|UNITED STATES                     
|----------------------------------
|SECURITIES AND EXCHANGE COMMISSION
|Washington, D.C. 20549            
|                                  
|FORM 10-Q                         
|                                  
|[X]                               
|                                  

|For the quarterly period ended | March 31, 2006                                                                          
|------------------------------ | ----------------------------------------------------------------------------------------
|                               |                                                                                         
|                              
|or                            
|                              
|[   ]                          | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                               |                                                                                         

|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                                                                                                                                                                                                                                                                                                            |         | (I.R.S. Employer Identification No.)
|or organization)                                                                                                                                                                                                                                                                                                                                         |         |                                     
|                                                                                                                                                                                                                                                                                                                                                         |         |                                     
|275 Kennedy Drive, South Burlington, Vermont                                                                                                                                                                                                                                                                                                             |         | 05403                               
|                                                                                                                                                                                                                                                                                                                                                         |         |                                     
|(Address of principal executive offices)                                                                                                                                                                                                                                                                                                                 |         | (Zip Code)                          
|                                                                                                                                                                                                                                                                                                                                                        
|802-658-3400                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                        
|(Registrant's telephone number, including area code)                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                        
|(Former name, former address and former fiscal year, if changed since last report)                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                        
|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 of 1934 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.
|[X]  Yes      [   ]  No                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                        
|Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a nonaccelerated filer. See the definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act.                                                                                                                  
|Large Accelerated Filer  [   ]      Accelerated Filer  [X]      Nonaccelerated Filer  [   ]                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                        
|Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).                                                                                                                                                                                                                                        
|[   ]  Yes      [X]  No                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                        
|As of April 28, 2006, there were 6,298,039 shares of the registrant's Common stock, par value $0.01 per share, outstanding.                                                                                                                                                                                                                             

<PAGE>

|MERCHANTS BANCSHARES, INC.    
|------------------------------
|FORM 10-Q                     
|TABLE OF CONTENTS             
|                              
|PART I - FINANCIAL INFORMATION
|                              
|Item  1.                      
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
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|                              
|                              
|                              
|Item  2.                      
|                              
|Item  3.                      
|Item  4.                      
|                              
|PART II - OTHER INFORMATION   
|                              
|Item  1.                      
|Item  1A.                     
|Item  2.                      
|Item  3.                      
|Item  4.                      
|Item  5.                      
|Item  6.                      
|Signatures                    
|Exhibits                      

<PAGE>

|MERCHANTS BANCSHARES, INC.                                         
|-------------------------------------------------------------------
|PART I - FINANCIAL INFORMATION                                     
|                                                                   
|ITEM 1. Financial Statements                                       
|                                                                   
|Merchants Bancshares, Inc.                                         
|Consolidated Balance Sheets                                        
|                                                                   
|                                                                   
|(In thousands except share data)                                   
|                                                                   
|ASSETS                                                             
|Cash and due from banks                                            
|Investments:                                                       
|Securities available for sale                                      
|Securities held to maturity (fair value of $7,338 and              
|$8,001)                                                            
|                                                                   
|Total investments                                                  
|                                                                   
|Loans                                                              
|Less: Allowance for loan losses                                    
|                                                                   
|Net loans                                                          
|                                                                   
|Federal Home Loan Bank stock                                       
|Bank premises and equipment, net                                   
|Investment in real estate limited partnerships                     
|Other real estate owned                                            
|Other assets                                                       
|                                                                   
|Total assets                                                       
|                                                                   
|LIABILITIES                                                        
|Deposits:                                                          
|Demand deposits                                                    
|Savings, NOW and money market accounts                             
|Time deposits $100 thousand and greater                            
|Other time deposits                                                
|                                                                   
|Total deposits                                                     
|                                                                   
|Demand note due U.S. Treasury                                      
|Other short-term borrowings                                        
|Other liabilities                                                  
|Long-term debt                                                     
|Securities sold under agreement to repurchase                      
|Junior subordinated debentures issued to unconsolidated            
|subsidiary trust                                                   
|                                                                   
|Total liabilities                                                  
|                                                                   
|Commitments and contingencies (Note 6)                             
|SHAREHOLDERS' EQUITY                                               
|Preferred stock Class A non-voting                                 
|Shares authorized - 200,000, none outstanding                      
|Preferred stock Class B voting                                     
|Shares authorized - 1,500,000, none outstanding                    
|Common stock, $.01 par value                                       
|Shares authorized                                                  
|Issued                                                             
|                                                                   
|Outstanding                                                        
|                                                                   
|Capital in excess of par value                                     
|Retained earnings                                                  
|Treasury stock, at cost                                            
|                                                                   
|                                                                   
|Deferred compensation arrangements                                 
|Accumulated other comprehensive loss                               
|                                                                   
|Total shareholders' equity                                         
|                                                                   
|Total liabilities and shareholders' equity                         
|                                                                   
|                                                                   
|See accompanying notes to interim consolidated financial statements

<PAGE>  1

|Merchants Bancshares, Inc.                                         
|-------------------------------------------------------------------
|Consolidated Statements of Income                                  
|(Unaudited)                                                        
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|(In thousands except per share data)                               
|                                                                   
|INTEREST AND DIVIDEND INCOME                                       
|Interest and fees on loans                                         
|Interest and dividends on investments                              
|U.S. Treasury and Agency obligations                               
|Other                                                              
|                                                                   
|Total interest and dividend income                                 
|                                                                   
|INTEREST EXPENSE                                                   
|Savings, NOW and money market accounts                             
|Time deposits $100 thousand and greater                            
|Other time deposits                                                
|Other borrowed funds                                               
|Long-term debt                                                     
|                                                                   
|Total interest expense                                             
|                                                                   
|Net interest income                                                
|Provision for loan losses                                          
|                                                                   
|Net interest income after provision for loan losses                
|                                                                   
|NONINTEREST INCOME                                                 
|Trust company income                                               
|Service charges on deposits                                        
|Gains on sales of investment securities, net                       
|Equity in losses of real estate limited partnerships, net          
|Other                                                              
|                                                                   
|Total noninterest income                                           
|                                                                   
|NONINTEREST EXPENSE                                                
|Salaries and wages                                                 
|Employee benefits                                                  
|Occupancy expense, net                                             
|Equipment expense                                                  
|Legal and professional fees                                        
|Marketing                                                          
|State franchise taxes                                              
|Other                                                              
|                                                                   
|Total noninterest expense                                          
|                                                                   
|Income before provision for income taxes                           
|Provision for income taxes                                         
|                                                                   
|NET INCOME                                                         
|                                                                   
|                                                                   
|Basic earnings per common share                                    
|Diluted earnings per common share                                  
|                                                                   
|See accompanying notes to interim consolidated financial statements

<PAGE>  2

|Merchants Bancshares, Inc.                                         
|-------------------------------------------------------------------
|Consolidated Statements of Comprehensive Income (Loss)             
|(Unaudited)                                                        
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|(In thousands)                                                     
|                                                                   
|Net income                                                         
|Change in net unrealized loss on securities                        
|available for sale, net of taxes of $(1,143) and $(1,763)          
|Reclassification adjustments for net securities gains              
|included in net income, net of taxes of $0 and $(21)               
|                                                                   
|Comprehensive income (loss) before transfers                       
|Impact of transfer of securities from available for sale           
|to held to maturity, net of taxes of $0 and $(1)                   
|                                                                   
|Comprehensive income (loss)                                        
|                                                                   
|                                                                   
|See accompanying notes to interim consolidated financial statements

<PAGE>  3

|Merchants Bancshares, Inc.                                          
|--------------------------------------------------------------------
|Consolidated Statements of Cash Flows                               
|(Unaudited)                                                         
|                                                                    
|For the three months ended March 31,                                
|                                                                    
|(In thousands)                                                      
|CASH FLOWS FROM OPERATING ACTIVITIES:                               
|Net income                                                          
|Adjustments to reconcile net income to net cash provided by         
|Operating activities:                                               
|Tax benefit from exercise of stock options                          
|Depreciation and amortization                                       
|Net gains on sales of investment securities                         
|Equity in losses of real estate limited partnerships                
|Changes in assets and liabilities:                                  
|Increase in interest receivable                                     
|Decrease in other assets                                            
|(Decrease) increase in interest payable                             
|Increase in other liabilities                                       
|                                                                    
|Net cash provided by operating activities                           
|                                                                    
|CASH FLOWS FROM INVESTING ACTIVITIES:                               
|Proceeds from sales of investment securities available for sale     
|Proceeds from maturities of investment securities available for sale
|Proceeds from maturities of investment securities held to maturity  
|Purchases of investment securities available for sale               
|Loan originations in excess of principal payments                   
|Purchases of Federal Home Loan Bank stock                           
|Investments in real estate limited partnerships                     
|Purchases of bank premises and equipment                            
|                                                                    
|Net cash used in investing activities                               
|                                                                    
|CASH FLOWS FROM FINANCING ACTIVITIES:                               
|Net decrease in deposits                                            
|Net increase (decrease) in short-term borrowings                    
|Proceeds from long-term debt                                        
|Net increase in securities sold under agreement to repurchase       
|Principal payments on long-term debt                                
|Cash dividends paid                                                 
|Purchases of treasury stock                                         
|Sale of treasury stock                                              
|Increase in deferred compensation arrangements                      
|Proceeds from exercise of stock options                             
|                                                                    
|Net cash provided by financing activities                           
|                                                                    
|                                                                    
|Decrease in cash and cash equivalents                               
|                                                                    
|Cash and cash equivalents beginning of year                         
|                                                                    
|Cash and cash equivalents end of period                             
|                                                                    
|                                                                    
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW                                
|INFORMATION:                                                        
|Total interest payments                                             
|Total income tax payments                                           
|SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING                       
|AND FINANCING ACTIVITIES                                            
|Increase in payable for investments purchased                       
|Distribution of stock under deferred compensation arrangements      
|Distribution of treasury stock in lieu of cash dividend             
|Transfer of loans to other real estate owned                        
|                                                                    
|See accompanying notes to interim consolidated financial statements 

<PAGE>  4

|Notes To Interim Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|See Merchants Bancshares, Inc. ("Merchants") 2005 Annual Report on Form 10-K for additional information.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Note 1: Financial Statement Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. 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 the interim consolidated financial statements of Merchants as of March 31, 2006, and for the three months ended March 31, 2006 and 2005, have been included. The information was prepared from the unaudited financial statements of Merchants Bancshares, Inc. and its subsidiaries, Merchants Bank, Merchants Trust Company, Merchants Properties, Inc. and MBVT Statutory Trust I.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Note 2: Stock-based Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Merchants has granted stock options to certain key employees. The options are exercisable immediately after the two-year vesting period. Nonqualified stock options may be granted at any price determined by the Nominating and Governance Committee of Merchants' Board of Directors. All stock options have been granted at or above fair market value at the date of grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|On January 1, 2006, Merchants adopted the provisions of FASB's revised statement No. 123 ("FAS 123R"), "Share-Based Payment", using a modified prospective application. However, based on the fact that Merchants has not granted options since August 2001, and all options previously granted have vested, Merchants does not expect FAS 123R to have any impact on the Company's financial position or results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model. Under SFAS No. 123, Merchants' net income and earnings per share for the three month periods ended March 31, 2006 and 2005 would have been the same as the amounts reported in the accompanying interim consolidated financial statements as all options are already vested. Pro forma compensation expense for options granted is reflected over the vesting period; therefore, future pro forma compensation expense may be greater if additional options are granted. A summary of option activity as of March 31, 2006, and changes during the quarter then ended is presented below:                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                               |                |  |          |  | Weighted     |  |                
|------------------------------ | -------------- |  | -------- |  | ------------ |  | ---------------
|                               |                |  | Weighted |  | Average      |  |                
|                               | Number Of      |  | Average  |  | Remaining    |  | Aggregate      
|                               | Shares         |  | Exercise |  | Contractual  |  | Intrinsic Value
|Options                        | (in thousands) |  | Price    |  | Term (years) |  | (in thousands) 
|                              
|Outstanding at January 1, 2006 | 204            |  | $17.96   |  | --           |  | --             
|Granted                        | --             |  | --       |  | --           |  | --             
|Exercised                      | 33             |  | 15.00    |  | --           |  | --             
|Forfeited or expired           | --             |  | --       |  | --           |  | --             
|                              
|Outstanding at March 31, 2006  | 171            |  | $18.52   |  | 2.6          |  | $1,033         
|                              
|Exercisable at March 31, 2006  | 171            |  | $18.52   |  | 2.6          |  | $1,033         
|                              
|                              

|The total intrinsic value of options exercised during the quarters ended March 31, 2006 and March 31, 2005, was $293 thousand and $772 thousand, respectively.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                              
|Note 3: Earnings Per Share                                                                                                                                    
|The following tables present reconciliations of the calculations of basic and diluted earnings per common share for the periods indicated:                    

<PAGE>  5

|                                               |                                   |  | Weighted  |  |          
|---------------------------------------------- | --------------------------------- |  | --------- |  | ---------
|                                               | Net                               |  | Average   |  | Per Share
|(In thousands except share and per share data) | Income                            |  | Shares    |  | Amount   
|                                              
|                                               | Three months ended March 31, 2006
|Basic earnings per common share:               |                                   |  |           |  |          
|Net income available to common                 |                                   |  |           |  |          
|shareholders                                   | $2,722                            |  | 6,302,153 |  | $0.43    
|Diluted earnings per common share:             |                                   |  |           |  |          
|Effect of dilutive stock options               | --                                |  | 25,914    |  | --       
|Net income available to common                 |                                   |  |           |  |          
|shareholders and stock option exercise         | 2,722                             |  | 6,328,067 |  | $0.43    
|                                               |                                   |  |           |  |          
|                                               | Three months ended March 31, 2005
|Basic earnings per common share:               |                                   |  |           |  |          
|Net income available to common                 |                                   |  |           |  |          
|shareholders                                   | $2,900                            |  | 6,320,850 |  | $0.46    
|Diluted earnings per common share:             |                                   |  |           |  |          
|Effect of dilutive stock options               | --                                |  | 44,260    |  | --       
|Net income available to common                 |                                   |  |           |  |          
|shareholders and stock option exercise         | 2,900                             |  | 6,365,110 |  | $0.46    
|                                               |                                   |  |           |  |          

|Basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding for the three month period ended March 31, 2006 and 2005. As of March 31, 2006 and 2005, there were no anti-dilutive stock options outstanding.                                                                                                                                                                                                                                                                                                                                                                                                      
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Note 4: Pension                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Prior to January 1995 Merchants maintained a noncontributory defined benefit plan (the "Plan") covering all eligible employees. The Plan was a final average pay plan with benefits based on the average salary rates over the last five of ten consecutive Plan years that produce the highest average. It was Merchants' policy to fund the cost of benefits expected to accrue during the year plus amortization of any unfunded accrued liability that had accumulated prior to the valuation date based on IRS regulations for funding. During 1995 the Plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or age will be accrued.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The following table summarizes the components of net periodic benefit costs for the periods indicated:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                               | Pension Benefits  
|------------------------------ | ------------------
|                               |                   
|                               | Three months ended
|                               | March 31,         
|(In thousands)                 | 2006              
|                              
|Interest cost                  | $ 115             
|Expected return on Plan assets | (127)             
|Amortization of net loss       | 81                
|                               |                   
|Net periodic benefit cost      | $   69            
|                               |                   
|                               |                   

|No contributions have been made to the pension plan during 2006 to date. Merchants has no required contribution for 2006.                                                                                                                                                                                                                         
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                  
|Note 5: Stock Repurchase Program                                                                                                                                                                                                                                                                                                                  
|In October of 2005 Merchants' Board of Directors approved a stock repurchase program, pursuant to which Merchants may repurchase 200,000 shares of its stock from time to time through October 2006. Merchants has purchased 21,900 shares of its common stock on the open market, at an average per share price of $24.41 through March 31, 2006.
|                                                                                                                                                                                                                                                                                                                                                  
|Note 6: Commitments and Contingencies                                                                                                                                                                                                                                                                                                             
|Merchants 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. These financial instruments primarily include commitments to extend credit and financial                                                                                                 



<PAGE>  6



|guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Merchants does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are conditional commitments issued by Merchants to guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $5.95 million at March 31, 2006 and represent the maximum potential future payments Merchants could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on balance sheet instruments. Merchants' policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of Merchants' standby letters of credit at March 31, 2006 was insignificant.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Merchants is involved in routine legal proceedings that occur in the ordinary course of business, which, in the aggregate, are believed by management to be immaterial to its financial condition and results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Note 7: Reclassifications                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Amounts reported for prior periods are reclassified, where necessary, to be consistent with the current period presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Forward Looking Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Except for the historical information contained herein, this Quarterly Report on Form 10-Q of Merchants may contain forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). Investors are cautioned that forward looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward looking statements due to certain risks and uncertainties, including, without limitation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
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<PAGE>  7

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | (viii) | the fact that the potential need to adapt to industry changes in information technology systems, on which Merchants is highly dependent to secure bank and customer financial information, could present operational issues, require significant capital spending or impact Merchants' reputation; and
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        |                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | (ix)   | the fact that Merchants actively evaluates acquisition and other expansion opportunities and strategies, the implementation of which could affect Merchants' financial performance.                                                                                                                   
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|These factors, as well as general economic and market conditions in the United States, may materially and adversely affect the market price of shares of Merchants' common stock. Because of these and other factors, including, without limitation, those set forth in Merchants' filings with the Securities Exchange Commission, past financial performance should not be considered an indicator of future performance. The forward looking statements contained herein represent Merchants' judgment as of the date of this Form 10-Q; Merchants cautions readers not to place undue reliance on such statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|General                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|All adjustments necessary for a fair presentation of the interim consolidated financial statements of Merchants as of March 31, 2006, and for the three months ended March 31, 2006 and 2005, have been included. The information was prepared from the unaudited financial statements of Merchants Bancshares, Inc. and its subsidiaries, Merchants Bank, Merchants Trust Company, Merchants Properties, Inc. and MBVT Statutory Trust I.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
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|Results of Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Overview                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Net income for the first quarter of 2006 was $2.72 million, compared to net income of $2.90 million for the first quarter of 2005. The return on average assets and return on average equity for the first quarter of 2006 were 1.01% and 16.47% respectively, compared to 1.11% and 17.68%, respectively, for the first quarter of 2005. The following were the major factors contributing to the results for the first quarter of 2006 compared to the first quarter of 2005:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *      | The quarter-over-quarter decrease in net income was driven by a decrease in net interest income, which decreased $385 thousand for the first quarter of 2006 compared to 2005, reflecting continued margin compression;                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        |                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *      | Noninterest income increased $112 thousand for the first quarter. Merchants experienced increases in both its overdraft fee income and in fees generated by electronic banking;                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        |                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *      | Average loans have increased $30.30 million, or 5.2%, over the first quarter of 2005;                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |        |                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *      | Average deposits have increased $19.16 million, or 2.3%, over the first quarter of 2005.                                                                                                                                                                                                              
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|Net Interest Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Merchants' net interest income, on a fully taxable equivalent basis, decreased $384 thousand for the first quarter of 2006 compared to 2005, as shown on the table on page 9. Merchants' liability sensitivity increased over the past year while short term interest rates continued to climb. Merchants' combined commercial mortgage and commercial loan portfolio continued to shift from variable rate to fixed rate as customers locked in their rates at lower levels. The variable rate portion of the commercial mortgage and commercial loan portfolio decreased by over $60 million over the past year, while the total loan portfolio has increased $36.12 million. This shift has mitigated Merchants' ability to take advantage of increases in the prime rate over the past year. At the same time, as shown in the table on page 9, Merchants' deposits have shifted from lower cost savings, NOW and money market accounts to higher rate time deposits as Merchants has responded to competitive pressures by offering higher rate time deposit and CD specials instead of making even greater changes in money market account rates. Merchants' short-term borrowing position consists primarily of borrowings from the Federal Home Loan Bank ("FHLB"). Increases in rates on these borrowings mirror movements in the federal funds rate, and the average cost of this funding source has increased 179 basis points over the past year. The combination of these factors, along with the flat to inverted yield curve environment, has resulted in decreased net interest income in spite of overall balance sheet growth.
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|Merchants is working to mitigate the effect of the current interest rate environment by taking advantage of alternative funding sources, and is in the process of rolling out a new cash management sweep product utilizing a repurchase agreement arrangement at a lower cost of funds than other short term borrowing alternatives. Merchants is also evaluating other lower cost funding sources. Merchants' net interest spread for the first quarter of 2006 compared to 2005 decreased 42 basis points to 3.55% from 3.97%. The net interest margin also decreased over the same period and was 3.83% for the first quarter of 2006, compared to 4.14% for the first quarter of 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|The following table attributes changes in Merchants' net interest income (on a fully taxable equivalent basis) to changes in either average balances or average rates for the three months ended March 31, 2006. Changes due to both interest rate and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

<PAGE>  8

|volume have been allocated to change due to balance and change due to rate in proportion to the relationship of the absolute dollar amounts of the change in each:
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|                                                                                                                                                                  
|Analysis of Changes in Fully Taxable Equivalent Net Interest Income                                                                                               
|                                                                                                                                                                  

|Three Months Ended March 31, 2006        
|-----------------------------------------
|                                         
|                                         
|(In thousands)                           
|                                         
|Fully Taxable Equivalent Interest Income:
|Loans                                    
|Investments                              
|Federal Funds Sold, Securities Sold Under
|Agreements to Repurchase and Interest    
|Bearing Deposits with Banks              
|                                         
|Total Interest Income                    
|                                         
|Less Interest Expense:                   
|Savings, Money Market & NOW Accounts     
|Time Deposits                            
|Short-term Borrowings                    
|Long-term Debt                           
|Securities sold under agreement to       
|repurchase                               
|Junior Subordinated debt                 
|                                         
|Total Interest Expense                   
|                                         
|Net Interest Income                      
|                                         
|                                         

|The following table sets forth certain information for the three months ended March 31, 2006 and 2005. For the periods indicated, the total dollar amount of interest income from average earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, are expressed both in dollars and rates, and on a tax equivalent basis.
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<PAGE>  9

|Merchants Bancshares, Inc.                                              
|------------------------------------------------------------------------
|Average Balance Sheets and Average Rates                                
|(Unaudited)                                                             
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|(In thousands, fully taxable equivalent)                                
|                                                                        
|ASSETS:                                                                 
|Loans, including fees on loans (1)                                      
|Taxable investments                                                     
|Federal funds sold, securities purchased under                          
|agreements to resell and interest bearing                               
|deposits with banks                                                     
|                                                                        
|Total interest earning assets                                           
|                                                                        
|Allowance for loan losses                                               
|Cash and due from banks                                                 
|Premises and equipment, net                                             
|Other assets                                                            
|                                                                        
|Total assets                                                            
|                                                                        
|                                                                        
|LIABILITIES AND SHAREHOLDERS'                                           
|EQUITY:                                                                 
|Interest bearing deposits:                                              
|Savings, NOW & money market accounts                                    
|Time deposits                                                           
|                                                                        
|Total interest bearing deposits                                         
|                                                                        
|Short-term borrowings                                                   
|Long-term debt                                                          
|Securities sold under agreement to repurchase                           
|Junior subordinated debentures issued to                                
|Unconsolidated subsidiary trust                                         
|                                                                        
|Total interest bearing liabilities                                      
|                                                                        
|Noninterest bearing deposits                                            
|Other liabilities                                                       
|Shareholders' equity                                                    
|                                                                        
|Total liabilities and shareholders' equity                              
|                                                                        
|                                                                        
|Net interest earning assets                                             
|                                                                        
|                                                                        
|Net interest income (fully taxable equivalent)                          
|                                                                        
|Tax equivalent adjustment                                               
|                                                                        
|Net interest income per book                                            
|                                                                        
|                                                                        
|Net interest rate spread                                                
|                                                                        
|                                                                        
|Net interest margin                                                     
|                                                                        
|                                                                        
|(1)   Includes principal balance of non-accrual loans and fees on loans.

<PAGE>  10

|Provision for Loan Losses: No provision for loan losses was recorded during the first quarter of 2006 or for the first quarter of 2005. Net recoveries during 2006 have totaled $43 thousand. The overall quality of the loan portfolio has improved during the quarter. Internally classified loans have decreased to $12.86 million from $14.48 million at December 31, 2005 and $26.34 million at June 30, 2005. The decline since June 30, 2005 is attributable to loan sales in the fourth quarter of 2005, principal paydowns, and upgrades. All of these factors are taken into consideration during management's quarterly review of the allowance for credit losses which management continues to deem adequate under current market conditions. See the discussion of Nonperforming Assets on pages 13-15 for additional information on the allowance for credit losses.                                                                                                                                                                                 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Noninterest Income: Total noninterest income increased 6.4% to $1.87 million from $1.75 million for the first quarter of 2006 compared to the first quarter of 2005. Merchants Trust Company income increased 8.8% over the first quarter of 2005. Service charges on deposits were also slightly higher quarter-over-quarter. Merchants' net overdraft fee income continued to trend upward during the first quarter of 2006 due to higher volumes and a recent price increase; while monthly increases in the earnings credit rate have allowed business customers to decrease the amount of hard dollar charges they incur each month, reducing that portion of service charge revenue. Other noninterest income increased 15.0% to $718 thousand in the first quarter of 2006 from $626 thousand for the first quarter of 2005. Electronic transactions have continued to increase, leading to increases in net revenue for ATM and debit cards.                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Noninterest Expense: Total noninterest expense was nearly unchanged for the first quarter of 2006 compared to the first quarter of 2005. Salaries and wages increased just over 1% to $3.01 million for the first quarter of 2006. This small increase was the result of a high number of vacant positions during the first quarter of 2006 and the outsourcing of the item processing function. These factors helped to offset the effect of normal salary increases, as well as higher projected incentive payouts to Merchants' corporate sales group due to strong balance sheet growth. Employee benefits increased slightly year-over-year, primarily a result of projected increased pension costs for 2006. Legal and professional fees increased $112 thousand, or 26%, to $537 thousand for the first quarter of 2006. Legal and professional fees incurred during the first quarter of 2006 related to the outsourcing of the item processing function were $176 thousand, which displaced a similar amount of salary and equipment associated expenses.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Merchants signed a lease for a new branch in Waterbury, VT, effective March 15, 2006 and have initiated plans to build a full service branch at this location with occupancy targeted for September 30, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Merchants adopted FASB 123R effective January 1, 2006. As a result of all options being vested as of December 31, 2005, adoption had no financial statement impact.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Balance Sheet Analysis                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Average loans for the first quarter of 2006 were $608.88 million compared to $578.58 million for the first quarter of 2005, and $598.16 million for the fourth quarter of 2005. Residential loan growth made up the bulk of the $30.30 million increase since the first quarter of 2005. The increase from the fourth quarter of 2005 to the first quarter of 2006 was primarily attributable to growth in the commercial real estate and commercial loan portfolios. Competitive pressure on loan structure and pricing continues to be an impediment to growth. Recently Merchants has chosen to meet the competition on pricing to retain strong existing relationships and obtain new business. Success in commercial real estate and commercial loans often requires a sustained development program. Most of the growth in the first quarter of 2006 can be attributed to the successful conclusion of a long-term sales process.                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The following table summarizes the components of Merchants' loan portfolio as of March 31, 2006 and December 31, 2005:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|(In thousands)                         | March 31, 2006 |  | December 31, 2005
|-------------------------------------- | -------------- |  | -----------------
|                                      
|Commercial, financial and agricultural | $  74,974      |  | $  71,912        
|Real estate loans - residential        | 296,049        |  | 293,158          
|Real estate loans - commercial         | 215,583        |  | 208,049          
|Real estate loans - construction       | 27,703         |  | 25,942           
|Installment loans                      | 6,351          |  | 6,345            
|All other loans                        | 1,214          |  | 520              
|                                      
|Total loans                            | $621,874       |  | $605,926         
|                                      
|                                      

|Average deposits for the first quarter of 2006 were $846.62 million compared to $827.46 million for the first quarter of 2005, and $854.59 million for the fourth quarter of 2005. Merchants' overall deposit growth was not robust enough in the first quarter of 2006 to outpace some seasonal deposit outflow. Merchants continues to focus on generating low cost transaction accounts with a new packaged offering featuring the historically popular free checking as the anchor product. At the same time, Merchants has responded to competitive pressure by offering competitive rates on a hybrid time deposit.
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<PAGE>  11

|This product has proven to be successful at stemming the potential outflow of core funding within the banks' money market category. Although average savings, NOW and money market balances have decreased by $15.27 million since December 2005, time deposit categories have increased by $10.40 million, primarily in this hybrid product. New account generation continues to be solid, with 2006 first quarter volume 10% stronger than a year ago for the same period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Merchants' investment portfolio has increased $19.89 million since year-end. Merchants continues to support a portion of its asset growth with borrowings from the FHLB. Quarter-end short-term borrowings from the FHLB totaled $75 million compared to $50 million at December 31, 2005. The cost of these borrowings follows changes in the federal funds rate, which has increased 200 basis points over the last year. Merchants is in the process of rolling out a new cash management sweep product utilizing a repurchase agreement arrangement at a lower cost of funds than other short-term borrowing alternatives.                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|In the ordinary course of business, Merchants makes commitments for possible future extensions of credit. On March 31, 2006, Merchants was obligated to fund $5.95 million of standby letters of credit. No losses are anticipated in connection with these commitments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Merchants and its subsidiaries are taxed on income by the Internal Revenue Service at the federal level. The State of Vermont levies franchise taxes on banks based upon average deposit levels in lieu of taxing income. Franchise taxes are included in noninterest expenses in the consolidated statements of income. Total income tax expense was $831 thousand for the first quarter of 2006, compared to $912 thousand for the first quarter of 2005. Merchants recognized favorable tax benefits of $413 thousand for the first quarter of 2006, compared to $425 thousand for the first quarter of 2005, representing the amount of the federal affordable housing tax credits earned during these periods. Merchants' statutory tax rate was 35% for all periods. The recognition of affordable housing tax credits is the principal reason for Merchants' effective tax rate of 23.3% and 23.9% for the first quarter of 2006 and 2005, respectively.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Liquidity and Capital Resources                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Merchants' liquidity is monitored by the Asset and Liability Committee ("ALCO"), based upon policies approved by Merchants' Board of Directors. For this purpose, liquidity means the ability to generate cash in the most economical way to satisfy loan demand, deposit withdrawal demand, and to meet other business opportunities which require cash. Merchants has an overnight line of credit with the FHLB of $5 million and an estimated additional borrowing capacity with the FHLB of $56 million. Additionally, Merchants has $28 million in available federal funds lines of credit at March 31, 2006 and the ability to borrow through the use of repurchase agreements, collateralized by Merchants' investments, with certain approved counterparties. Merchants' investment portfolio, which is managed by Merchants' ALCO, totaled $410.35 million at March 31, 2006, and is a strong source of cash flow for Merchants.                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|In October of 2005 Merchants' Board of Directors approved a new stock repurchase program, pursuant to which Merchants may repurchase 200,000 shares of its stock from time to time through October 2006. Merchants was active in its stock buyback plan during the first quarter of 2006 and purchased 21,900 shares at an average price of $24.41 during such period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|As of March 31, 2006, Merchants exceeded all applicable regulatory capital requirements. The following table represents the actual capital ratios and capital adequacy requirements for Merchants as of March 31, 2006 and 2005:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                          |                                                                                                                                                                |  | For Capital      
|------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------
|                          | Actual                                                                                                                                                         |  | Adequacy Purposes
|                          |                                                                                                                                                                |  |                  
|(In thousands)            | Amount (1)                                                                                                                                                     |  | Percent          
|                         
|                          | As of March 31, 2006                                                                                                                                          
|Tier 1 leverage capital   | $91,295                                                                                                                                                        |  | 8.44%            
|Tier 1 risk-based capital | 91,295                                                                                                                                                         |  | 12.96%           
|Total risk-based capital  | 98,421                                                                                                                                                         |  | 13.97%           
|                          |                                                                                                                                                                |  |                  
|                          | As of March 31, 2005                                                                                                                                          
|Tier 1 leverage capital   | $85,779                                                                                                                                                        |  | 8.22%            
|Tier 1 risk-based capital | 85,779                                                                                                                                                         |  | 12.44%           
|Total risk-based capital  | 93,256                                                                                                                                                         |  | 13.52%           
|                         
|(1)                       | Amounts include $20 million in trust preferred securities issued in December 2004. These hybrid securities qualify as regulatory capital up to certain limits.

<PAGE>  12

|Nonperforming Assets and the Allowance for Credit Losses                                                                                                                                                                                                                                                                                                                                                      
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Stringent credit quality is a major strategic focus of Merchants. Although Merchants has been successful to date in minimizing its problem assets, Merchants cannot assure that problem assets will remain at these levels, particularly in light of current or future economic conditions. There is also no assurance that Merchants will not need to increase the allowance for credit losses in the future.
|                                                                                                                                                                                                                                                                                                                                                                                                              
|The following table summarizes Merchants' nonperforming assets at the dates indicated:                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                              

|(In thousands)                     | March 31, 2006 |  | December 31, 2005 |  | March 31, 2005
|---------------------------------- | -------------- |  | ----------------- |  | --------------
|                                  
|Nonaccrual loans                   | $ 1,797        |  | $ 2,284           |  | $ 3,638       
|Loans past due 90 days or more and |                |  |                   |  |               
|still accruing interest            | --             |  | --                |  | --            
|Restructured loans                 | 79             |  | 80                |  | 82            
|                                  
|Total nonperforming loans ("NPL")  | $ 1,876        |  | $ 2,364           |  | $ 3,720       
|Other Real Estate Owned ("OREO")   | 312            |  | --                |  | --            
|                                  
|Total nonperforming assets ("NPA") | $ 2,188        |  | $ 2,364           |  | $ 3,720       
|                                  
|                                  

|The level of nonperforming assets declined slightly during the first quarter of 2006 from December 31, 2005. Several small relationships totaling $230 thousand were transferred to nonaccrual. Additionally, a loan secured by a small grocery store property in northeastern Vermont was transferred to OREO during the first quarter of 2006.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  13

|The allowance for credit losses comprises the allowance for loan losses and the reserve for unfunded credit commitments. The following table summarizes year-to-date activity in Merchants' allowance for credit losses through the dates indicated:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                    

|(In thousands)                       | March 31, 2006                                                                                                                                                                    |  | December 31, 2005 |  | March 31, 2005
|------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- |  | --------------
|                                    
|Balance, beginning of year           | $ 7,083                                                                                                                                                                           |  | $ 7,512           |  | $ 7,512       
|Charge-offs :                        |                                                                                                                                                                                   |  |                   |  |               
|Commercial, lease financing          |                                                                                                                                                                                   |  |                   |  |               
|and all other                        | (2)                                                                                                                                                                               |  | (336)             |  | (64)          
|Real estate - construction           | --                                                                                                                                                                                |  | --                |  | --            
|Real estate - commercial             | --                                                                                                                                                                                |  | --                |  | --            
|Real estate - mortgage               | --                                                                                                                                                                                |  | (339)             |  | (1)           
|Installment and other consumer       | (3)                                                                                                                                                                               |  | (18)              |  | --            
|                                    
|Total charge-offs                    | (5)                                                                                                                                                                               |  | (693)             |  | (65)          
|                                    
|Recoveries:                          |                                                                                                                                                                                   |  |                   |  |               
|Commercial, lease financing          |                                                                                                                                                                                   |  |                   |  |               
|and all other                        | 47                                                                                                                                                                                |  | 144               |  | 14            
|Real estate - commercial             | --                                                                                                                                                                                |  | --                |  | --            
|Real estate - mortgage               | --                                                                                                                                                                                |  | 115               |  | 15            
|Installment and other consumer       | 1                                                                                                                                                                                 |  | 5                 |  | 1             
|                                    
|Total recoveries                     | 48                                                                                                                                                                                |  | 264               |  | 30            
|                                    
|Net recoveries (charge-offs)         | 43                                                                                                                                                                                |  | (429)             |  | (35)          
|                                    
|Provision for loan losses            | --                                                                                                                                                                                |  | --                |  | --            
|                                    
|Balance end of period                | $ 7,126                                                                                                                                                                           |  | $ 7,083           |  | $ 7,477       
|                                    
|                                     |                                                                                                                                                                                   |  |                   |  |               
|Components:                          |                                                                                                                                                                                   |  |                   |  |               
|Allowance for loan losses            | $ 6,637                                                                                                                                                                           |  | $ 7,083           |  | $ 7,477       
|Reserve for unfunded commitments (1) | 489                                                                                                                                                                               |  | --                |  | --            
|                                    
|Allowance for Credit Losses          | $ 7,126                                                                                                                                                                           |  | $ 7,083           |  | $ 7,477       
|                                    
|                                    
|(1)                                  | Effective March 31, 2006 Merchants transferred the portion of the allowance for loan losses related to commercial lending commitments and letters of credit to other liabilities.
|                                     |                                                                                                                                                                                  

|The allowance for loan losses is based on management's estimate of the amount required to reflect the inherent losses in the loan portfolio, based on circumstances and conditions at each reporting date. Merchants reviews the adequacy of the allowance for loan losses at least quarterly. Factors considered in evaluating the adequacy of the allowance for loan losses include previous loss experience, current economic conditions and their effect on the borrowers, the performance of individual loans in relation to contract terms and estimated fair values of properties to be foreclosed. The method used in determining the amount of the allowance for loan losses is not based on maintaining a specific percentage of allowance for loan losses to total loans or total NPA. Rather, the methodology is a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors, which indicate both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Losses are charged against the allowance for loan losses when management believes that the collectibility of principal is doubtful. To the extent management determines the level of anticipated losses in the portfolio has significantly increased or diminished, the allowance for loan losses is adjusted through current earnings. As part of Merchants' analysis of specific credit risk, detailed and extensive reviews are performed on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and internal credit rating reports. An outside loan review firm examines portions of Merchants' commercial loan portfolio three times per year. Over the course of the year, approximately 70% of commercial loan balances are reviewed, including all relationships over $1.0 million and criticized and classified loans over $500 thousand. Issues addressed by the loan review process include the accuracy of Merchants' internal risk ratings system, loan quality, and adequacy of the allowance for loan losses.                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Loans deemed impaired at March 31, 2006 totaled $1.43 million and are included as nonaccrual loans in the table on page 13.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

<PAGE>  14

|The allowance for credit losses reflects management's current strategies and efforts to maintain the allowance for credit losses at a level adequate to provide for loan losses based on an evaluation of known and inherent risks in the loan portfolio, as well as the potential risk from unfunded loan commitments and letters of credit. Among the factors that management considers in establishing the level of the allowance for credit losses are overall findings from an analysis of individual loans, the overall risk characteristics and size of the loan portfolio, past credit loss history, management's assessment of current economic and real estate market conditions and estimates of the current value of the underlying collateral. Management considered the balance of the allowance for credit losses adequate at March 31, 2006.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The following table reflects Merchants' nonperforming asset and coverage ratios as of the dates indicated:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

|                                 | March 31, 2006 |  | December 31, 2005 |  | March 31, 2005
|-------------------------------- | -------------- |  | ----------------- |  | --------------
|                                
|NPL to total loans               | 0.30%          |  | 0.39%             |  | 0.64%         
|NPA to total loans plus OREO     | 0.35%          |  | 0.39%             |  | 0.64%         
|Allowance for loan losses        |                |  |                   |  |               
|to total loans                   | 1.07%          |  | 1.17%             |  | 1.28%         
|Allowance for credit losses      |                |  |                   |  |               
|to total loans                   | 1.15%          |  | 1.17%             |  | 1.28%         
|Allowance for loan losses to NPL | 354%           |  | 300%              |  | 201%          
|Allowance for loan losses to NPA | 303%           |  | 300%              |  | 201%          
|                                 |                |  |                   |  |               

|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|General                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Management and Merchants' Board of Directors are committed to sound risk management practices throughout the organization. Merchants has developed and implemented a centralized risk management monitoring program. Risks associated with Merchants' business activities and products are identified and measured as to probability of occurrence and impact on Merchants (low, moderate, or high), and the control or other activities in place to manage those risks are identified and assessed. Periodically, department-level and senior managers re-evaluate and report on the risk management processes for which they are responsible. This documented program provides management with a comprehensive framework for monitoring Merchants' risk profile from a macro perspective; it also serves as a tool for assessing internal controls over financial reporting as required under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), and the Sarbanes-Oxley Act of 2002.                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Market Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Market risk is defined as the risk of loss in a financial instrument arising from adverse changes in market rates and prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. Merchants' primary market risk exposure is interest rate risk. An important component of Merchants' asset and liability management process is the ongoing monitoring and management of this risk, which is governed by established policies that are reviewed and approved annually by Merchants' Board of Directors. The Board of Directors delegates responsibility for carrying out the asset and liability management policies to the ALCO. In this capacity the ALCO develops guidelines and strategies impacting Merchants' asset and liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. Merchants has an outside investment advisory firm which provides assistance in identifying opportunities for increased yield without significantly increasing risk in the investment portfolio.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Interest Rate Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The ALCO is responsible for evaluating and managing the interest rate risk which arises naturally from imbalances in repricing, maturity and cash flow characteristics of Merchants' assets and liabilities. The ALCO is responsible for ensuring that the Board of Directors receives accurate information regarding Merchants' interest rate risk position at least quarterly. The ALCO uses an outside consultant to perform rate shocks of Merchants' balance sheet, and to perform a variety of other analyses. The consultant's most recent review was as of February 28, 2006. At that time Merchants' one-year gap position was a $185.74 million liability-sensitive position compared to a $137.23 million liability-sensitive position at the end of 2005.                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The consultant ran a simulation assuming no changes in rates or balance sheet mix. Assuming interest rates and the Bank's balance sheet and mix remain similar to February 28th, net interest income is projected to trend gradually upward from                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

<PAGE>  15

|February 2006 levels during the simulation period as replacement asset yields increase sufficiently to offset funding rate increases.                                                                                                                                                                                                                                                                                                           
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Merchants' consultant also modeled a 200 basis point rising and falling interest rate scenario at the February 28, 2006 review. The model assumes a parallel and pro rata shift of the yield curve over a one-year period and assumes no changes or growth in the balance sheet. At the February 28, 2006 review the change in net interest income for the next twelve months from Merchants' expected or "most likely" forecast was as follows:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                

| |                       | Percent Change in   | 
| | --------------------- | ------------------- | 
| | Rate Change           | Net Interest Income | 
| |                       |                    
| | Up 200 basis points   | (2.79)%             | 
| | Down 200 basis points | 1.03%               | 
| |                       |                    
| |                       |                    

|Merchants liability sensitivity is evident in the results of the rising rate scenario. In a rising rate environment net interest income trends downward as funding costs initially rise more quickly than asset yields. This trend is expected to begin to reverse in year two as asset yield improvements outpace slowing funding rate increases. Net interest income levels are projected to rise during the first year in a falling rate scenario as short-term borrowings drive funding costs lower more quickly than asset yields. This trend is projected to begin to reverse in the second year as funding costs stabilize while asset yields continue to cycle downward. The degree to which this exposure materializes will depend, in part, on Merchants' ability to manage deposit rates as interest rates rise or fall.                                                            
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The analysis discussed above includes no growth assumptions. Merchants' consultant ran additional simulations, which modeled a downward movement in rates with a steepening yield curve and a simulation using Merchants' current growth assumptions. The growth model showed that margin dollars increase in both rising and falling rate environments as Merchants continues to grow its balance sheet. Falling rates, accompanied by a yield curve that steepens in the short end, resulted in net interest income increases over the entire five-year simulation period. These types of dynamic analyses give the ALCO a more thorough understanding of how Merchants' balance sheet will perform in a variety of rate environments.                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The preceding sensitivity analysis does not represent Merchants' forecast and should not be relied upon as indicative of expected operating results. These estimates are based upon numerous assumptions, including without limitation: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit run-off rates, pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows, among others. While assumptions are developed based upon current economic and local market conditions, Merchants cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The model used to perform the balance sheet simulation assumes a parallel shift of the yield curve over twelve months and reprices every interest bearing asset and liability on Merchants' balance sheet. The model uses contractual repricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposits such as Free Checking for LifeÒ
 accounts and money market accounts which are subject to repricing based on current market conditions. Investment securities with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. The model also assumes that the rate at which certain mortgage related assets prepay will vary as rates rise and fall, based on prepayment estimates derived from the Office of Thrift Supervision's Net Portfolio Value Model.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|As market conditions vary from those assumed in the sensitivity analysis, actual results will likely differ due to: the varying impact of changes in the balances and mix of loans and deposits differing from those assumed, the impact of possible off balance sheet hedging strategies, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect all actions that the ALCO might take in responding to or anticipating changes in interest rates.                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Merchants periodically, if deemed appropriate, uses interest rate swaps, floors and caps, which are common derivative financial instruments, to hedge its interest rate risk position. Merchants' Board of Directors has approved hedging policy statements governing Merchants' use of these instruments. As of March 31, 2006 Merchants had no derivative instruments. The risks associated with entering into such transactions are the risk of default from the counterparty with whom Merchants has entered into agreement and a poor correlation between the item being hedged and the derivative instrument. Merchants' risk from default of a counterparty is limited to the expected cash flow anticipated from the counterparty, not the notional value.                                                                                                                             

<PAGE>  16

|Credit Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Merchants' Board of Directors reviews and approves Merchants' loan policy on an annual basis. Among other things, the loan policy establishes restrictions regarding the types of loans that may be granted, and the distribution of loan types within Merchants' portfolio. Merchants' Board of Directors grants each loan officer the authority to originate loans on behalf of Merchants, subject to certain limitations. These authorized lending limits are reviewed at least annually and are based upon the lender's knowledge and experience. Loan requests that exceed a lender's authority require the signature of Merchants' credit division manager, senior loan officer, and/or president. All extensions of credit of $2.5 million or greater to any one borrower or related party interest, are reviewed and approved by the Loan Committee of Merchants' Board of Directors. Merchants' loan portfolio is continuously monitored for performance, creditworthiness and strength of documentation through the use of a variety of management reports and with the assistance of an external loan review firm. Credit ratings are assigned to commercial loans and are routinely reviewed. Loan officers or the loan workout function take remedial actions to assure full and timely payment of loan balances when necessary. Merchants' policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due 90 or more days and the ultimate collectibility of principal or interest becomes doubtful.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Item 4. Controls and Procedures                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|The principal executive officer, principal financial officer, and other members of senior management of Merchants have evaluated the disclosure controls and procedures of Merchants as of the end of the period covered by this quarterly report. Based on this evaluation, Merchants' principal executive officer and principal financial officer have concluded that the disclosure controls and procedures effectively ensure that information required to be disclosed in Merchants' filings and submissions with the Securities and Exchange Commission under the Exchange Act, is accumulated and communicated to Merchants' management (including the principal executive officer and principal financial officer) and is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission. In addition, Merchants has reviewed its internal controls over financial reporting and there have been no significant changes in its internal controls that have materially affected, or are reasonably likely to material affect, those controls during the quarter ended March 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                             

<PAGE>  17

|MERCHANTS BANCSHARES, INC.                                         
|-------------------------------------------------------------------
|PART II - OTHER INFORMATION                                        
|                                                                   
|Item 1. Legal Proceedings                                          
|                                                                   
|None.                                                              
|                                                                   
|Item 1A. Risk Factors                                              
|                                                                   
|None.                                                              
|                                                                   
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
|                                                                   
|Issuer Purchases of Equity Securities by the Issuer                
|                                                                   



|                               |                 |  |                |  | (c) Total Number  |  | (d) Maximum     
|------------------------------ | --------------- |  | -------------- |  | ----------------- |  | ----------------
|                               |                 |  |                |  | of Shares         |  | Number of Shares
|                               |                 |  |                |  | Purchased as Part |  | that May Yet Be 
|                               | a) Total Number |  | (b) Average    |  | of Publicly       |  | Purchased Under 
|                               | of Shares       |  | Price Paid per |  | Announced Plans   |  | the Plans or    
|Period                         | Purchased       |  | Share          |  | or Programs       |  | Programs        
|                              
|January 1 through January 31   | -               |  | $        -     |  | -                 |  | 197,894         
|February 1 through February 28 | 14,600          |  | $24.43         |  | 14,600            |  | 183,294         
|March 1 through March 31       | 7,300           |  | $24.38         |  | 7,300             |  | 175,994         
|                               |                
|Total                          | 21,900          |  | $24.41         |  | 21,900            |  | -               
|                               |                

|In October of 2005 Merchants' Board of Directors approved a stock repurchase program, pursuant to which Merchants may repurchase 200,000 shares of its stock from time to time through October 2006. Under the plan, Merchants has purchased 21,900 shares of its own common stock on the open market, at an average per share price of $24.41 through March 31, 2006.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                      
|Item 3. Defaults Upon Senior Securities                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                      
|None                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                      
|Item 4. Submission of Matters to a Vote of Security Holders                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                      
|None                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                      
|Item 5. Other Information                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                      
|None                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                      
|Item 6. Exhibits                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                      
|(a) Exhibits:                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                      

<PAGE>  18

|MERCHANTS BANCSHARES, INC.                                                                                                                                                              
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|SIGNATURES                                                                                                                                                                              
|                                                                                                                                                                                        
|Pursuant to 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.
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<PAGE>  19