NOTE 12: STOCK-BASED COMPENSATION PLANS

Merchants has established stock based compensation plans for directors and for certain employees. The Amended and Restated Merchants Bancshares, Inc. 2008 Stock Incentive Plan (the “Plan”) allows us to grant stock options and restricted stock grants to certain employees. The Plan allows for the issuance of up to 600,000 shares of stock. As of December 31, 2012, there were 461,310 shares that remain available for future grants under the Plan. The Merchants Bancshares, Inc. and Subsidiaries Amended and Restated 2008 Compensation Plan for Non-Employee Directors and Trustees allows us to issue up to 150,000 shares of stock. As of December 31, 2012 there were 113,878 shares that remain available for future issuance under the Plan.

The fair value of stock option and restricted stock awards, measured at the grant date are amortized to compensation expense on a straight-line basis over the vesting period. The total compensation cost related to stock option awards and restricted stock awards was $172 thousand, $164 thousand and $101 thousand for 2012, 2011 and 2010, respectively. There were no restricted stock awards prior to 2011. Compensation cost related to stock option and restricted stock awards is included in salary expense in the accompanying consolidated statements of income. Remaining compensation expense relating to current outstanding stock option grants is $27 thousand. Remaining compensation expense related to current outstanding restricted stock awards is $228 thousand.

Deferred Compensation Plans for Non-Employee Directors

Merchants has established deferred compensation plans for non-employee directors. Under the terms of these plans participating directors can elect to have all, or a specified percentage, of their director’s fees for a given year paid in the form of cash or deferred in the form of restricted shares of Merchants’ common stock. These shares are held in a rabbi trust and are considered outstanding for purposes of computing earnings per share. Directors who elect to have their compensation deferred are credited with a number of shares of Merchants’ common stock equal in value to the amount of fees deferred. The participating director may not sell, transfer or otherwise dispose of these shares prior to distribution. With respect to shares of common stock issued or otherwise transferred to a participating director, the participating director will have the right to receive dividends or other distributions thereon. Deferred director’s fees are recognized as an expense in the year incurred.

Restricted Stock

Restricted stock provides grantees with rights to shares of common stock upon completion of a service period. During the service period, all shares are considered outstanding and dividends are paid on the restricted stock. We made a grant of 6,680 and 11,054 restricted shares in 2012 and 2011, respectively. The shares vest three years after the grant date. The grant date fair value of restricted stock granted during 2012 and 2011 was $26.33 per share and $25.00 per share, respectively.

Stock Options

Stock options are granted at 100% of fair market value and vest over three years. No stock options were granted during 2012 or 2011. We granted 52,475 options during May 2010. The fair value of the options granted during 2010 was $3.06 per option. The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model that requires Merchants to develop estimates for assumptions used in the model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed based on historical volatility of our stock. We use historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on our stock.

A summary of Merchants’ stock option plan as of December 31, 2012, 2011 and 2010 and changes during the years then ended are as follows, with numbers of shares in thousands:



	2012			2011			2010
		Weighted			Weighted			Weighted
		Average			Average			Average
	Number	Exercise		Number	Exercise		Number	Exercise
	Of	Price		Of	Price		Of	Price
	Shares	Per Share		Shares	Per Share		Shares	Per Share
Options outstanding, beginning of year	121	$	22.81	127	$	22.82	81	$	23.30
Granted	0		0	0		0	52		22.07
Exercised	18		22.81	6		22.93	2		23.00
Forfeited	8		22.07	0		0	4		22.75
Expired	0		0	0		0	0		0
Options outstanding, end of year	95	$	22.87	121	$	22.81	127	$	22.82
Options exercisable	51	$	23.57	34	$	24.01	10	$	26.63

As of December 31, 2012, there were options outstanding within the following ranges: 85 thousand at an exercise price within the range of $22.07 to $22.93, and 10 thousand at $26.63.

Options outstanding at December 31, 2012 had an intrinsic value of $372 thousand and a weighted average remaining term of 6.39 years. The total intrinsic value of options exercised was $73 thousand, $8 thousand and $6 thousand for the three years ended December 31, 2012, 2011 and 2010, respectively. We generally use shares held in treasury for option exercises. Options exercisable at December 31, 2012 had an intrinsic value of $163 thousand and a weighted average remaining term of 5.52 years. The total cash received from employees, net of withholding taxes, as a result of employee stock option exercises was $280 thousand, $0 and $59 thousand for the years ended December 31, 2012, 2011 and 2010, respectively. The tax benefit realized as a result of the stock option exercises was approximately $20 thousand, $1 thousand and $2 thousand for the years ended December 31, 2012, 2011 and 2010, respectively.