(

)

Stock-Based Compensation

The fair value of all awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.

Bancorp currently has

one

stock-based compensation plan. At Bancorp's

2015

Annual Meeting of Shareholders, shareholders approved the

2015

Omnibus Equity Compensation Plan and authorized the shares available from the expiring

2005

plan for future awards under the

2015

plan.

additional shares were made available. As of

September 30, 2017,

there were

285,133

shares available for future awards.

Options, which have

not

been granted since

2007,

had a vesting schedule of

20%

per year

and as of

February 2017;

all options have been exercised or expired. Stock appreciation rights (“SARs”) have a vesting schedule of

20%

per year. SARs expire

ten

years after the grant date unless unvested grants are forfeited due to employment termination. SARs granted under the

2005

plan expire as late as

2025.

Restricted shares granted to officers vest over

five

years. All restricted shares have been granted at a price equal to the market value of common stock at the time of grant. For all grants prior to

2015,

grantees

were entitled to dividend payments during the vesting period. For grants in

2015

and after, forfeitable dividends are deferred until shares are vested.

Grants of performance stock units (“PSUs”) vest based upon service and a

three

-year performance period which begins

January 1

of the

first

year of the performance period. Because grantees are

not

entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the fair value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Beginning in

2015,

grants require a

one

year post-vesting holding period. For

2015

2016

and

2017,

the fair value of such grants incorporates a liquidity discount of

4.80%,

4.50%

and

5.12%,

respectively, related to the holding period.

Grants of restricted stock units (“RSUs”) to directors are time-based and vest

months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs is

equal to the fair value of underlying shares on the date of grant.

Bancorp has recognized stock-based compensation expense, within salaries and employee benefits for employees, and within other non-interest expense for directors, in the consolidated statements of income as follows:

	For three months ended						For nine months ended
	September 30,						September 30,
(in thousands)	2017			2016			2017			2016
Stock-based compensation expense before income taxes	$	670		$	573		$	2,012		$	1,646
Less: deferred tax benefit		(235	)		(200	)		(704	)		(576	)
Reduction of net income	$	435		$	373		$	1,308		$	1,070

Bancorp

’s net income for the

three

and

nine

-month periods ended

September 30, 2017

reflected the implementation of ASU

2016

which changed the way excess tax benefits and deficiencies related to share-based compensation are recorded. Prior to

2017

these were recorded directly to additional paid-in capital and, thus did

not

affect earnings. Beginning in

2017

these are recorded as a tax expense or benefit in the income statement. For the

three

and

nine

months ended

September 30, 2017

these benefits resulted in a

$241

thousand and a

$1.4

million increase in net income, respectively. This tax benefit is

not

reflected in the table above.

Bancorp expects to record an additional $

679

thousand of stock-based compensation expense in

2017

for equity grants outstanding as of

September 30, 2017.

As of

September 30, 2017,

Bancorp has

$4.9

million of unrecognized stock-based compensation expense that is expected to be recorded as compensation expense over the next

five

years as awards vest. Bancorp used cash of

$216

thousand during the

first

nine

months of

2017

for purchase of shares upon vesting of restricted stock units, net of cash received for options exercised. This compares to cash received of

$1.6

million during the

first

nine

months of

2016

for similar activity.

Fair values of Bancorp

’s SARs are estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating the value of stock options and SARs. This model requires input of assumptions, changes to which can materially affect the fair value estimate. Fair value of restricted shares is equal to Bancorp’s closing stock price on the date of grant. The following assumptions were used in SAR valuations at the grant date in each year:

	2017			2016

Dividend yield		2.72	%		2.94	%
Expected volatility		19.47	%		19.31	%
Risk free interest rate		2.29	%		1.70	%
Expected life of SARs (in years)		7.0			7.3

Dividend yield and expected volatility are based on historical information for Bancorp for time periods corresponding to the expected life of options and SARs granted. Expected volatility is the price volatility of the underlying shares for the expected term measured on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the award. The expected life of SARs is based on actual experience of past like-term SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.

A summary of stock option and SARs activity and related information for the

twelve

month period ended

December 31, 2016

and the

nine

month period ended

September 30, 2017

follows:

														Weighted
								Weighted		Aggregate		Weighted		average
	Options							average		intrinsic		average		remaining
	and SARs			Exercise				exercise		value		fair		contractual
	(in thousands)			price				price		(in thousands)		value		life (in years)

At December 31, 2015
Vested and exercisable		656		$	14.02	-	19.44	$	15.75	$	6,191	$	3.39		3.7
Unvested		266			15.24	-	24.55		18.66		1,733		3.29		7.7
Total outstanding		922			14.02	-	24.55		16.59		7,924		3.36		4.8


Granted		88			25.76	-	33.08		25.84		1,866		3.56
Exercised		(272	)		14.02	-	17.89		16.38		4,155		3.73
Forfeited		(3	)		14.02	-	15.84		15.18		60		2.94

At December 31, 2016
Vested and exercisable		475			14.02	-	24.56		15.72		14,820		3.16		4.3
Unvested		260			15.24	-	33.08		21.53		6,623		3.43		7.8
Total outstanding		735			14.02	-	33.08		17.78		21,443		3.26		5.5


Granted		46			40.00	-	40.00		40.00		-		6.34
Exercised		(47	)		14.02	-	17.89		15.52		1,168		3.27
Forfeited		-				-			-		-		-

At September 30, 2017
Vested and exercisable		519			14.02	-	25.76		16.39		11,218		3.15		4.3
Unvested		215			15.24	-	40.00		26.45		2,567		4.17		7.9
Total outstanding		734			14.02	-	40.00		19.17	$	13,785		3.45		5.3

Vested year-to-date		92		$	15.24	-	25.76	$	19.34	$	1,723	$	3.18

Intrinsic value for stock options and SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grant price.

46,410

shares had an intrinsic value of

zero

because the exercise price for those shares exceeded the current market price at

September 30, 2017.

There are

options outstanding as of

September 30, 2017;

all have been exercised or have expired.

A summary of

activity for restricted shares of common stock granted to officers for the periods ending

December 31, 2016

and

September 30, 2017

is outlined in the following table:

				Grant date
				weighted-
	Number			average cost
Unvested at December 31, 201 5		155,858		$	18.98

2016 activity:
Shares awarded		51,122			25.78
Restrictions lapsed and shares released		(49,265	)		17.98
Shares forfeited		(12,480	)		20.69
Unvested at December 31, 2016		145,235		$	21.57

2017 activity:
Shares awarded		28,625			44.85
Restrictions lapsed and shares released		(46,220	)		19.76
Shares forfeited		(7,154	)		25.03
Unvested at September 30, 2017		120,486		$	27.59

Bancorp

awarded PSUs to executive officers of Bancorp, the

three

-year performance period for which began

January 1

of the award year. Shares awarded in

2017

under the

2014

grant totaled

50,022.

Shares awarded in

2016

under the

2013

grant totaled

55,188.

The following table outlines

outstanding PSU grants:

	Vesting				Expected
Grant	period		Fair		shares to
year	in years		value		be awarded
2015		3	$	20.02		51,910
2016		3		22.61		58,786
2017		3		35.66		24,756

In the

first

quarter of

201

Bancorp awarded

4,680

RSUs to directors of Bancorp with a grant date fair value of

$220

thousand.

awards were made in the

second

third

quarters of

2017.