MBSs and Agency CMOs are based on final contractual maturities.

Proceeds from sales of available for sale debt securities were $22.67 million and $64.34 million for the three and nine months ended September 30, 2012, respectively. Gross gains of $36 thousand and $530 thousand and gross losses of $62 thousand and $108 thousand were realized from these sales for the three and nine months ended September 30, 2012. Proceeds from sales of available for sale debt securities were $54.99 million and $132.02 million during the three and nine months ended September 30, 2011, respectively. Gross gains of $970 thousand and $1.19 million and gross losses of $50 thousand and $141 thousand were realized from these sales during the three and nine months ended September 30, 2011, respectively.

Gross unrealized losses on investment securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2012 and December 31, 2011, were as follows:



	Less than 12 months				12 months or more				Total
(In thousands)	Fair Value		Loss		Fair Value		Loss			Fair Value	Loss
As of September 30, 2012
Agency CMBSs	$	5,024	$	66	$	0	$	0	$	5,024	$	66
Agency CMOs		34,511		198		0		0		34,511		198
Non-agency CMOs		0		0		3,126		20		3,126		20
	$	39,535	$	264	$	3,126	$	20	$	42,661	$	284



	Less than 12 months				12 months or more				Total
(In thousands)	Fair Value		Loss		Fair Value		Loss		Fair Value		Loss
As of December 31, 2011
U.S. Agency Obligations	$	2,536	$	6	$	0	$	0	$	2,536	$	6
FHLB Obligations		5,047		3		0		0		5,047		3
Agency MBSs		10,452		18		0		0		10,452		18
Agency CMOs		43,708		205		2,861		40		46,569		245
Non-agency CMOs		0		0		4,805		493		4,805		493
	$	61,743	$	232	$	7,666	$	533	$	69,409	$	765

There were no securities held to maturity with unrealized losses as of September 30, 2012 and December 31, 2011.

Unrealized losses on investment securities result from the cost basis of the security being higher than its current fair value. These discrepancies generally occur because of changes in interest rates since the time of purchase, or because the credit quality of the issuer has deteriorated. We perform a quarterly analysis of each security in our portfolio to determine if impairment exists, and if it does, whether that impairment is other-than-temporary.

Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), or the Government National Mortgage Association (“GNMA”) with various origination dates and maturities. Non-Agency CMOs are tracked individually and their performance is tracked at least quarterly.

We use an external pricing service to obtain fair market values for our investment portfolio. We have obtained and reviewed the service provider’s pricing and reference data document. Evaluations are based on market data and vary by asset class and incorporate available trade, bid and other market information. Because many fixed income securities do not trade on a daily basis, the service provider’s evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, model processes, such as the Option Adjusted Spread model are used to assess interest rate impact and develop prepayment scenarios. We test the values provided to us by the pricing service through a combination of back testing on actual sales of securities and by obtaining prices on all bonds from an alternative pricing source.

Our investment portfolio consists almost entirely of U.S. Treasury and Agency obligations, or Agency-guaranteed mortgage securities. We have two non-agency CMOs with a current cost basis of $4.75 million. Management, with the help of outside experts, has performed impairment analyses on these bonds.

One of the non-Agency CMOs, with a cost basis of $3.15 million and a fair value of $3.13 million at September 30, 2012, is rated BBB by Fitch and Ba3 by Moody’s. Delinquencies have been fairly low and prepayments on the bond have led to increased credit support. We own a senior tranche in this bond. Although losses are expected in the bond overall, our position in the structure of the bond is expected to protect us from realizing losses. The second bond has a cost basis of $1.60 million and a fair value of $1.61 million. This bond is rated CCC by Fitch and S&P. We own a super senior tranche in this bond. Although losses are expected in the bond overall, our super senior position in the structure is expected to protect us from realizing a material loss.

We do not intend to sell the investment securities that are in an unrealized loss position, and it is unlikely that we will be required to sell the investment securities before recovery of their amortized cost bases, which may be maturity.

As a member of the FHLB system, we are required to invest in stock of the FHLB of Boston (the “FHLBB”) in an amount determined based on our borrowings from the FHLBB. At September 30, 2012, our investment in FHLBB stock totaled $8.15 million, a decrease of $485 thousand from our year end balance of $8.63 million. We received dividend income totaling $11 thousand and $36 thousand during the three and nine months ended September 30, 2012, respectively. We received $6 thousand and $19 thousand for the three

and nine months ended September 30, 2011, respectively.

Note 4: Loans and the Allowance for Credit Losses

Loans

We primarily originate residential real estate, commercial, commercial real estate, municipal obligations and installment loans to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Loans totaled $1.07 billion at September 30, 2012 and $1.03 billion at December 31, 2011. At September 30, 2012 and December 31, 2011, total loans included $(192) thousand and $11 thousand, respectively, of net deferred loan origination fees (costs). The aggregate amount of overdrawn deposit balances classified as loan balances was $334 thousand and $399 thousand at September 30, 2012 and December 31, 2011, respectively.

Allowance for Credit Losses

We have divided the loan portfolio into portfolio segments, each with different risk characteristics and methodologies for assessing risk. Each portfolio segment is broken down into class segments where appropriate. Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan and lease losses. Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class segment. A description of the segments follows:

Commercial, financial and agricultural: We offer a variety of loan options to meet the specific needs of commercial customers including term loans and lines of credit. Such loans are made available to businesses to finance inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment, receivables, inventory or other assets owned by the borrower. These loans require different monitoring than commercial real estate loans because of the nature of the underlying collateral, and the fact that collateral values may change daily. Management generally employs enhanced monitoring requirements, obtains personal guarantees and, where appropriate, may also attempt to secure real estate as collateral.

Municipal: Municipal loans consist of short and long term loans issued on a taxable and tax-exempt basis which are general obligations of the municipality. These loans are generally viewed as lower risk as municipalities have taxing power to meet their financial obligations. Included in municipal loans are longer term loans under the federal Qualified School Construction Bond program. Proceeds are used for the construction, rehabilitation or repair of public school properties and we receive a federal tax credit in lieu of interest income on these loans.

Real Estate – Residential: Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. We originate adjustable-rate and fixed-rate, one- to four-family residential real estate loans for the construction, purchase or refinancing of a mortgage. These loans are collateralized by owner-occupied properties located in our market area. Loans on one- to four-family residential real estate are generally originated in amounts of no more than 80 percent of the purchase price or appraised value (whichever is lower). Mortgage title insurance and hazard insurance are required.

Real Estate – Commercial: We offer commercial real estate loans to finance real estate purchases and refinancing of existing commercial properties. These commercial real estate loans are secured by first liens on the real estate, which may include both owner occupied and non owner occupied facilities. The types of facilities financed include apartments, hotels, warehouses, retail facilities, manufacturing facilities and office buildings.

Real Estate – Construction: We offer construction loans for the construction, expansion and improvement of residential and commercial properties which are secured by the real estate being developed. A review of all plans and budgets is performed prior to approval, third party progress documents are usually required during construction, and an independent approval process for all draw and release requests is maintained to ensure that funding is prudently administered and that funds are sufficient to complete the project.

Installment - We offer traditional direct consumer installment loans for various personal needs, including vehicle financing. The vast majority of these loans are secured by a lien on the purchased vehicle and are underwritten using credit scores and income verification. We do not provide any indirect consumer lending activities.

For purposes of evaluating the adequacy of the allowance for credit losses, we consider a number of significant factors that affect the collectability of the portfolio. For individually evaluated loans, these include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans and leases, estimates of our exposure to credit loss reflect a current assessment of a number of factors, which could affect collectability. These factors include: past loss experience; size, trend, composition, and nature of loans; changes in lending policies and procedures, including underwriting standards and collection, charge-offs and recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in our market; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff. Qualitative factors used in the evaluation of the adequacy of the allowance are reviewed and updated on a quarterly basis, these factors directly impact the allocation of the allowance.

Past loss experience is based on net loan losses as a percentage of portfolio balances, using a five year weighted average. An external loan review firm and various regulatory agencies periodically review our allowance for credit losses.

After a thorough consideration of the factors discussed above, any required additions to the allowance for credit losses are made periodically by charges to the provision for credit losses. These charges are necessary to maintain the allowance for credit losses at a level which Management believes is reasonable for the overall inherent risk of probable loss in the portfolio. While Management uses available information to recognize losses on loans, additions may fluctuate from one reporting period to another. These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in Management’s assessment of any or all of the determining factors discussed above.

The following table reflects our loan loss experience and activity in the allowance for credit losses for the three months ended September 30, 2012:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	3,102	$	410	$	3,476	$	4,557	$	233	$	21	$	18	$	11,817
Charge-offs		0		0		0		0		0		0		0		0
Recoveries		3		0		1		1		8		0		0		13
Provision (credit)		136		31		85		3		(10)		(2)		7		250
Ending balance	$	3,241	$	441	$	3,562	$	4,561	$	231	$	19	$	25	$	12,080

The following table reflects our loan loss experience and activity in the allowance for credit losses for the nine months ended September 30, 2012, and our loan portfolio as of September 30, 2012:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	2,905	$	309	$	3,138	$	4,484	$	477	$	23	$	17	$	11,353
Charge-offs		(9)		0		(20)		0		0		0		0		(29)
Recoveries		21		0		13		1		21		0		0		56
Provision (credit)		324		132		431		76		(267)		(4)		8		700
Ending balance	$	3,241	$	441	$	3,562	$	4,561	$	231	$	19	$	25	$	12,080
Ending balance individually
evaluated for impairment	$	4	$	0	$	270	$	60	$	0	$	0	$	0	$	334
Ending balance collectively
evaluated for impairment		3,237		441		3,292		4,501		231		19		25		11,746
Totals	$	3,241	$	441	$	3,562	$	4,561	$	231	$	19	$	25	$	12,080
Financing receivables:
Ending balance individually
evaluated for impairment	$	20	$	0	$	2,132	$	581	$	0	$	7	$	0	$	2,740
Ending balance collectively
evaluated for impairment		169,430		82,048		475,189		326,601		11,285		5,252		334		1,070,139
Totals	$	169,450	$	82,048	$	477,321	$	327,182	$	11,285	$	5,259	$	334	$	1,072,879
Components:
Allowance for loan losses	$	2,795	$	435	$	3,472	$	4,502	$	196	$	19	$	25	$	11,444
Reserve for undisbursed
lines of credit		446		6		90		59		35		0		0		636
Total allowance for credit
losses	$	3,241	$	441	$	3,562	$	4,561	$	231	$	19	$	25	$	12,080

The following table reflects our loan loss experience and activity in the allowance for credit losses for the three months ended September 30, 2011:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	3,122	$	115	$	2,563	$	4,856	$	193	$	25	$	27	$	10,901
Charge-offs		(2)		0		(14)		0		(85)		(2)		0		(103)
Recoveries		32		0		2		0		7		0		0		41
Provision (credit)		(274)		182		678		(507)		175		0		(4)		250
Ending balance	$	2,878	$	297	$	3,229	$	4,349	$	290	$	23	$	23	$	11,089

The following table reflects our loan loss experience and activity in the allowance for credit losses for the nine months ended September 30, 2011, and our loan portfolio as of September 30, 2011:


For the transition period from			to

Commission File Number: 0-11595

Merchants Bancshares, Inc.
(Exact name of registrant as specified in its charter)

Delaware			03-0287342
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

275 Kennedy Drive, South Burlington, VT			05403
(Address of principal executive offices)			(Zip Code)

802-658-3400
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements

	Consolidated Balance Sheets (Unaudited)
	As of September 30, 2012 and December 31, 2011	3

	Consolidated Statements of Income (Unaudited)
	Three and nine months ended September 30, 2012 and 2011	4

	Consolidated Statements of Comprehensive Income (Unaudited)
	Three and nine months ended September 30, 2012 and 2011	5

	Consolidated Statements of Cash Flows (Unaudited)
	Three and nine months ended September 30, 2012 and 2011	6

	Notes to Interim Unaudited Consolidated Financial Statements	8

Item 2.	Management's Discussion and Analysis of Financial
	Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41
Item 4.	Controls and Procedures	43

PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3.	Defaults upon Senior Securities	44
Item 4.	Mine Safety Disclosure	44
Item 5.	Other Information	44
Item 6.	Exhibits	44
	Signatures	45
	Exhibits