===============================================================================

                     SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C. 20549
                                  FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                     THE SECURITIES EXCHANGE ACT OF 1934
                 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
                       COMMISSION FILE NUMBER 0-11595

                         MERCHANTS BANCSHARES, INC.
           (Exact name of registrant as specified in its charter)

Incorporated in the State of Delaware  Employer Identification No. 03-0287342

 164 College St., Burlington, Vermont                   05401
(Address of principal executive office)              (Zip Code)

                Registrant's telephone number: (802) 658-3400
         Securities registered pursuant to Section 12(b) of the Act:
                              (Not Applicable)
         Securities registered pursuant to Section 12(g) of the Act:

            Title of Class: Common Stock (Par Value $.01 a share)
                  Name of Exchange on which listed: NASDAQ

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.

                             Yes   X   No      
                                 -----    -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 
405 of Regulation S-K is not contained herein, and will not be contained, to 
the best of registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this Form 10-K.

         X   Contained herein                      Not contained herein
       -----                                 -----

The aggregate market value of the voting stock held by non-affiliates is 
$104,750,428 as computed using the average bid and asked prices of stock, as 
of February 23, 1999.

The number of shares outstanding for each of the registrant's classes of 
common stock, as of February 23, 1999 is:
                Class: Common stock, par value $.01 per share
                        Outstanding: 4,375,997 shares

                     DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report to Shareholders for the year ended December 
31, 1998 are incorporated herein by reference to Parts I and II.

Portions of the Proxy Statement to Shareholders for the year ended December 
31, 1998 are incorporated herein by reference to Part III.

===============================================================================


TABLE OF CONTENTS                                                  Page


Independent Auditors' Report                                         3


Consolidated Balance Sheets                                          4


Consolidated Statements of Operations                                5


Consolidated Statements of Comprehensive Income                      6


Consolidated Statements of Changes in Stockholders' Equity           7


Consolidated Statements of Cash Flows                                8


Notes to Consolidated Financial Statements                           9


Summary of Unaudited Quarterly Financial Information                30


Management's Discussion and Analysis of Financial Condition and 
 Results of Operations                                              33


Form 10-K                                                           50


Five Year Selected Financial Data                                   60


Signatures                                                          64



                      ARTHUR ANDERSEN LLP [LETTERHEAD]


                  REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF
MERCHANTS BANCSHARES, INC.


We have audited the accompanying consolidated balance sheets of Merchants 
Bancshares, Inc. (a Delaware corporation) and subsidiaries as of December 
31, 1998 and 1997, and the related consolidated statements of operations, 
comprehensive income, changes in stockholders' equity and cash flows for 
each of the three years in the period ended December 31, 1998. These 
consolidated financial statements are the responsibility of the Company's 
management. Our responsibility is to express an opinion on these 
consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation. We believe that our audits provide a 
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the financial position of 
Merchants Bancshares, Inc. and subsidiaries as of December 31, 1998 and 
1997, and the results of its operations and its cash flows for each of the 
three years in the period ended December 31, 1998, in conformity with 
generally accepted accounting principles.


/s/ Arthur Andersen LLP


Boston, Massachusetts
January 15, 1999



                         Merchants Bancshares, Inc.
                         Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                           December 31,     December 31,
(In thousands except share and per share data)                                 1998             1997
--------------------------------------------------------------------------------------------------------
<S>                                                                          <C>              <C>
ASSETS
  Cash and Due from Banks                                                    $ 30,528         $ 20,139
  Investments:
    Debt Securities Available for Sale                                          72,205          44,241
    Debt Securities Held to Maturity                                           103,851         111,458
     (Fair Value of $105,717 and $112,467)
    Trading Securities                                                           1,095           1,031
--------------------------------------------------------------------------------------------------------
      Total Investments                                                        177,151         156,730
--------------------------------------------------------------------------------------------------------
  Loans                                                                        405,492         390,388
  Reserve for possible loan losses                                              11,300          15,831
--------------------------------------------------------------------------------------------------------
      Net Loans                                                                394,192         374,557
--------------------------------------------------------------------------------------------------------
  Federal Home Loan Bank Stock                                                   2,482           2,296
  Bank Premises and Equipment, Net                                              13,185          13,428
  Investments in Real Estate Limited Partnerships                                2,860           1,972
  Other Real Estate Owned                                                          470             591
  Other Assets                                                                  14,005          14,539
--------------------------------------------------------------------------------------------------------
      Total Assets                                                            $634,873        $584,252
========================================================================================================

LIABILITIES
  Deposits:
    Demand                                                                    $ 85,998        $ 76,712
    Savings, NOW and Money Market Accounts                                     309,897         267,396
    Time Deposits $100 thousand and Greater                                     22,746          23,307
    Other Time                                                                 131,821         138,429
--------------------------------------------------------------------------------------------------------
      Total Deposits                                                           550,462         505,844
--------------------------------------------------------------------------------------------------------
  Demand Note Due U.S. Treasury                                                    283           4,000
  Other Short-Term Borrowings                                                    9,000           4,000
  Other Liabilities                                                              7,890          11,057
  Long-Term Debt                                                                 6,409           6,415
--------------------------------------------------------------------------------------------------------
      Total Liabilities                                                        574,044         531,316
--------------------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 12)
STOCKHOLDERS' EQUITY
  Preferred Stock Class A Non-Voting Authorized-200,000, Outstanding 0               -               -
  Preferred Stock Class B Voting Authorized-1,500,000, Outstanding 0                 -               -
  Common Stock, $.01 Par Value                                                      44              44
    Shares Authorized                  7,500,000
    Outstanding,  Current Period       4,259,278
                  Prior Period         4,290,698
  Treasury Shares (At Cost)                                                     (3,133)         (2,220)
                  Current Period         175,342
                  Prior Period           143,922
  Capital in Excess of Par Value                                                33,073          33,223
  Retained Earnings                                                             28,308          21,537
  Deferred Compensation Arrangements                                             2,166             (10)
  Unrealized Gain on Securities Available for Sale, Net                            371             362
--------------------------------------------------------------------------------------------------------
      Total Stockholders' Equity                                                60,829          52,936
--------------------------------------------------------------------------------------------------------
      Total Liabilities and Stockholders' Equity                              $634,873        $584,252
========================================================================================================
</TABLE>

      The accompanying notes are an integral part of these consolidated 
                            financial statements.


                         Merchants Bancshares, Inc.
                    Consolidated Statements of Operations

<TABLE>
<CAPTION>
                                                                    Years Ended December 31,
(In thousands except per share data)                              1998        1997        1996
------------------------------------------------------------------------------------------------
<S>                                                              <C>         <C>         <C>
INTEREST AND DIVIDEND INCOME:
  Interest and Fees on Loans                                     $36,796     $38,543     $39,953
  Interest and Dividends on Investments:
    U.S. Treasury and Agency Obligations                          10,728       9,433       7,588
    Other                                                            499         182         463
------------------------------------------------------------------------------------------------
Total Interest and Dividend Income                                48,023      48,158      48,004
------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
  Savings, NOW and Money Market Accounts                           9,175       8,403       8,216
  Time Deposits $100 Thousand and Greater                          1,566       1,428       1,397
  Other Time Deposits                                              7,007       7,485       8,112
  Other Borrowed Funds                                               322         509         345
  Debt                                                               460         413         602
------------------------------------------------------------------------------------------------
Total Interest Expense                                            18,530      18,238      18,672
------------------------------------------------------------------------------------------------
Net Interest Income                                               29,493      29,920      29,332
  Provision for Possible Loan Losses                              (1,737)     (1,862)      3,150
------------------------------------------------------------------------------------------------
Net Interest Income after Provision for Possible Loan Losses      31,230      31,782      26,182
------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
  Trust Company Income                                             1,910       1,635       1,493
  Service Charges on Deposits                                      2,756       3,075       3,347
  Merchant Discount Fees                                           1,444       1,537       1,696
  Gains on Sale of Investment Securities, Net                         44         784          33
  FDIC Assistance Received-Loss Sharing                                -           -         407
  Other                                                            1,158         885       2,387
------------------------------------------------------------------------------------------------
Total Noninterest Income                                           7,312       7,916       9,363
------------------------------------------------------------------------------------------------
NONINTEREST EXPENSES:
  Salaries and Wages                                               9,434       8,682       8,222
  Employee Benefits                                                2,036       1,992       1,791
  Occupancy Expense, Net                                           1,974       2,171       2,054
  Equipment Expense                                                2,593       2,325       2,024
  Legal and Professional Fees                                      2,447       3,888       1,961
  Provision for Impairment of Investment Security                      -         229           -
  Equity in Losses of Real Estate Limited Partnerships               379         641         846
  Losses on and Write-downs of Other Real Estate Owned               225         314       3,400
  Losses and Write-downs of Segregated Assets                          -           -         407
  Loss (Gain) on Disposition of Fixed Assets                         127       1,088        (565)
  Other                                                            6,257       7,152       7,349
------------------------------------------------------------------------------------------------
Total Noninterest Expenses                                        25,472      28,482      27,489
------------------------------------------------------------------------------------------------
Income Before Provision for Income Taxes                          13,070      11,216       8,056
Provision for Income Taxes                                         3,248       2,383       1,832
------------------------------------------------------------------------------------------------
NET INCOME                                                       $ 9,822     $ 8,833     $ 6,224
================================================================================================

BASIC EARNINGS PER COMMON SHARE                                  $  2.22     $  2.00     $  1.45
DILUTED EARNINGS PER COMMON SHARE                                   2.21        1.99        1.45
</TABLE>


      The accompanying notes are an integral part of these consolidated 
                            financial statements.


                         Merchants Bancshares, Inc.
               Consolidated Statements of Comprehensive Income

<TABLE>
<CAPTION>
                                                                         Twelve Months Ended
                                                                             December 31,
(In thousands)                                                        1998       1997       1996
-------------------------------------------------------------------------------------------------
<S>                                                                  <C>        <C>        <C>
Net Income as Reported                                               $9,822     $8,833     $6,224
Change in Net Unrealized Appreciation of Securities, Net of Tax          40        625       (337)
Less: Reclassification Adjustments for Securities Gains Included
 in Net Income, Net of Taxes                                             29        517         22
-------------------------------------------------------------------------------------------------
Comprehensive Income before transfers from Available
 for Sale to Held to Maturity                                         9,833      8,941      5,865
Impact of transfer from Available for Sale to Held to Maturity           (2)        10        136
-------------------------------------------------------------------------------------------------
Comprehensive Income                                                 $9,831     $8,951     $6,001
=================================================================================================
</TABLE>


      The accompanying notes are an integral part of these consolidated 
                            financial statements.


                         Merchants Bancshares, Inc.
         Consolidated Statements of Changes in Stockholders' Equity
      For Each of the Three Years in the Period Ended December 31, 1998

<TABLE>
<CAPTION>
                                                                                                 Net Unrealized
                                                                                                  Appreciation
                                               Capital in                           Deferred     (Depreciation)
                                      Common   Excess of    Retained   Treasury   Compensation   of Investment
(In thousands)                        Stock    Par Value    Earnings    Stock     Arrangements     Securities      Total
-------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>      <C>         <C>        <C>            <C>            <C>          <C>
Balance, December 31, 1995             $44      $33,155     $ 8,621    $ 2,038            -          $ 467        $40,249
  Net Income                             -            -       6,224          -            -              -          6,224
  Change in Net Unrealized
   Appreciation (Depreciation) of
   Securities Available for Sale,
   Net of Tax                            -            -           -          -            -           (359)          (359)
  Change in Net Unrealized
   Appreciation of Securities
   Transferred to the Held to
   Maturity Portfolio, Net of Tax        -            -           -          -            -            136            136
-------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1996              44       33,155      14,845     (2,038)           -            244         46,250
  Net Income                             -            -       8,833          -            -              -          8,833
  Purchase of Treasury Stock             -            -           -     (1,390)           -              -         (1,390)
  Sales of Treasury Stock                -          219           -      1,015            -              -          1,234
  Issuance of Stock under
   Employee Stock Option Plans           -         (151)          -        193            -              -             42
  Dividends Paid                         -            -      (2,141)         -            -              -         (2,141)
  Unearned Compensation-
   Restricted Stock Awards               -            -           -          -          (10)             -            (10)
  Change in Net Unrealized
   Appreciation (Depreciation) of
   Securities Available for Sale,
   Net of Tax                            -            -           -          -            -            108            108
  Change in Net Unrealized
   Appreciation of Securities
   Transferred to the Held to
   Maturity Portfolio, Net of Tax        -            -           -          -            -             10             10
-------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1997              44       33,223      21,537     (2,220)         (10)           362         52,936
  Net Income                             -            -       9,822          -            -              -          9,822
  Purchase of Treasury Stock             -            -           -     (1,420)           -              -         (1,420)
  Issuance of Stock under
   Employee Stock Option Plans           -         (210)          -        374            -              -            164
  Tax Benefit Related to Stock
   Option Exercises                      -           60           -          -            -              -             60
  Issuance of Stock under Deferred
   Compensation Arrangements             -            -           -        133            -              -            133
  Dividends Paid                         -            -      (3,051)         -            -              -         (3,051)
  Unearned Compensation-
   Restricted Stock Awards               -            -           -          -          (20)             -            (20)
  Compensation Arrangements              -            -           -          -        2,196              -          2,196
  Change in Net Unrealized
   Appreciation (Depreciation) of
   Securities Available for Sale,
   Net of Tax                            -            -           -          -            -             11             11
  Change in Net Unrealized
   Appreciation of Securities
   Transferred to the Held to
   Maturity Portfolio, Net of Tax        -            -           -          -            -             (2)            (2)
-------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1998             $44      $33,073     $28,308    $(3,133)      $2,166          $ 371        $60,829
=========================================================================================================================
</TABLE>

      The accompanying notes are an integral part of these consolidated 
                            financial statements.


                         Merchants Bancshares, Inc.
                    Consolidated Statement of Cash Flows

<TABLE>
<CAPTION>
(In thousands)                                                                1998         1997         1996
---------------------------------------------------------------------------------------------------------------

<S>                                                                         <C>          <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income                                                                  $  9,822     $  8,833     $   6,224
Adjustments to Reconcile Net Income to Net Cash Provided by
 Operating Activities:
  Provision for Possible Loan Losses                                          (1,737)      (1,862)        3,150
  Provision for Possible Losses on Other Real Estate Owned                        20           34         2,495
  Provision for Impairment of Investment Security                                  -          229             -
  Provision for Depreciation and Amortization                                  2,632        2,377         2,667
  Net Gains on Sales of Investment Securities                                    (44)        (784)          (33)
  Net Gains on Sales of Loans and Leases                                        (213)         (11)         (505)
  Net Losses on Sales of Premises and Equipment                                  127        1,088          (565)
  Net Gains (Losses) on Sales of Other Real Estate Owned                         101         (138)         (328)
  Equity in Losses of Real Estate Limited Partnerships                           379          641           846
Changes in Assets and Liabilities:
  (Increase) Decrease in Interest Receivable                                    (165)         (63)          936
  Increase (Decrease) in Interest Payable                                         33           14          (313)
  (Increase) Decrease in Other Assets                                            698         (444)        5,527
  Decrease in Other Liabilities                                               (1,004)         (44)         (724)
-------------------------------------------------------------------------------------------------------------------------
      Net Cash Provided by Operating Activities                               10,649        9,870        19,377
-------------------------------------------------------------------------------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from Sales of Investment Securities Available for Sale             14,053       18,907        42,522
  Proceeds from Maturities of Investment Securities                           33,834       13,985        16,000
  Proceeds from Sales of Loans and Leases                                     14,659        3,131        19,576
  Purchases (Redemptions) of Federal Home Loan Bank Stock                       (186)         545           334
  Proceeds from Sales of Premises and Equipment                                    -            6         1,818
  Proceeds from Sales of Other Real Estate Owned                               1,179        2,112         6,144
  Purchases of Available for Sale Investment Securities                      (58,156)     (10,005)     (105,929)
  Purchases of Held to Maturity Investment Securities                        (10,272)     (33,278)            -
  Loan Originations (in Excess of) Less than Principal Payments              (32,990)      (4,364)       37,292
  Investments in Real Estate Limited Partnerships                             (1,362)        (102)         (111)
  Purchases of Premises and Equipment                                         (2,607)      (4,099)       (4,688)
-------------------------------------------------------------------------------------------------------------------------
      Net Cash Provided by (Used in) Investing Activities                    (41,848)     (13,162)       12,958
-------------------------------------------------------------------------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Net Increase (Decrease) in Deposits                                         44,618       (2,436)      (36,234)
  Net Increase (Decrease) in Other Borrowed Funds                              1,283       (1,599)        4,263
  Principal Payments on Debt                                                      (6)          (5)       (9,005)
  Cash Dividends Paid                                                         (3,051)      (2,141)            -
  Acquisition of Treasury Stock                                               (1,420)      (1,390)            -
  Proceeds From Sales of Treasury Stock                                            -        1,234             -
  Proceeds From Exercise of Employee Stock Options                               164           42             -
-------------------------------------------------------------------------------------------------------------------------
      Net Cash Provided by (Used In) Financing Activities                     41,588       (6,295)      (40,976)
-------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents                              10,389       (9,587)       (8,641)
Cash and Cash Equivalents Beginning of Year                                   20,139       29,726        38,367
-------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period                                     $ 30,528     $ 20,139     $  29,726
=========================================================================================================================
Total Interest Payments                                                     $ 18,498     $ 18,224     $  18,985
Total Income Tax Payments                                                      2,170        3,820             -
Transfer of Loans and Premises to Other Real Estate Owned                        954          515         2,815
Transfer of Securities Available for Sale to Held to Maturity Portfolio            -            -        87,509
</TABLE>

      The accompanying notes are an integral part of these consolidated 
                            financial statements.


                         Merchants Bancshares, Inc.
                 Notes to Consolidated Financial Statements
                              December 31, 1998

(1)   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of 
Merchants Bancshares, Inc. (the "Company") and its wholly owned 
subsidiaries; Merchants Bank (the "Bank") including the Bank's wholly owned 
subsidiaries Merchants Trust Company (the "Trust Company"), and certain 
trusts; and Merchants Properties, Inc., after elimination of all material 
intercompany accounts and transactions. Queneska Capital Corporation, 
formerly a wholly owned subsidiary of the Bank, was dissolved in December 
1997. The Bank and the Trust Company offer a full range of deposit, loan, 
cash management and trust services to meet the financial needs of individual 
consumers, businesses and municipalities at 33 full-service banking 
locations throughout the State of Vermont.

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with generally 
accepted accounting principles requires management to make estimates and 
assumptions that affect the reported amounts of assets and liabilities and 
disclosure of contingent assets and liabilities at the date of the financial 
statements and the reported amounts of income and expenses during the 
reporting periods. Operating results in the future could vary from the 
amounts derived from management's estimates and assumptions.

Investment Securities

The Company classifies certain of its investments in debt securities as held 
to maturity, which are carried at amortized cost if the Company has the 
positive intent and ability to hold such securities to maturity. Investments 
in debt securities that are not classified as held to maturity and equity 
securities that have readily determinable fair values are classified as 
trading securities or available for sale securities. Trading securities are 
investments purchased and held principally for the purpose of selling in the 
near term; available for sale securities are investments not classified as 
trading or held to maturity. Available for sale securities are carried at 
fair value which is measured at each reporting date. The resulting 
unrealized gain or loss is reflected in Comprehensive Income and 
Stockholders' Equity net of the associated tax effect. Trading securities 
are also carried at fair value, gains and losses are recognized through the 
Statement of Operations.

Transfers from securities available for sale to securities held to maturity 
are recorded at the securities' fair values on the date of the transfer. Any 
net unrealized gains or losses continue to be reported as a separate 
component of stockholders' equity, on a net of tax basis as long as the 
securities are carried in the held to maturity portfolio, such amounts are 
amortized over the estimated remaining life of the transferred securities as 
an adjustment to yield in a manner consistent with the amortization of 
premiums and discounts.

Dividend and interest income, including amortization of premiums and 
discounts, is recorded in earnings for all categories of investment 
securities. Discounts and premiums related to debt securities are amortized 
using a method which approximates the level-yield method. The gain or loss 
recognized on the sale of an investment security is based upon the adjusted 
cost of the specific security.

Management reviews all reductions in fair value below book value to 
determine whether the impairment is other than temporary. If the impairment 
is determined to be other than temporary in nature, the carrying value of 
the security is written down to the appropriate level by a charge to 
earnings in the period of determination.

Loan Origination and Commitment Fees

Loan origination and commitment fees and certain direct loan origination 
costs are deferred and amortized over the lives of the related loans. Net 
deferred origination fees were $787 thousand and $859 thousand at December 
31, 1998 and 1997, respectively.

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation and 
amortization. Depreciation and amortization are provided using straight-line 
and accelerated methods at rates that depreciate the original cost of the 
premises and equipment over their estimated useful lives. Expenditures for 
maintenance, repairs and renewals of minor items are generally charged to 
expense as incurred. When premises and equipment are replaced, retired, or 
deemed no longer useful they are valued at estimated selling price less 
costs to sell, and to the extent the net book value exceeds this value the 
difference is charged to current earnings.

Gains and Losses on Sales of Loans

Gains and losses on sales of loans are recognized based upon the difference 
between the selling price and the carrying amount of loans sold. Gains and 
losses are adjusted for excess servicing rights resulting from the sale of 
certain loans with servicing rights retained. Origination fees collected, 
net of commitment fees paid in connection with the sales of loans and net of 
the direct cost of originating the loans, are recognized at the time such 
loans are sold.

Income Taxes

Deferred tax assets and liabilities are reflected at currently enacted 
income tax rates applicable to the period in which the deferred tax assets 
or liabilities are expected to be realized or settled. As changes in tax 
laws or rates are enacted, deferred tax assets and liabilities are adjusted 
through the provision for income taxes. Low-income housing tax credits are 
recognized in the year in which they are earned.

Investments in Real Estate Limited Partnerships

The Bank has investments in various real estate limited partnerships that 
acquire, develop, own and operate low and moderate-income housing. The 
Bank's ownership interest in these limited partnerships varies from 35% to 
99.9% as of December 31, 1998. The Company consolidates the financial 
statements of the limited partnership in which the Company is the general 
partner, actively involved in management and has a controlling interest. The 
Bank accounts for its investments in limited partnerships where the Bank 
neither actively participates nor has a controlling interest under the 
equity method of accounting.

Management periodically reviews the results of operations of the various 
real estate limited partnerships to determine if the partnerships generate 
sufficient operating cash flow to fund their current obligations. In 
addition, management reviews the current value of the underlying property 
compared to the outstanding debt obligations. If it is determined that the 
investment suffers from a permanent impairment, the carrying value is 
written down to the estimated realizable value.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand, amounts due from banks 
and federal funds sold in the accompanying consolidated statements of cash 
flows. At December 31, 1998 and 1997, cash and cash equivalents included 
$2.5 million and $2.2 million, respectively, held to satisfy the reserve 
requirements of the Federal Reserve Bank.

Other Real Estate Owned

Collateral acquired through foreclosure is recorded at the lower of cost or 
fair value, less estimated costs to sell, at the time of acquisition. Bank 
premises held for sale are recorded at the lower of cost or market, less 
estimated costs to sell, at the date of transfer. Subsequent changes in the 
fair value of other real estate owned are reflected as a write-down and 
charged to expense. Net operating income or expense related to foreclosed 
property and Bank premises held for sale is included in noninterest expense 
in the accompanying consolidated statements of operations. There are 
inherent uncertainties in the assumptions with respect to the estimated fair 
value of other real estate owned. Because of these inherent uncertainties, 
the amount ultimately realized on other real estate owned ("OREO") may 
differ from the amounts reflected in the consolidated financial statements. 
The Bank recognized losses due to write downs of $20 thousand, $34 thousand 
and $2,495 thousand during 1998, 1997 and 1996, respectively. At December 
31, 1998 the balance in the OREO portfolio consisted of foreclosed real 
estate of $470 thousand.

Intangible Assets

Premiums paid for the purchase of core deposits are recorded as other assets 
and amortized using a straight-line method over 15 years. Management reviews 
the value of the intangible asset by comparing purchased deposit levels to 
the current level of acquired deposits in the branches purchased. If any 
significant deposit runoff has occurred and is determined to be permanent in 
nature, the asset is written down accordingly.

Earnings Per Share

In 1997 the Company adopted Statement of Financial Accounting Standards 
("SFAS") No. 128, "Earnings Per Share" which establishes new standards for 
computing and presenting earnings per share ("EPS"). SFAS No. 128 applies to 
entities with publicly held common stock or potential common stock. This 
statement requires dual presentation of basic and diluted EPS on the face of 
the income statement for all entities with complex capital structures and 
requires a reconciliation of the numerators and denominators of the basic 
and diluted EPS computations for all prior-period EPS data presented. Refer 
to Note 11 for additional information.

Comprehensive Income

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS 
No. 130, "Reporting Comprehensive Income". This statement establishes 
standards for reporting and display of comprehensive income and its 
components (revenues, expenses, gains and losses). Components of 
comprehensive income are net income and all other non-owner changes in 
equity. This statement requires that an enterprise (a) classify items of 
other comprehensive income by their nature in a financial statement and (b) 
display the accumulated balance of other comprehensive income separately 
from retained earnings and additional paid-in capital in the equity section 
of a statement of financial position. This statement is effective, and has 
been adopted, for the Company's financial statements issued for the year 
ended December 31, 1998.

Segment Information

In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of 
an Enterprise and Related Information". This statement establishes the 
standards for reporting information about segments in annual and interim 
financial statements. SFAS No. 131 introduces a new model for segment 
reporting; the "management approach". The management approach is based on 
the way the chief operating decision-maker organizes segments within a 
company for making operating decisions and assessing performance. Reportable 
segments are based on products and services, geography, legal structure, 
management structure - any manner in which management disaggregates a 
company. This statement is effective and has been adopted for the Company's 
financial statements for the fiscal year ended December 31, 1998. Refer to 
Note 14 for additional information.

Derivative Instruments and Hedging Activities

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative 
Instruments and Hedging Activities". This statement establishes standards 
for reporting and accounting for derivative instruments ("derivatives") and 
hedging activities. The statement requires that derivatives be reported as 
assets or liabilities in the consolidated balance sheets and that 
derivatives be reported at fair value. The statement establishes criteria 
for accounting for changes in the fair value of derivatives based on the 
intended use of the derivatives. The statement is effective for all quarters 
of years beginning after June 15, 1999. Based on the Bank's current and 
anticipated investment and hedging activities the Company does not expect 
the adoption of SFAS No. 133 to have a material impact on the Company's 
financial position or results of operations.

Reclassification

Certain amounts reported for prior periods have been reclassified to be 
consistent with the current period presentation.

(2)   INVESTMENT SECURITIES

Investments in debt securities are classified as trading, available for sale 
or held to maturity as of December 31, 1998 and 1997. The amortized cost and 
fair values of the debt securities classified as available for sale and held 
to maturity as of December 31, 1998 and 1997 are as follows:

SECURITIES AVAILABLE FOR SALE:

<TABLE>
<CAPTION>
                                                     Gross          Gross
                                     Amortized     Unrealized     Unrealized       Fair
                                       Cost          Gains          Losses        Value
      -----------------------------------------------------------------------------------
      1998                                              (In thousands)
      -----------------------------------------------------------------------------------
      <S>                            <C>             <C>             <C>         <C>
      U.S. Agency Obligations        $ 30,774        $  481          $ 62        $ 31,193
      Mortgage-backed Securities       41,058           130           176          41,012
      -----------------------------------------------------------------------------------
                                     $ 71,832        $  611          $238        $  2,205
      ===================================================================================

<CAPTION>
                                                     Gross          Gross
                                     Amortized     Unrealized     Unrealized       Fair
                                       Cost          Gains          Losses        Value
      -----------------------------------------------------------------------------------
      1997                                              (In thousands)
      -----------------------------------------------------------------------------------
      <S>                            <C>             <C>             <C>         <C>
      U.S. Agency Obligations        $ 31,058        $  271          $  -        $ 31,329
      Mortgage-backed securities       12,825           105            18          12,912
      -----------------------------------------------------------------------------------
                                     $ 43,883        $  376          $ 18        $ 44,241
      ===================================================================================

SECURITIES HELD TO MATURITY:

<CAPTION>
                                                     Gross          Gross
                                     Amortized     Unrealized     Unrealized       Fair
                                       Cost          Gains          Losses        Value
      -----------------------------------------------------------------------------------
      1998                                              (In thousands)
      <S>                            <C>             <C>             <C>         <C>
      U.S. Treasury Obligations      $    452        $   13          $  -        $    465
      U.S. Agency Obligations          14,979            84             -          15,063
      Mortgage-backed Securities       88,420         1,786            17          90,189
      -----------------------------------------------------------------------------------
                                     $103,851        $1,883          $ 17        $105,717
      ===================================================================================

<CAPTION>
                                                     Gross          Gross
                                     Amortized     Unrealized     Unrealized       Fair
                                       Cost          Gains          Losses        Value
      -----------------------------------------------------------------------------------
      1997                                              (In thousands)
      -----------------------------------------------------------------------------------
      <S>                            <C>             <C>             <C>         <C>
      U.S. Treasury Obligations      $    200        $    -          $  -        $    200
      U.S. Agency Obligations          12,526            94             4          12,616
      Mortgage-backed Securities       98,732           960            41          99,651
      -----------------------------------------------------------------------------------
                                     $111,458        $1,054          $ 45        $112,467
      ===================================================================================
</TABLE>

The fair value of securities held for trading was $1,095 thousand and $1,031 
thousand at December 31, 1998 and 1997 respectively. Gains on securities 
held for trading were $331 thousand and $267 thousand as of December 31, 
1998 and 1997, respectively.

The contractual maturities of all debt securities held at December 31, 1998 
are as follows:

<TABLE>
<CAPTION>
                                                 Amortized     Fair
      (In thousands)                               Cost        Value
      -----------------------------------------------------------------
      <S>                                        <C>           <C>
      Due within one year                        $  1,399      $  1,405
      Due after one year through five years        19,473        19,820
      Due after five years through ten years       58,937        59,942
      Due after ten years                          95,874        96,755
      -----------------------------------------------------------------
                                                 $175,683      $177,922
      =================================================================
</TABLE>

Proceeds from sales of available for sale debt securities were $14 million 
and $18.9 million during 1998 and 1997, respectively. Gross gains of $44 
thousand, $840 thousand and $120 thousand and gross losses of $0, $56 
thousand and $87 thousand were realized from sales of securities in 1998, 
1997 and 1996, respectively.

On November 29, 1996, $87.5 million of securities available for sale were 
transferred to the held to maturity portfolio. Net unrealized gains of $219 
thousand associated with these securities are being amortized over the 
remaining lives of the individual securities. 

At December 31, 1998, securities with a face value of $16.2 million were 
pledged to secure public deposits, and for other purposes required by law.

(3)   LOANS

The composition of the loan portfolio at December 31, 1998 and 1997 is as 
follows:

<TABLE>
<CAPTION>
      (In thousands)                               1997         1997
      ----------------------------------------------------------------
      <S>                                        <C>          <C>
      Commercial, Financial and Agricultural     $ 63,953     $ 73,523
      Real Estate-Commercial                      170,892      181,018
      Real Estate-Residential                     147,348      111,270
      Real Estate-Construction                      8,091        8,695
      Installment Loans to individuals             14,676       15,450
      All Other Loans (including overdrafts)          532          432
      ----------------------------------------------------------------
      Total Loans                                $405,492     $390,388
      ================================================================
</TABLE>

The Bank currently originates primarily residential real estate loans, 
commercial and installment loans, and commercial real estate loans to 
customers throughout the state of Vermont. There were no loans held for sale 
at December 31, 1998 and 1997. Substantially all of the Bank's loan 
portfolio is based in the state of Vermont. There are no known significant 
industry concentrations in the loan portfolio. Loans serviced for others at 
December 31, 1998 and 1997 amounted to $160 million and $230 million, 
respectively.

The reserve for possible loan losses is based on management's estimate of 
the amount required to reflect the risks in the loan portfolio, based on 
circumstances and conditions known or anticipated at each reporting date. 
There are inherent uncertainties with respect to the final outcome of 
certain of the Bank's loans and nonperforming assets. Because of these 
inherent uncertainties, actual losses may differ from the amounts reflected 
in these consolidated financial statements. Factors considered in evaluating 
the adequacy of the reserve 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. Losses are charged against the reserve 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 have significantly increased or diminished the 
reserve is adjusted through current earnings.

Key elements of the above estimates, including those used in independent 
appraisals, are dependent upon the economic conditions prevailing at the 
time of the estimates. Accordingly, uncertainty exists as to the final 
outcome of certain of the valuation judgments. The inherent uncertainties in 
the assumptions relative to the projected sales prices or rental rates may 
result in the ultimate realization of amounts on certain loans that are 
different from the amounts reflected in these consolidated financial 
statements.

An analysis of the reserve for possible loan losses for the years ended 
December 31, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>
      (In thousands)                          1998        1997
      ----------------------------------------------------------
      <S>                                    <C>         <C>
      Balance, Beginning of Year             $15,831     $15,700
      Provision for Possible Loan Losses      (1,737)     (1,862)
      Loans Charged Off                       (3,935)     (1,696)
      Recoveries                               1,141       3,689
      ----------------------------------------------------------
      Balance, End of Year                   $11,300     $15,831
      ==========================================================
</TABLE>

The allowance for possible loan losses related to loans that are identified 
as impaired is based on discounted cash flows using the loan's effective 
interest rate or the fair value of the collateral for certain collateral 
dependent loans. The Company has determined that commercial and commercial 
real estate loans recognized by the Company as nonaccrual, loans past due 
over 90 days and still accruing, restructured troubled debt and certain 
internally adversely classified loans are generally equivalent to impaired 
loans.

Total impaired loans at December 31, 1998 and 1997 with a related allowance 
were $3.9 million and $4.8 million respectively, and the allowance 
associated with such loans was $400 thousand and $665 thousand, 
respectively. Interest payments on impaired loans are generally recorded as 
principal reductions if the remaining loan balance is not expected to be 
paid in full. If full collection of the remaining loan balance is expected, 
payments are recognized as interest income on a cash basis. During 1998 and 
1997, the Company recorded interest income on impaired loans of 
approximately $240 thousand and $394 thousand, respectively. The average 
balance of impaired loans was $6.9 million in 1998 and $7.9 million in 1997.

Nonperforming assets at December 31, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
      (In thousands)                     1998       1997
      ----------------------------------------------------
      <S>                                <C>        <C>
      Nonaccrual loans                   $2,103     $2,686
      Restructured Loans                    320        215
      Loans Past Due 90 Days or More
       and Still Accruing Interest          170        403
      ----------------------------------------------------
      Total Nonperforming Loans           2,593      3,304
      Other Real Estate Owned, Net          470        591
      ----------------------------------------------------
      Total Nonperforming Assets         $3,063     $3,895
      ====================================================
</TABLE>

The Bank had $320 thousand and $215 thousand of restructured loans that were 
performing in accordance with the modified agreement at December 31, 1998 
and 1997, respectively.

The Bank's policy is to discontinue the accrual of interest and reverse 
uncollected interest receivable on loans when scheduled payments become 
contractually past due in excess of 90 days or, in the judgment of 
management, the ultimate collectibility of principal or interest becomes 
doubtful.

The amount of interest which was not earned but which would have been earned 
had the nonaccrual and restructured loans performed in accordance with their 
original terms and conditions was approximately $441 thousand, $395 thousand 
and $1,493 thousand in 1998, 1997 and 1996, respectively.

During 1998 the Bank consummated transactions involving sales of loans, 
including certain impaired loans. The aggregate net book value of loans sold 
was approximately $15.1 million. The Bank recognized total income of $357 
thousand from the sale of these loans. During 1997, the Bank consummated two 
such transactions, including certain impaired loans. The aggregate net book 
value of loans sold in 1997 was approximately $2.7 million, resulting in a 
gain on sales of $396 thousand, which was credited to the reserve for 
possible loan losses. All loans were sold without recourse.

An analysis of loans to directors, executive officers, and associates of 
such persons for the year ended December 31, 1998 is as follows:

<TABLE>
<CAPTION>
      (In thousands)
      -------------------------------------
      <S>                            <C>
      Balance, December 31, 1997     $8,950
      Additions                         718
      Repayments                       (783)
      -------------------------------------
      Balance, December 31, 1998     $8,885
      =====================================
</TABLE>

It is the policy of the Bank to grant such loans on substantially the same 
terms, including interest rates and collateral, as those prevailing for 
comparable lending transactions with other persons. The December 31, 1998 
balance has been adjusted to reflect changes in status of directors and 
executive officers during 1998.

(4)   PREMISES AND EQUIPMENT

The components of premises and equipment included in the accompanying 
consolidated balance sheets are as follows:

<TABLE>
<CAPTION>
      (In thousands)                          1998        1997
      ----------------------------------------------------------
      <S>                                    <C>         <C>
      Land and Buildings                     $12,926     $12,601
      Leasehold Improvements                   1,221       1,288
      Furniture, Equipment, and Software      10,322      10,617
      ----------------------------------------------------------
                                              24,469      24,506
      Less: Accumulated Depreciation
       and Amortization                       11,284      11,078
      ----------------------------------------------------------
                                             $13,185     $13,428
      ==========================================================
</TABLE>

Depreciation and amortization expense related to premises and equipment 
amounted to $2.2 million, $2.0 million and $1.7 million in 1998, 1997, and 
1996, respectively.

The Bank leases certain properties for branch operations. Rent expense on 
these properties totaled $303 thousand, $263 thousand and $240 thousand for 
the years ended December 31, 1998, 1997 and 1996, respectively. Minimum 
lease payments for these properties subsequent to December 31, 1998 are as 
follows: 1999-$329 thousand; 2000-$293 thousand; 2001-$286 thousand; 2002-
$242 thousand; 2003-$180 thousand and $288 thousand thereafter.

(5)   EMPLOYEE BENEFIT PLANS

Pension Plan

Prior to January 1995, the Company maintained a noncontributory defined 
benefit plan covering all eligible employees. The plan was a final average 
pay plan with benefits based on the average salary rates over the five 
consecutive plan years out of the last ten consecutive plan years that 
produce the highest average. It was the Company's 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 1994, the Company made the 
decision to freeze the plan beginning on January 1, 1995. 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 plan's funded status and amounts recognized in the accompanying 
consolidated balance sheets and statements of operations as of December 31, 
1998 and 1997 are as follows:

<TABLE>
<CAPTION>
      (In thousands)                                          1998       1997
      -----------------------------------------------------------------------
      <S>                                                   <C>        <C>
      Change in Projected Benefit Obligation
      Projected Benefit Obligation at Beginning of Year     $6,610     $5,180
      Interest Cost                                            465        452
      Actuarial Gain                                           473      1,444
      Benefits Paid                                           (475)      (466)
      -----------------------------------------------------------------------
      Projected Benefit Obligation at Year End              $7,073     $6,610
      -----------------------------------------------------------------------
      Change in Plan Assets
      Fair Value of Plan Assets at Beginning of Year        $7,308     $6,778
      Actuarial Return on Plan Assets                          866        996
      Benefits Paid                                           (475)      (466)
      -----------------------------------------------------------------------
      Fair Value of Plan Assets at Year End                 $7,699     $7,308
      -----------------------------------------------------------------------
      Funded Status of the Plan
      Amount Over Funded                                    $  626     $  698
      Unrecognized Net Actuarial Loss                          771        602
      Unrecognized Prior Service Cost                          (15)       (54)
      -----------------------------------------------------------------------
      Net Amount Recognized                                 $  756     $  548
      -----------------------------------------------------------------------
      Amounts Recognized in the Statements of 
       Financial Position Consist of the Following:
      Prepaid Benefit Cost                                  $1,382     $1,246
      =======================================================================
</TABLE>

A summary of (income) expense relating to the Company's pension fund for 
each of the three years in the period ended December 31, 1998 is as follows:

<TABLE>
<CAPTION>
      (In thousands)                              1998      1997      1996
      ---------------------------------------------------------------------
      <S>                                         <C>       <C>       <C>
      Interest Cost on Projected Benefit
       Obligation                                 $ 465     $ 452     $ 402
      Expected Return on Plan Assets               (530)     (563)     (507)
      Amortization of Unrecognized Transition
       Asset                                        (39)      (39)      (39)
      Recognized Net Losses                           4         -         -
      ---------------------------------------------------------------------
      Net Periodic Pension Costs                  $(100)    $(150)    $(144)
      =====================================================================
</TABLE>

The actuarial present value of the projected benefit obligation was 
determined using a weighted average discount rate of 6.75%, 7% and 7.6% as 
of December 31, 1998, 1997 and 1996, respectively. For 1998, 1997 and 1996 
there was no assumed rate of increase in future compensation due to the 
freeze on plan benefits. The expected long-term rate of return on assets 
used was 8% in 1998, 8% in 1997 and 9% in 1996.

Employee Stock Ownership Plan/401(k) Plan 

Under the terms of the Company's Employee Stock Ownership Plan (ESOP), 
eligible employees are entitled to contribute up to 15% of their 
compensation to the ESOP, and the Company contributes a percentage of the 
amounts contributed by the employees, as authorized by the Company's Board 
of Directors. The Company contributed approximately 128% and 126%, 
respectively, of the amounts contributed by the employees (200% of up to 
4.5% of individual employee compensation) in 1998 and 1997. Substantially 
all employer contributions to the ESOP are funded with cash and are used to 
purchase the Company's common stock.

Deferred Compensation Plans

Until July 1, 1997, Directors of the Bank were entitled to defer a portion 
of their compensation into a Deferred Compensation Plan for Directors known 
as the "Floating Growth (savings)" program. The Board of Directors voted at 
their February 1997 meeting to amend the Plan to provide that no additional 
compensation may be deferred into the Floating Growth (savings) program 
after July 1, 1997.  Benefits accrue based on the Directors' fees deferred 
and a monthly allowance for interest at a rate that is fixed from time to 
time at the discretion of the Board of Directors. The benefits under the 
Floating Growth (savings) program of the Deferred Compensation Plan for 
Directors and the New Plans are generally payable starting on the January 2 
following a participant's 65th birthday or earlier death, and will be 
distributed to the participant (or upon the participant's death, to the 
participant's designated beneficiary) in accordance with the Plan.

A summary of (income) expense relating to the Company's various employee 
benefit plans for each of the three years in the period ended December 31, 
1998 is as follows:

<TABLE>
<CAPTION>
      (In thousands)                   1998       1997       1996
      -----------------------------------------------------------
      <S>                             <C>        <C>        <C>
      Pension Plan                    $(100)     $(150)     $(144)
      Employee Stock Ownership
       Plan/401(k) Plan                 588        685        653
      Deferred Compensation Plans        11         20         27
      -----------------------------------------------------------
      Total                           $ 499      $ 555      $ 536
      ===========================================================
</TABLE>

(6)   STOCK-BASED COMPENSATION PLANS

Stock Option Plans

The Company has granted stock options to certain key employees. The options 
granted vest after two years and are immediately exercisable upon vesting. 
Nonqualified stock options may be granted at any price determined by the 
Compensation Committee of the Board of Directors. All stock options have 
been granted at or above fair market value at the date of grant.

A summary of the Company's stock option activity is as follows

<TABLE>
<CAPTION>
                                            1998                   1997                    1996
       -----------------------------------------------------------------------------------------------
                                                Weighted                Weighted                Option
                                      Number    Average      Number     Average      Number     Price
                                        of      Exercise       of       Exercise       of        Per
                                      Shares     Price       Shares      Price       Shares     Share
       -----------------------------------------------------------------------------------------------
                                                    (In thousands except per share data)
      <S>                              <C>       <C>          <C>        <C>           <C>      <C>
      Options outstanding,
       Beginning of year               103       $21.88        50        $12.45        40       $11.72
      Granted                           48       $30.50        71        $25.69        10       $15.38
      Exercised                         13       $12.61        18        $10.72         -            -
       -----------------------------------------------------------------------------------------------
      Options outstanding,
       end of year                     138       $25.76       103        $21.88        50       $12.45
      Options exercisable               19       $13.98        22        $12.53        20       $11.00
      Weighted average fair value
       per option of options
       granted during year                       $ 6.92                  $ 6.71                 $ 6.83
       -----------------------------------------------------------------------------------------------
</TABLE>


As of December 31, 1998, the exercisable options outstanding were 
exercisable at prices ranging from $10.00 to $15.37 and had a weighted-
average remaining contractual life of 3.8 years.

In October, 1995 the FASB issued SFAS No. 123, "Accounting for Stock Based 
Compensation" ("SFAS No. 123"), which establishes a fair value based method 
of recognizing stock-based compensation expense. As permitted by SFAS No. 
123, the Company has elected to continue to apply APB No. 25 to account for 
its stock-based compensation plans. Had compensation cost for awards under 
the Company's stock-based compensation plans been determined consistent with 
the method set forth under SFAS No. 123, the effect on the Company's net 
income and earnings per share would have been as follows:

<TABLE>
<CAPTION>
                                               1998                          1997
      --------------------------------------------------------------------------------------
                                     As Reported     Pro Forma     As Reported     Pro Forma
      --------------------------------------------------------------------------------------
                                              (In thousands except per share data)
      <S>                              <C>            <C>            <C>            <C>
      Net Income                       $9,822         $9,712         $8,833         $8,679
      Basic Earnings per Share         $ 2.22         $ 2.19         $ 2.00         $ 1.97
      Diluted Earnings per Share       $ 2.21         $ 2.19         $ 1.99         $ 1.96
      --------------------------------------------------------------------------------------
</TABLE>

Because the method prescribed by SFAS No. 123 has not been applied to 
options granted prior to January 1, 1995, the resulting pro forma 
compensation expense may not be representative of the amount to be expected 
in future years. Pro forma compensation expense for options granted is 
reflected over the vesting period; therefore, future pro forma compensation 
expense may be greater as additional options are granted.

The fair value of each option grant is estimated on the grant date using the 
Black-Scholes option-pricing model with the following weighted-average 
assumptions used for grants in 1998 and 1997, respectively: Risk-free 
interest rates of 4.59% for 1998 and 6.0% 1997; expected lives of options of 
5 years for 1998 and 4 years for 1997; expected volatility of stock of 
30.05% for 1998 and 34.37% for 1997;  rate of dividends of 2.53% for 1998 
and 2.48% for 1997; and pro-forma after tax compensation expense of $110 
thousand for 1998 and $308 thousand for 1997.

The Black-Scholes option-pricing model was developed for use in estimating 
the fair value of traded options that have no vesting restrictions and are 
fully transferable. In addition, option-pricing models require the input of 
highly subjective assumptions. Because the Company's employee stock options 
have characteristics significantly different from those of traded options, 
and because changes in the subjective input assumptions can materially 
affect the fair value estimate, in management's opinion, the existing models 
do not necessarily provide a reliable single measure of the fair value of 
its employee stock options.

Deferred Compensation Plans

Through December 1995, the Bank maintained an Executive Salary Continuation 
Plan and a Deferred Compensation Plan for Directors. In December 1995, the 
Bank and participants in its Executive Salary Continuation Plan and in the 
Fixed Growth Program of its Deferred Compensation Plan for Directors agreed 
to amend or terminate the existing plans. In satisfaction of all liabilities 
under those plans, the Bank agreed to make payments to, or credits for, the 
participants. Pursuant to these agreements, the Bank established several new 
plans (the "New Plans") and established certain trusts (the "Trusts") with 
Merchants Trust Company, to which it contributed an amount sufficient to 
cover the Bank's obligations under the New Plans. The New Plans used those 
payments, in part, to purchase newly issued common stock of the Company at 
its market price. The purchases have been accounted for as treasury stock 
transactions in the Company's consolidated financial statements. The 
portions of the payments made to the New Plans that were not invested in the 
common stock of the Company are included as investments in the consolidated 
financial statements and are classified as trading. In conjunction with the 
amendment and termination of the existing plans, the Bank either sold or 
surrendered certain life insurance policies and used the proceeds as a 
partial source to fund the lump sum payments made to the New Plans. To the 
extent the obligations of the Company under the New Plans are based on 
investments by the New Plans in other than shares of the Company, the 
investments are revalued at each reporting date with a corresponding 
adjustment to compensation expense. In addition, the obligation related to 
certain Company shares, originally purchased for $200 thousand, were 
revalued at each reporting date, with a corresponding adjustment to 
compensation expense. These Company shares were sold during December 1997.

In July 1998, the Emerging Issues Task Force ("EITF") issued guidance on 
Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where 
Amounts Earned Are Held in a Rabbi Trust and Invested" (the "Guidance"). 
This Guidance establishes standards for reporting and accounting for certain 
deferred compensation agreements between the Company and certain of its 
directors. This Guidance requires that the deferred compensation obligation 
be classified in the "Stockholders' Equity" section of the balance sheets. 
These amounts were previously classified as other liabilities in the 
"Liabilities" section of the balance sheets. The Company adopted this 
guidance prospectively on September 30, 1998 and on that date reclassified 
deferred compensation obligations totaling $2.13 million to a component 
within Stockholders' Equity labeled "Deferred Compensation Arrangements".

Restricted Stock Plans

The Company and the Bank adopted new compensation plans for non-employee 
directors during 1997. Under the terms of the plans, participating directors 
may elect to have all or a specified percentage of his or her compensation 
for a given year paid in the form of cash or deferred in the form of shares 
of restricted common stock of the Company. Directors who elect to have their 
compensation deferred shall be credited with a number of shares of the 
Company's stock equal in value to the amount of fees deferred plus a risk 
premium of not more than 25% of the amount deferred. The participating 
director may not generally sell, transfer or otherwise dispose of these 
shares, prior to the fifth anniversary of the date of the grant of such 
shares. With respect to shares of common stock issued or otherwise 
transferred to a participating director, the participating Director will 
have the right to vote the shares and receive dividends or other 
distributions thereon. If a participating Director resigns under certain 
circumstances the Director shall forfeit all of his or her restricted 
shares, which are risk premium shares. During 1998, 5,200 shares of common 
stock of the Company were distributed to a trust established under the terms 
of the new compensation plan. The "risk premium" is reflected within a 
component of Stockholders' Equity labeled "Deferred Compensation 
Arrangements" and will be recognized as an expense ratably over the five-
year restriction period.

(7)   INCOME TAXES

The provision (benefit) for income taxes for each of the three years in the 
period ended December 31, 1998 consists of the following:

<TABLE>
<CAPTION>
      (In thousands)          1998       1997       1996
      ----------------------------------------------------
      <S>                    <C>        <C>        <C>
      Current                $3,065     $1,499     $ 3,307
      Deferred (Prepaid)        183        884      (1,475)
      ----------------------------------------------------
                             $3,248     $2,383     $ 1,832
      ====================================================
</TABLE>

Prepaid and deferred income taxes result from differences between the income 
for financial reporting and tax reporting relating primarily to the 
provision for possible loan losses. The net deferred tax asset amounted to 
approximately $4.2 million and $4.4 million at December 31, 1998 and 1997, 
respectively. This tax asset is included in other assets in the accompanying 
consolidated balance sheets.

The components of the net deferred tax asset as of December 31, 1998 and 
1997 are as follows:

<TABLE>
<CAPTION>
      (In thousands)                                       1997        1996
      -----------------------------------------------------------------------
      <S>                                                 <C>         <C>
      Reserve for Possible Loan Losses                    $ 4,064     $ 5,605
      Deferred Compensation                                 1,340       1,335
      Unrealized Securities Gains                            (191)       (197)
      Loan Fees                                               104         191
      Depreciation                                           (876)       (599)
      Accrued Liabilities                                      46        (335)
      Capital Loss Carryforwards                                -         618
      Investments in Real Estate Limited Partnerships        (968)       (712)
      Excess Servicing Right                                  (17)        (31)
      Loan Market Adjustment                               (2,932)     (4,505)
      Other                                                  (975)     (1,131)
      Tax Credit Carryforwards                              4,190       4,293
      Core Deposit Intangible                                 472         526
      -----------------------------------------------------------------------
                                                            4,257       5,058
      Valuation Allowance                                       -        (618)
      -----------------------------------------------------------------------
                                                          $ 4,257     $ 4,440
      =======================================================================
</TABLE>

A valuation allowance is provided when it is more likely than not that some 
portion of the net prepaid tax asset will not be realized. The Company had 
established a valuation allowance for capital loss carryforwards since such 
losses may only be utilized against future capital gains.

The following is a reconciliation of the federal income tax provision 
(benefit), calculated at the statutory rate, to the recorded provision 
(benefit) for income taxes:

<TABLE>
<CAPTION>
      (In thousands)                              1997        1996        1995
      --------------------------------------------------------------------------
      <S>                                        <C>         <C>         <C>
      Applicable Statutory Federal Income
       Tax                                       $ 4,444     $ 3,779     $ 2,739
      (Reduction) Increase in Taxes
       Resulting From:
        Gain (Loss) on Investment Securities           -        (134)         27
        Tax-exempt Income                            (41)        (55)        (74)
        Tax Credits                               (1,328)     (1,089)       (980)
        Other, Net                                   173        (118)        120
      --------------------------------------------------------------------------
                                                 $ 3,248     $ 2,383     $ 1,832
      ==========================================================================
</TABLE>

The state of Vermont assesses a franchise tax for banks in lieu of income 
tax. The franchise tax is assessed based on deposits and amounted to 
approximately $590 thousand, $386 thousand, and $255 thousand in 1998, 1997, 
and 1996, respectively. These amounts are included in other expenses in the 
accompanying consolidated statements of operations. The Company received 
refunds of its 1995, 1994, and 1993 Vermont Franchise Taxes of $797 thousand 
during 1996.

(8)   OTHER BORROWED FUNDS

Other borrowed funds consist of the following at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
      (In thousands)                   1998       1997
      -------------------------------------------------
      <S>                             <C>        <C>
      Treasury Tax and Loan Notes     $  283     $4,000
      Short Term Borrowing             9,000      4,000
      -------------------------------------------------
                                      $9,283     $8,000
      =================================================
</TABLE>

As of December 31, 1998, the Bank may borrow up to $35 million in overnight 
funds on an unsecured basis. 

The following table provides certain information regarding other borrowed 
funds for the two years ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                        Maximum                         Weighted
                                       Month-End        Average       Average Rate       Weighted
                                        Amount          Amount           During        Average Rate
      (In thousands)                  Outstanding     Outstanding       the Year       at Year End
      ---------------------------------------------------------------------------------------------
      <S>                               <C>             <C>              <C>              <C>
      1998
      Treasury Tax and Loan Notes       $ 4,000         $1,939           5.14%            4.12%
      Federal Funds Purchased             6,000            730           5.70%               -
      Short Term Borrowing               20,000          2,986           5.68%            5.66%
      ---------------------------------------------------------------------------------------------
      1997
      Treasury Tax and Loan Notes       $ 4,182         $2,413           5.39%            5.27%
      Federal Funds Purchased             3,850            906           5.99%               -
      Short Term Borrowing               15,000          4,880           5.87%            6.16%
      ---------------------------------------------------------------------------------------------
</TABLE>

(9)   DEBT

Debt consists of the following at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
      (In thousands)                                                1998       1997
      ------------------------------------------------------------------------------
      <S>                                                          <C>        <C>
      9%  Note Payable, Monthly Installments of
       $1.7 thousand (Principal and Interest), Annual
       Installments of $30 Thousand (Principal only) , Through
       July 2003                                                   $  197     $  200
      8.75% Mortgage Note, payable in Monthly Installments of
       $2.5 thousand (Principal and Interest) Through 2039          1,182      1,185
      Federal Home Loan Bank Notes Payable, Interest Rates
       From 7.52% to 8.66% Due in 2001                              5,030      5,030
      ------------------------------------------------------------------------------
                                                                 $  6,409     $6,415
      ==============================================================================
</TABLE>

The 8.75% mortgage note relates to a low-income housing project. The monthly 
installments are subsidized by the U.S. Department of Agriculture, which 
pays amounts annually so as to reduce the monthly principal and interest 
payments to an amount equivalent to a loan at a rate of 1%.

Maturities of debt subsequent to December 31, 1998 are as follows: 1999-$37 
thousand; 2000-$41 thousand; 2001-$5,075 thousand; 2002-$49 thousand; 2003-
$44 thousand and $1,163 thousand thereafter.

As of December 31, 1998, the Company is in compliance with all of the 
covenants of the Federal Home Loan Bank ("FHLB") agreements.

(10)  STOCKHOLDERS' EQUITY

Vermont state law requires the Bank to appropriate a minimum of 10% of net 
income to surplus until such time as appropriated amounts equal 10% of 
deposits and other liabilities. The Company's stockholders' equity includes 
$9.0 million as of December 31, 1998 and $8.1 million as of December 31, 
1997 of such appropriations. Vermont state law also restricts the payment of 
dividends under certain circumstances.

(11)  EARNINGS PER SHARE

The following table presents a reconciliation of the calculations of basic 
and diluted earnings per share for the year ended December 31, 1998:

<TABLE>
<CAPTION>
                                                                                    Per Share
      1998                                                 Income      Shares        Amount
      ---------------------------------------------------------------------------------------------
                                                     (In thousands except share and per share data)
      <S>                                                  <C>        <C>             <C>
      Basic Earnings Per Share:
       Income Available to Common Shareholders             $9,822     4,425,031       $2.22
      Diluted Earnings Per Share:
       Options issued to Executives (See Note 6)                -        15,034
       Income Available to Common Shareholders
        Plus Assumed Conversions                           $9,822     4,440,065       $2.21
      =============================================================================================

<CAPTION>
                                                                                    Per Share
      1997                                                 Income      Shares        Amount
      ---------------------------------------------------------------------------------------------
                                                     (In thousands except share and per share data)
      <S>                                                  <C>        <C>             <C>
      Basic Earnings Per Share:
       Income Available to Common Shareholders             $8,833     4,423,153       $2.00
      Diluted Earnings Per Share:
       Options issued to Executives (See Note 6)                -        23,256
       Income Available to Common Shareholders
        Plus Assumed Conversions                           $8,833     4,446,409       $1.99
      =============================================================================================
</TABLE>

Basic earnings per common share were computed by dividing net income by the 
weighted average number of shares of common stock outstanding during the 
year. Upon adoption of SFAS No. 128 the Company's reported earnings per 
share for 1996 were restated. There was no effect on earnings per share for 
1996.

(12)  COMMITMENTS AND CONTINGENCIES

The Bank is a counterclaim defendant in a litigation entitled Pasquale and 
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim 
Defendant, now pending in the United States Bankruptcy Court for the 
District of Vermont.

In this litigation, the Vescios have made a number of "lender liability" 
claims dealing with a commercial development known as Brattleboro West in 
Brattleboro, Vermont. The pending litigation arose out of a suit to 
foreclose on several real estate mortgages and personal property originally 
delivered to the Bank as collateral by the Vescios in connection with the 
financing of a supermarket in the Brattleboro West project and various other 
projects.

Among other things, the Vescios have alleged that the Bank or its 
representatives violated supposed oral promises in connection with the 
origination and funding of the financing, and have claimed that the Bank is 
liable to them for damages based on the Bank's supposed "control" of the 
project and its alleged breach of covenants of "good faith" which the 
plaintiffs believe are to be implied from the loan documents. In addition, 
the plaintiffs have contended that the Bank breached a duty of care they 
believe it owed to them, and have claimed that the Bank should not have 
exercised its contract rights when the loan went into default, but should 
have worked out the default in a way that was more favorable to the 
borrowers.  Trial concluded in United States Bankruptcy Court in November 
1998. Although it is not possible at this stage to predict the outcome of 
this litigation, the Bank believes that it has meritorious defenses to the 
plaintiffs' allegations. The Bank intends to vigorously defend itself 
against these claims.

The Company, the Bank, the Trust Company (the "Companies") and certain of 
their directors are defendants in a lawsuit filed in November 1994 (the 
"Vermont Proceedings"). The Vermont Proceedings arose from certain 
investments managed for Trust Company customers and placed in the Piper 
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In 
December 1994, the Companies made payments to the Trust Company customers in 
amounts that the Companies believed reimbursed those customers fully for 
Portfolio losses. The United States District Court for the District of 
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with 
prejudice, as moot, and ordered payment of approximately $99,000 in 
attorney's fees. The Plaintiff and his attorneys  appealed those District 
Court orders to the Second Circuit Court of Appeals, and the Companies 
appealed on certain limited issues. By Order dated January 28, 1999 the 
Second Court affirmed those District Court orders in all material respects 
and remanded the case to the District Court with instructions to clarify 
whether the dismissal of the claims as moot was to be with prejudice. Still 
pending before the Second Circuit is a separate appeal from the District 
Court's denial of Plaintiff's requests for sanctions and other relief based 
on asserted improprieties in the defense of the litigation. The Companies 
believe the Plaintiff's assertions in that regard are groundless and will 
continue to seek denial of Plaintiff's requests.

The Companies have separately pursued claims against others on account of 
the losses suffered as a result of the investments in the Portfolio. Claims 
against Piper Jaffray Companies, Inc. were joined with the claims of others 
in a class action in the United States District Court for the District of 
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were 
settled by the parties and in February of 1997 the District Court ordered 
the net share of the settlement proceeds attributable to the Trust Company's 
investments to be paid to the Trust Company, starting approximately 60 days 
after the Court's order becomes final, except to the extent, if at all, any 
other court with jurisdiction has sooner given leave for some or all of 
those payments to be deposited with such other court pursuant to applicable 
rules. The attorneys representing the Plaintiff in the Vermont Proceedings 
and also representing, in the Minnesota Proceedings, the beneficiaries of 
four other Trust Company accounts, appealed that order to the Eighth Circuit 
Court of Appeals. By Per Curiam decision filed July 25, 1998, the Eighth 
Circuit denied that appeal. The attorneys for the Plaintiffs have filed a 
petition for certiorari to the United States Supreme Court, which has not 
yet acted upon it. The same attorneys also have announced an intention to 
initiate separate proceedings to seek to intercept at least a portion of any 
payments coming from the Minnesota Proceedings, in order to seek to deprive 
the Companies of at least a portion of the reimbursement that otherwise 
could be available.  Any recovery by the Companies from the Minnesota 
Proceedings is subject to the terms of an agreement between the Companies 
and their insurance carrier, which reimbursed the Companies, in part, for 
the December, 1994 payments.

Merchants Bancshares, Inc. and certain of its subsidiaries have been named 
as defendants in various other legal proceedings arising from their normal 
business activities. Although the amount of any ultimate liability with 
respect to such proceedings cannot be determined, in the opinion of 
management, based upon the opinion of counsel on the outcome of such 
proceedings, any such liability will not have a material effect on the 
consolidated financial position of Merchants Bancshares, Inc. and its 
subsidiaries.

(13)  PARENT COMPANY

The Parent Company's investments in its subsidiaries are recorded using the 
equity method of accounting. Summarized financial information relative to 
the Parent Company only balance sheets at December 31, 1998 and 1997 and 
statements of operations and cashflows for each of the three years in the 
period ended December 31, 1998 are as follows:

<TABLE>
<CAPTION>
Balance Sheets as of December 31
(In thousands)                                     1998        1997
---------------------------------------------------------------------
<S>                                               <C>         <C>
Assets:
  Investment in and Advances to Subsidiaries*     $60,329     $54,703
  Other Assets                                        511       1,337
---------------------------------------------------------------------
      Total Assets                                $60,840     $56,040
=====================================================================
Liabilities and Equity Capital:
  Other Liabilities                               $    11     $ 3,104
  Equity Capital                                   60,829      52,936
---------------------------------------------------------------------
      Total Liabilities and Equity Capital        $60,840     $56,040
=====================================================================

<CAPTION>
Statements of Operations for the Years Ended December 31

(In thousands)                                             1998       1997       1996
--------------------------------------------------------------------------------------
<S>                                                       <C>        <C>        <C>
Dividends from Merchants Bank*                            $4,000     $2,267     $    -
Equity in Undistributed Earnings of Subsidiaries           5,907      6,652      6,306
Other Expense, Net                                          (129)      (130)      (125)
Benefit from Income Taxes                                     44         44         43
--------------------------------------------------------------------------------------
Net Income                                                $9,822     $8,833     $6,224
======================================================================================

<FN>
--------------------
<F*>  Account balances are partially or fully eliminated in consolidation.
</FN>
</TABLE>

Statements of Cash Flows for the Years Ended December 31

<TABLE>
<CAPTION>
(In thousands)                                          1998        1997        1996
--------------------------------------------------------------------------------------
<S>                                                    <C>         <C>         <C>
Cash Flows from Operating Activities:
  Net Income                                           $ 9,822     $ 8,833     $ 6,224
  Adjustments to Reconcile Net Income to Net Cash
   Provided by Operating Activities:
    Decrease in Miscellaneous Receivables                   71          89          99
    Increase (Decrease) in Miscellaneous Payables           (2)         40           -
    Equity in Undistributed Income of Subsidiaries      (5,907)     (6,652)     (6,306)
--------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities                3,984       2,310          17
--------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
  Sale of Treasury Stock                                    80       1,234           -
  Acquisition of Treasury Stock                         (1,420)     (1,390)          -
  Proceeds from Exercise of Employee Stock Options         164          42           -
  Tax Benefit from Employee Stock Option Exercise           60           -           -
  Dividends Paid                                        (3,051)     (2,217)          -
  Other, Net                                                75         (35)          -
--------------------------------------------------------------------------------------
Net Cash Used in Financing Activities                   (4,092)     (2,366)          -
--------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents          (108)        (56)         17
Cash and Cash Equivalents at Beginning of Year             262         318         301
--------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year               $   154     $   262      $  318
======================================================================================

Total Interest Payments                                $     -     $     -      $    -
Taxes Paid                                               2,170       3,820           -
--------------------------------------------------------------------------------------
</TABLE>

(14)  BUSINESS SEGMENTS

On January 1, 1998 the Company adopted Statement of Financial Accounting 
Standards No. 131, "Disclosures about Segments of an Enterprise and Related 
Information" ("SFAS No. 131"). The adoption of SFAS No. 131 did not have a 
material effect on the Company's primary financial statements.

The Company has identified Community Banking as its reportable operating 
business segment. The Community Banking business segment consists of 
commercial banking and retail banking. The Community Banking business 
segment is managed as a single strategic unit which derives its revenues 
from a wide range of banking services, including lending activities, 
acceptance of demand, savings and time deposits, safe deposit facilities, 
merchant card services and mortgage servicing income from investors.

Non-reportable operating segments of the Company's operations which do not 
have similar characteristics to the Community Banking segment and do not 
meet the quantitative thresholds requiring disclosure are included in the 
Other category in the disclosure of business segments below. These non-
reportable segments include Trust and Investment Services, as well as parent 
company financial information (Note 13).

The following tables present the results of the Company's reportable 
operating business segment results as of December 31, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                       Community                 Consolidation
December 31, 1998                       Banking       Other       Adjustment       Consolidated
-----------------------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>               <C>
Interest Income                        $ 47,990      $    33       $      -          $ 48,023
Interest Expense                         18,501           29              -            18,530
Provision for Possible Loan Losses       (1,737)           -              -            (1,737)
-----------------------------------------------------------------------------------------------
Net Interest Income After Provi-
 sion for Possible Loan Losses           31,226            4              -            31,230
-----------------------------------------------------------------------------------------------
Noninterest Income:
  Trust Company Income                        -        1,910              -             1,910
  Service Charges on Deposits             2,756            -              -             2,756
  Merchants Discount Fees                 1,444            -              -             1,444
  Other                                   1,074          128              -             1,202
-----------------------------------------------------------------------------------------------
Total Noninterest Income                  5,274        2,038              -             7,312
-----------------------------------------------------------------------------------------------
Noninterest Expenses:
  Salaries and Employee Benefits         10,780          690              -            11,470
  Occupancy and Equipment                 4,474           93              -             4,567
  Legal and Professional                  2,220          227              -             2,447
  Other Expenses                          6,523          465              -             6,988
-----------------------------------------------------------------------------------------------
Total Noninterest Expenses               23,997        1,475              -            25,472
-----------------------------------------------------------------------------------------------
Income Before Provision For 
 Income Taxes                            12,503          567              -            13,070
-----------------------------------------------------------------------------------------------
Provision for Income Taxes                2,994          254              -             3,248
-----------------------------------------------------------------------------------------------
Net Income                             $  9,509      $   313       $      -          $  9,822
===============================================================================================

End of Period Securities               $178,539      $ 1,094       $      -          $179,633
End of Period Net Loans                 394,192            -              -           394,192
End of Period Assets                    632,613       67,280        (65,020)          634,873
End of Period Deposits                  552,351            -         (1,889)          550,462
End of Period Borrowings                 14,510        1,182              -            15,692
End of Period Liabilities               573,394        2,539         (1,889)          574,044
-----------------------------------------------------------------------------------------------

<CAPTION>
                                       Community                 Consolidation
December 31, 1997                       Banking       Other       Adjustment       Consolidated
-----------------------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>               <C>
Interest Income                        $ 48,155      $     3       $      -          $ 48,158
Interest Expense                         18,238            -              -            18,238
Provision for Possible Loan Losses       (1,862)           -              -            (1,862)
-----------------------------------------------------------------------------------------------
Net Interest Income After Provi-
 sion for Possible Loan Losses           31,779            3              -            31,782
-----------------------------------------------------------------------------------------------
Noninterest Income:
  Trust Company Income                        -        1,635              -             1,635
  Service Charges on Deposits             3,075            -              -             3,075
  Merchants Discount Fees                 1,537            -              -             1,537
  Other                                   1,599           70              -             1,669
-----------------------------------------------------------------------------------------------
Total Noninterest Income                  6,211        1,705              -             7,916
-----------------------------------------------------------------------------------------------
Noninterest Expenses
  Salaries and Employee Benefits          9,967          707              -            10,674
  Occupancy and Equipment                 4,460           36              -             4,496
  Legal and Professional                  3,486          402              -             3,888
  Other Expenses                          8,462          962              -             9,424
-----------------------------------------------------------------------------------------------
Total Noninterest Expenses               26,375        2,107              -            28,482
-----------------------------------------------------------------------------------------------
Income Before Provision For 
 Income Taxes                            11,615         (399)             -            11,216
Provision for Income Taxes                2,375            8              -             2,383
-----------------------------------------------------------------------------------------------
Net Income                             $  9,240      $  (407)      $      -          $  8,833
===============================================================================================

End of Period Securities               $157,996      $ 1,030       $      -          $159,026
End of Period Net Loans                 374,557            -              -           374,557
End of Period Assets                    583,575       62,243        (61,566)          584,252
End of Period Deposits                  508,778            -         (2,934)          505,844
End of Period Borrowings                 13,231        1,184              -            14,415
End of Period Liabilities               529,674        4,576         (2,934)          531,316
-----------------------------------------------------------------------------------------------

<CAPTION>
                                       Community                 Consolidation
December 31, 1996                       Banking       Other       Adjustment       Consolidated
-----------------------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>               <C>
Interest Income                        $ 48,001      $     3       $      -          $ 48,004
Interest Expense                         18,644           28              -            18,672
Provision for Possible Loan Losses        3,150            -              -             3,150
-----------------------------------------------------------------------------------------------
Net Interest Income After Provi-
 sion for Possible Loan Losses           26,207          (25)             -            26,182
-----------------------------------------------------------------------------------------------
Noninterest Income:
  Trust Company Income                        -        1,493              -             1,493
  Service Charges on Deposits             3,347            -              -             3,347
  Merchants Discount Fees                 1,696            -              -             1,696
  Other                                   2,676          151              -             2,827
-----------------------------------------------------------------------------------------------
Total Noninterest Income                  7,719        1,644              -             9,363
-----------------------------------------------------------------------------------------------
Noninterest Expenses
  Salaries and Employee Benefits          9,391          622              -            10,013
  Occupancy and Equipment                 4,054           24              -             4,078
  Legal and Professional                  1,486          475              -             1,961
  Other Expenses                         10,911          526              -            11,437
-----------------------------------------------------------------------------------------------
Total Noninterest Expenses               25,842        1,647              -            27,489
-----------------------------------------------------------------------------------------------
Income Before Provision For 
 Income Taxes                             8,084          (28)             -             8,056
Provision for Income Taxes                1,824            8              -             1,832
-----------------------------------------------------------------------------------------------
Net Income                             $  6,260      $   (36)      $      -          $  6,224
===============================================================================================

End of Period Securities               $144,560      $   730       $      -          $145,290
End of Period Net Loans                 371,533            -              -           371,533
End of Period Assets                    579,482       58,267        (56,113)          581,636
End of Period Deposits                  511,714            -         (3,434)          508,280
End of Period Borrowings                 14,832        1,187              -            16,019
End of Period Liabilities               532,331        7,343         (4,288)          535,386
-----------------------------------------------------------------------------------------------
</TABLE>

(15)  FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

Commitments and Off-Balance Sheet Risk

The Bank 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 guarantees. Such instruments involve, to varying degrees, 
elements of credit and interest rate risk that are not recognized in the 
accompanying consolidated balance sheets.

Exposure to credit loss in the event of nonperformance by the other party to 
the financial instruments for commitments to extend credit and financial 
guarantees written is represented by the contractual amount of those 
instruments. The Bank uses the same credit policies in making commitments as 
it does for on-balance sheet instruments. The contractual amounts of these 
financial instruments at December 31, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
      (In thousands)                                    Contractual Amount
      --------------------------------------------------------------------
      <S>                                                    <C>
      1998
      Financial Instruments Whose Contract Amounts
       Represent Credit Risk:
        Commitments to Extend Credit                         $105,112
        Standby Letters of Credit                               5,321
        Loans Sold with Recourse                                1,106
      --------------------------------------------------------------------

<CAPTION>
      (In thousands)                                    Contractual Amount
      --------------------------------------------------------------------
      <S>                                                    <C>
      1997
      Financial Instruments Whose Contract Amounts
       Represent Credit Risk:
        Commitments to Extend Credit                         $ 81,762
        Standby Letters of Credit                               5,650
        Loans Sold with Recourse                                1,182
      --------------------------------------------------------------------
</TABLE>

Commitments to extend credit are agreements to lend to a customer as long as 
there is no violation of any condition established in the contract. 
Commitments generally have fixed expiration dates or other termination 
clauses and may require payment of a fee. Since a portion of the commitments 
are expected to expire without being drawn upon, the total commitment amount 
does not necessarily represent a future cash requirement. The Bank evaluates 
each customer's creditworthiness on a case-by-case basis. The amount of 
collateral obtained by the Bank upon extension of credit is based on 
management's credit evaluation of the counterparty, and an appropriate 
amount of real and/or personal property is obtained as collateral.

Standby letters of credit and financial guarantees written are conditional 
commitments issued by the Bank to guarantee performance of a customer to a 
third party. Those guarantees are primarily issued to support public and 
private borrowing arrangements. Most guarantees extend for less than two 
years, and approximately 85% are for less than $100 thousand. The credit 
risk involved in issuing letters of credit is essentially the same as that 
involved in extending loan facilities to customers. The Bank obtains real 
and/or personal property as collateral for those commitments for which 
collateral is deemed to be necessary.

The Bank may enter into commitments to sell loans, which involve market and 
interest rate risk. There were no such commitments at December 31, 1998 or 
1997.

Interest Rate Cap and Floor Contracts

Interest rate cap and floor transactions generally involve the exchange of 
fixed and floating rate interest payments without the exchange of the 
underlying principal amounts. The Company uses floor contracts to mitigate 
the effects on net interest income in the event interest rates on floating 
rate loans decline and uses cap contracts to mitigate the effects on net 
interest income should interest rates on floating rate deposits increase. 
The Company is exposed to risk should the counterparty default in its 
responsibility to pay interest under the terms of the cap or floor 
agreement, but minimizes this risk by performing normal credit reviews on 
the counterparties, by limiting its exposure to any one counterparty, and by 
utilizing well known national investment firms as counterparties. Notional 
principal amounts are a measure of the volume of agreements transacted, but 
the level of credit risk is significantly less. At December 31, 1998 and 
December 31, 1997, the notional principal amounts of such contracts 
outstanding was $80 million and $30 million respectively. At December 31, 
1998 and December 31, 1997, the amortized cost of such contracts was $302 
thousand and $69 thousand, respectively. $2 thousand was received during 
1998 with respect to these contracts.

(16)  FAIR VALUE OF FINANCIAL INSTRUMENTS

Investments

The carrying amounts reported in the consolidated balance sheets for cash 
and cash equivalents and stock in the Federal Home Loan Bank of Boston 
approximate fair values. Fair value for investment securities is determined 
from quoted market prices, when available. If quoted market prices are not 
available, fair values are based on quoted market prices of comparable 
instruments.

An analysis of the fair value of the investment securities as of December 
31, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>
                                                 1998                        1997
      -------------------------------------------------------------------------------------
                                        Carrying                    Carrying
      (In thousands)                     Amount      Fair Value      Amount      Fair Value
      -------------------------------------------------------------------------------------
      <S>                               <C>           <C>           <C>           <C>
      Securities Available for Sale     $ 72,205      $ 72,205      $ 44,241      $ 44,241
      Securities Held to Maturity        103,851       105,717       111,458       112,467
      -------------------------------------------------------------------------------------
                                        $176,056      $177,922      $155,699      $156,708
      =====================================================================================
</TABLE>

Loans

The fair value of variable rate loans that reprice frequently and have no 
significant credit risk is based on carrying values. The fair value for 
other loans is estimated using discounted cash flow analyses, using interest 
rates currently being offered for loans with similar terms to borrowers of 
similar credit quality.

An analysis of the fair value of the loan portfolio as of December 31, 1998 
and 1997 is as follows:

<TABLE>
<CAPTION>
                                  1998                        1997
      ----------------------------------------------------------------------
                         Carrying                    Carrying
      (In thousands)      Amount      Fair Value      Amount      Fair Value
      ----------------------------------------------------------------------
      <S>                <C>           <C>           <C>           <C>
      Net Loans          $394,192      $400,469      $374,557      $378,093
      ----------------------------------------------------------------------
</TABLE>

Deposits

The fair value of demand deposits approximates the amount reported in the 
consolidated balance sheets. The fair value of variable rate, fixed term 
certificates of deposit also approximate the carrying amount reported in the 
consolidated balance sheets. The fair value of fixed rate and fixed term 
certificates of deposit is estimated using a discounted cash flow which 
applies interest rates currently being offered for deposits of similar 
remaining maturities. 

An analysis of the fair value of deposits as of December 31, 1998 and 1997 
is as follows:

<TABLE>
<CAPTION>
                                                 1998                        1997
      -------------------------------------------------------------------------------------
                                        Carrying                    Carrying
      (In thousands)                     Amount      Fair Value      Amount      Fair Value
      -------------------------------------------------------------------------------------
      <S>                               <C>           <C>           <C>           <C>
      Demand Deposits                   $ 85,998      $ 85,998      $ 76,712      $ 76,712
      Savings, NOW and
       Money Market                      309,897       311,453       267,396       268,380
      Time Deposits $100 thousand
       and greater                        22,746        24,243        23,307        23,540
      Other Time Deposits                131,821       131,915       138,429       139,812
      -------------------------------------------------------------------------------------
                                        $550,462      $553,609      $505,844      $508,444
      =====================================================================================
</TABLE>

Debt

The fair value of debt is estimated using current market rates for 
borrowings of similar remaining maturity.

An analysis of the fair value of the borrowings of the Company as of 
December 31, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>
                                         1998                        1997
      ----------------------------------------------------------------------------
                               Carrying                    Carrying
      (In thousands)            Amount      Fair Value      Amount      Fair Value
      ----------------------------------------------------------------------------
      <S>                       <C>           <C>           <C>           <C>
      Other Borrowed Funds      $9,283        $9,283        $8,000        $8,000
      ----------------------------------------------------------------------------
      Debt                       6,409         6,731         6,415         6,645
      ----------------------------------------------------------------------------
</TABLE>

Commitments to Extend Credit And Standby Letters Of Credit

The fair value of commitments to extend credit is estimated using the fees 
currently charged to enter into similar agreements, taking into account the 
remaining terms of the agreements and the present creditworthiness of the 
counterparties. For fixed rate loan commitments, fair value also considers 
the difference between current levels of interest rates and the committed 
rates. The fair value of financial standby letters of credit is based on 
fees currently charged for similar agreements or on the estimated cost to 
terminate them or otherwise settle the obligations with the counterparties. 
The fair value of commitments to extend credit and standby letters of credit 
is $53 thousand and $65 thousand as of December 31, 1998 and 1997, 
respectively.

Interest Rate Caps and Floors

The fair value of the interest rate caps and floors associated with variable 
rate commercial loans approximates the book carrying value. Management bases 
estimates on quotes, from qualified investment brokers, of the market value 
of the cap or floor at the reporting date. The fair value of the interest 
rate cap and floor contracts at December 31, 1998 was $280 thousand, the 
amortized cost was $302 thousand.

(17)  SUMMARY OF UNAUDITED FINANCIAL INFORMATION:

<TABLE>
<CAPTION>
(In thousands except per share data)                1998                                              1997
--------------------------------------------------------------------------------------------------------------------------------
                                 Q4        Q3        Q2        Q1       Year       Q4        Q3        Q2        Q1       Year
--------------------------------------------------------------------------------------------------------------------------------
<S>                            <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
Interest and Fee
 Income                        $12,006   $11,969   $12,154   $11,894   $48,023   $12,120   $12,137   $12,017   $11,884   $48,158
Interest Expense                 4,629     4,687     4,663     4,551    18,530     4,616     4,578     4,576     4,468    18,238
--------------------------------------------------------------------------------------------------------------------------------
Net Interest Income              7,377     7,282     7,491     7,343    29,493     7,504     7,559     7,441     7,416    29,920
Provision for  Possible
 Loan Losses(1)(2)              (1,618)        -      (119)        -    (1,737)   (2,162)        -         -       300    (1,862)
Noninterest Income(3)            1,809     1,770     1,976     1,757     7,312     2,700     1,740     1,715     1,761     7,916
Noninterest Expense(4)           6,957     5,931     6,489     6,095    25,472     9,057     6,445     6,468     6,512    28,482
--------------------------------------------------------------------------------------------------------------------------------
Income Before Provision
 for Income Taxes                3,847     3,121     3,097     3,005    13,070     3,309     2,854     2,688     2,365    11,216
Provision For Income
 Taxes                             911       789       789       759     3,248       607       665       610       501     2,383
--------------------------------------------------------------------------------------------------------------------------------
Net Income                     $ 2,936   $ 2,332   $ 2,308   $ 2,246   $ 9,822   $ 2,702   $ 2,189   $ 2,078   $ 1,864   $ 8,833
================================================================================================================================
Basic Earnings Per
 Share                         $  0.66   $  0.53   $  0.52   $  0.51   $  2.22   $  0.61   $  0.50   $  0.47   $  0.42   $  2.00
================================================================================================================================
Cash Dividends
 Declared Per Share            $  0.19   $  0.18   $  0.17   $  0.17   $  0.71   $  0.15   $  0.15   $  0.10   $  0.10   $  0.50
================================================================================================================================

<FN>
--------------------
<F1>  During the fourth quarter of 1998, the Bank reduced its reserve for 
      possible loan losses by approximately $1.6 million. The reduction is 
      primarily a result of management's determination that a lower 
      requirement was appropriate due to a changing mix of the loan 
      portfolio, the impact of conservative underwriting standards 
      implemented in previous periods and the favorable resolution of a 
      significant troubled credit.
<F2>  During the fourth quarter of 1997 the Bank recognized recoveries on 
      two previously charged off loans of approximately $2.2 million. This 
      amount was credited to income through the provision for loan losses.
<F3>  During the fourth quarter of 1997 the Bank recognized a gain of $840 
      on a security it held with a zero basis.
<F4>  During the fourth quarter of 1997 the Bank recognized losses resulting 
      from its conversion to the Windows NT platform totaling $590 thousand; 
      the Bank incurred or accrued legal and professional expenses in 
      conjunction with a lawsuit brought by a former customer totaling $1.2 
      million; the Bank made a one-time contribution to the Merchants Bank 
      Foundation of $400 thousand; and a $478 thousand write-down was taken 
      against one of the Bank's branch properties, based on the decision to 
      sell the property.
</FN>
</TABLE>

(18)  REGULATORY ENVIRONMENT

The Bank and the Company are subject to various regulatory capital 
requirements administered by federal banking agencies. Failure to meet 
minimum capital requirements can initiate certain mandatory, and possible 
additional discretionary, actions by regulators that, if undertaken, could 
have a direct material effect on the Bank's and the Company's financial 
statements. Under capital adequacy guidelines, the Bank and the Company must 
meet specific capital guidelines that involve quantitative measures of the 
Bank's and the Company's assets, liabilities, and certain off-balance-sheet 
items as calculated under regulatory accounting practices. The Bank is also 
subject to the regulatory framework for prompt corrective action that 
requires the Bank to meet specific capital guidelines to be considered well 
capitalized. The Bank's and the Company's capital amounts and classification 
are also subject to qualitative judgments by the regulators about 
components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy 
require the Bank and the Company to maintain minimum ratios (set forth in 
the table below) of total and Tier-1 capital (as defined in the regulations) 
to risk-weighted assets (as defined) and of Tier-1 capital (as defined) to 
average assets (as defined). Management believes, as of December 31, 1998, 
that the Bank and the Company meet all capital adequacy requirements to 
which it is subject.

As of December 31, 1998, the most recent notification from the FDIC 
categorized the Bank as well-capitalized under the regulatory framework for 
prompt corrective action. There are no conditions or events since that 
notification that management believes have changed the institution's 
category. To be considered well capitalized under the regulatory framework 
for prompt corrective action, the Bank must maintain minimum Tier-1 
Leverage, Tier-1 Risk-Based, and Total Risk-Based Capital ratios as set 
forth in the table below.

<TABLE>
<CAPTION>
                                                                                   To Be Well-
                                                                                 Capitalized Under
                                                            For Capital          Prompt Corrective
(In thousands)                        Actual             Adequacy Purposes       Action Provisions
---------------------------------------------------------------------------------------------------
                                Amount      Percent     Amount      Percent     Amount      Percent
---------------------------------------------------------------------------------------------------
<S>                             <C>         <C>         <C>          <C>        <C>         <C>
As of December 31, 1998:

Merchants Bancshares, Inc.:
  Tier 1 Risk-Based Capital     $58,677     14.45%      $16,248      4.00%        N/A
  Total Risk-Based Capital       63,747     15.69%       32,591      8.00%        N/A
  Tier 1 Leverage Capital        58,677      9.49%       24,828      4.00%        N/A
Merchants Bank:
  Tier 1 Risk-Based Capital     $58,582     14.38%      $16,295      4.00%      $37,242      6.00%
  Total Risk-Based Capital       63,652     15.62%       32,591      8.00%       40,738     10.00%
  Tier 1 Leverage Capital        58,582      9.45%       24,876      4.00%       31,096      5.00%
---------------------------------------------------------------------------------------------------
As of December 31, 1997:

Merchants Bancshares, Inc.:
  Tier 1 Risk-Based Capital     $50,596     12.49%      $16,210      4.00%        N/A
  Total Risk-Based Capital       55,806     13.78%       32,401      8.00%        N/A
  Tier 1 Leverage Capital        50,596      8.70%       23,313      4.00%        N/A
Merchants Bank:
  Tier 1 Risk-Based Capital     $52,536     12.94%      $16,246      4.00%      $24,369      6.00%
  Total Risk-Based Capital       57,746     14.22%       32,491      8.00%       40,614     10.00%
  Tier 1 Leverage Capital        52,536      9.01%       23,313      4.00%       29,141      5.00%
---------------------------------------------------------------------------------------------------
</TABLE>

                 Merchants Bancshares, Inc. and Subsidiaries
                        Interest Management Analysis

<TABLE>
<CAPTION>
(In thousands, taxable equivalent)                    1998                   1997                   1996
----------------------------------------------------------------------------------------------------------------
                                               Interest     % of      Interest     % of      Interest     % of
                                               Income/     Average    Income/     Average    Income/     Average
                                               Expense     Assets     Expense     Assets     Expense     Assets
----------------------------------------------------------------------------------------------------------------
<S>                                            <C>         <C>        <C>         <C>        <C>         <C>
NET INTEREST INCOME:
  Total Interest Income, Including
   Fees on Loans                               $ 48,098     7.97%     $ 48,254     8.35%     $ 48,140     8.29%
  Interest Expense                               18,530     3.07        18,238     3.15        18,672     3.21
----------------------------------------------------------------------------------------------------------------
  Net Interest Income Before Provision for
   Possible Loan Losses                          29,568     4.90        30,016     5.20        29,468     5.08
  Provision for Possible Loan Losses             (1,737)   -0.29        (1,862)   -0.32         3,150     0.54
----------------------------------------------------------------------------------------------------------------
  Net Interest Income                          $ 31,305     5.19%     $ 31,878     5.52%     $ 26,318     4.54%
================================================================================================================

OPERATING EXPENSE ANALYSIS:
  Noninterest Expense
    Personnel                                  $ 11,470     1.90%     $ 10,674     1.85%     $ 10,013     1.72%
    Occupancy and Equipments Expense              4,567     0.76         4,496     0.78         4,078     0.70
    Legal and Professional Fees                   2,447     0.41         3,888     0.67         1,961     0.34
    Loss / (Gain) on Disposition of Fixed
     Assets                                         127     0.02         1,088     0.19          (565)   -0.10
    Other                                         6,861     1.14         8,336     1.44        12,002     2.07
----------------------------------------------------------------------------------------------------------------
  Total Noninterest Expense                      25,472     4.22        28,482     4.93        27,489     4.73
----------------------------------------------------------------------------------------------------------------
  Less Noninterest Income
    Service Charges on Deposits                   2,756     0.46         3,075     0.53         3,347     0.58
    Other, Including Securities Gains             4,556     0.76         4,841     0.84         6,016     1.04
----------------------------------------------------------------------------------------------------------------
  Total Noninterest Income                        7,312     1.22         7,916     1.37         9,363     1.62
----------------------------------------------------------------------------------------------------------------
  Net Operating Expense                        $ 18,160     3.00%     $ 20,566     3.56%     $ 18,126     3.11%
================================================================================================================

SUMMARY:
  Net Interest Income                          $ 31,305     5.19%     $ 31,878     5.52%     $ 26,318     4.54%
    Less: Net Operating Expense                  18,160     3.00        20,566     3.56        18,126     3.11
----------------------------------------------------------------------------------------------------------------
  Profit Before Taxes-
   Taxable Equivalent Basis                      13,145     2.19        11,312     1.96         8,192     1.43
  Net Profit (Loss) After Taxes                $  9,822     1.63%     $  8,833     1.53%     $  6,224     1.07%
----------------------------------------------------------------------------------------------------------------
TOTAL AVERAGE ASSETS                           $603,312               $578,090               $580,860
================================================================================================================
</TABLE>

              MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                     CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, this Annual Report 
on Form 10-K 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. 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, (i) the fact that the Company's success is 
dependent to a significant extent upon general economic conditions in 
Vermont and Vermont's ability to attract new business, (ii) the fact that 
the Company's earnings depend to a great extent upon the level of net 
interest income (the difference between interest income earned on loans and 
investments and the interest expense paid on deposits and other borrowings) 
generated by the Bank, and the level of net interest income and thus the 
Bank's results of operations may be adversely affected by increases or 
decreases in interest rates, and (iii) the fact that the banking business is 
highly competitive and the profitability of the Company depends upon the 
Bank's ability to attract loans and deposits in Vermont, where the Bank 
competes with a variety of traditional banking and nontraditional 
institutions such as credit unions and finance companies, and (iv) the fact 
that at December 31, 1998, the Company's balance sheet loan portfolio was 
$405 million of which commercial loans represented 52.2%, exposing the 
Company to the risks inherent in financings based upon analyses of credit 
risk, the value of underlying collateral, including real estate, and other 
more intangible factors which are considered in making commercial loans. 
Accordingly, the Company's profitability may be negatively impacted by 
errors in risk analyses and by loan defaults and the ability of certain 
borrowers to repay such loans may be adversely affected by any downturn in 
general economic conditions. Additional risks and uncertainties are inherent 
in the Year 2000 project. The costs of the Year 2000 conversion, the date 
which the Company has set to complete its Year 2000 project and statements 
about anticipated compliance are based on the Company's current estimates 
and are subject to various uncertainties that could cause actual results to 
differ materially from the Company's expectations. Such uncertainties 
include, among others, the success of the Company in identifying systems 
that are not Year 2000 compliant, the nature and amount of programming 
required to upgrade or replace each of the affected systems, the 
availability of qualified personnel, consultants and other resources, and 
the success of the Year 2000 compliance efforts of others. These factors, as 
well as general economic and market conditions, may materially and adversely 
affect the market price of the Company's common shares. Because of these and 
other factors, past financial performance should not be considered an 
indicator of future performance. The forward-looking statements contained 
herein represent the Company's judgment as of the date of this Form 10-K, 
and the Company cautions readers not to place undue reliance on such 
statements.

The following discussion and analysis of financial condition and results of 
operations of the Company and its subsidiaries for the three years ended 
December 31, 1998 should be read in conjunction with the consolidated 
financial statements and notes thereto and selected statistical information 
appearing elsewhere in this Annual Report on Form 10-K. The information is 
discussed on a fully taxable equivalent basis. The financial condition and 
operating results of the Company essentially reflect the operations of its 
principal subsidiary, Merchants Bank.

RESULTS OF OPERATIONS: OVERVIEW

The Company recognized net income of $9.8 million for the year ended 
December 31, 1998, an increase of $1.0 million from 1997. The one-time 
charges and credits that influenced 1998 earnings included a $1.6 million 
negative provision for possible loan losses during the fourth quarter of 
1998. For a more detailed discussion of the Bank's reserve for possible loan 
losses see "Credit Quality and Reserve for Possible Loan Losses". 
Conversely, the Company incurred legal and professional expenses in 
conjunction with a lawsuit brought by a former customer totaling $845 
thousand during 1998 (See "Noninterest Income and Expenses"). An additional 
event affecting overall earnings during 1998 was an unscheduled contribution 
of $150 thousand to the Merchants Bank Foundation, a charitable organization 
created during the 1980s to promote community activities in Vermont. 

Basic earnings per share were $2.22, $2.00 and $1.45 for the years ended 
December 31, 1998, 1997 and 1996, respectively. Diluted earnings per share 
were $2.21, $1.99 and $1.45 for the years ended December 31, 1998, 1997 and 
1996, respectively. The Company declared and distributed a total of $.71 per 
share during 1998. In January 1999, the Company declared a dividend of $0.19 
per share. 

Net income as a percentage of average equity capital was 17.46%, 17.98%, and 
14.44% for 1998, 1997 and 1996, respectively. The ten-year average return on 
equity is 7.78% at December 31, 1998. Net income as a percentage of average 
assets was 1.63%, 1.53%, and 1.07% in 1998, 1997 and 1996, respectively. The 
ten-year average return on assets is .60% at December 31, 1998.

NET INTEREST INCOME

Net interest income before the provision for possible loan losses is the 
difference between total interest, loan fees and investment income, and 
total interest expense. Total interest and dividend income decreased $135 
thousand from 1997 to 1998 (.3%) and total interest expense increased by 
$292 thousand (1.6%), resulting in a decrease in net interest income of $427 
thousand (1.4%). The overall decrease in net interest income, and resultant 
decrease in net interest margin is attributable to several factors. One of 
these is the flat yield curve and lower interest rate environment that was 
prevalent during 1998. Many of the Bank's longer term assets are funded with 
short term, or variable rate, liabilities. As the yield curve flattened over 
the course of 1998 loan and investment rates dropped more quickly than 
deposit rates. Overall average earning assets increased by $25.3 million 
(4.6%) from $541 million to $566 million during 1998, but the average rate 
earned on those assets decreased by 42 basis points from 8.92% to 8.50%. 
Changes in the mix of earning assets account for a portion of this change. 
Average investments, which generally have a lower yield than loans, grew by 
$23.7 million during 1998. Average loans decreased by $2.6 million during 
1998, and the loan mix changed as the Bank continued its strategy to move 
higher risk commercial real estate loans off the balance sheet. At the same 
time, average interest bearing liabilities increased by $11.7 million from 
$446 million to $457 million (2.6%), while the average rate on those 
liabilities decreased by only 4 basis points, from 4.09% to 4.05%. The 
following table presents the condensed annual average balance sheets for 
1998, 1997 and 1996. The total dollar amount of interest income from assets 
and the subsequent yields are calculated on a taxable equivalent basis.

                         Merchants Bancshares, Inc.
        Distribution of Assets, Liabilities and Stockholders' Equity; 
                  Interest Rates and Interest Differential

<TABLE>
<CAPTION>
                                                1998                            1997                            1996
---------------------------------------------------------------------------------------------------------------------------------
Taxable Equivalent                             Interest   Average              Interest   Average              Interest   Average
(In thousands)                      Average    Income/    Yield/    Average    Income/    Yield/    Average    Income/    Yield/
ASSETS:                             Balance    Expense     Rate     Balance    Expense     Rate     Balance    Expense     Rate
---------------------------------------------------------------------------------------------------------------------------------

<S>                                 <C>        <C>        <C>       <C>        <C>        <C>       <C>        <C>        <C>
Investment Securities:
  U.S. Treasury and Agencies        $165,071   $10,728     6.50%    $142,070   $ 9,443     6.65%    $117,908   $ 7,588     6.44%
  Other, Including FHLB Stock          3,098       161     5.20%       2,435       172     7.06%       2,865       148     5.17%
---------------------------------------------------------------------------------------------------------------------------------
      Total Investment Securities    168,169    10,889     6.48%     144,505     9,615     6.65%     120,773     7,736     6.41%
---------------------------------------------------------------------------------------------------------------------------------

Loans, Including Fees on Loans:
  Commercial                          67,609     7,017    10.38%      68,036     7,479    10.99%      68,783     7,281    10.59%
  Real Estate                        309,534    28,095     9.08%     311,490    29,286     9.40%     322,690    31,135     9.65%
  Consumer                            14,671     1,759    11.99%      14,763     1,763    11.94%      15,041     1,673    11.12%
---------------------------------------------------------------------------------------------------------------------------------
      Total Loans(a)(b)              391,814    36,871     9.41%     394,289    38,528     9.77%     406,514    40,089     9.86%
---------------------------------------------------------------------------------------------------------------------------------

Federal Funds Sold, Securities Sold
 Under Agreements to Repurchase
 and Interest Bearing Deposits
 with Banks                            6,143       338     5.50%       2,036       111     5.45%       5,905       315     5.33%
---------------------------------------------------------------------------------------------------------------------------------
      Total Earning Assets           566,126    48,098     8.50%     540,830    48,254     8.92%     533,192    48,140     9.03%
---------------------------------------------------------------------------------------------------------------------------------

Reserve for Possible Loan Losses     (14,790)                        (16,267)                        (15,983)
Cash and Due From Banks               21,115                          22,833                          28,907
Premises and Equipment                13,358                          14,513                          13,298
Other Assets                          17,503                          16,182                          21,446
---------------------------------------------------------------------------------------------------------------------------------
      Total Assets                  $603,312                        $578,090                        $580,860
=================================================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest Bearing  Deposits:
Savings, Money Market & NOW
 Accounts                           $285,489   $ 9,175     3.21%    $265,578   $ 8,452     3.18%    $264,611   $ 8,217     3.11%
Time Deposits                        159,430     8,573     5.38%     164,437     8,864     5.39%     170,439     9,508     5.58%
---------------------------------------------------------------------------------------------------------------------------------
      Total Interest Bearing
       Deposits                      444,919    17,748     3.99%     430,015    17,316     4.03%     435,050    17,725     4.07%
---------------------------------------------------------------------------------------------------------------------------------

Federal Funds Purchased                  730        42     5.75%         906        54     5.96%         703        32     4.59%
Demand Notes Due U.S. Treasury         1,939       100     5.16%       2,463       130     5.28%       2,134       108     5.04%
Other Short-Term Borrowings            2,986       170     5.69%       5,925       307     5.18%       4,206       205     4.88%
Long-Term Debt                         6,890       470     6.82%       6,417       431     6.72%       8,925       602     6.75%
---------------------------------------------------------------------------------------------------------------------------------
      Total Interest Bearing
       Liabilities                   457,464    18,530     4.05%     445,726    18,238     4.09%     451,019    18,672     4.14%
---------------------------------------------------------------------------------------------------------------------------------

  Demand Deposits                     80,541                          75,972                          78,873
  Other Liabilities                    9,064                           7,252                           7,857
  Stockholders' Equity                56,243                          49,140                          43,111
---------------------------------------------------------------------------------------------------------------------------------
      Total Liabilities &
       Stockholders' Equity         $603,312                        $578,090                        $580,860
=================================================================================================================================
Net Interest Income(a)                         $29,568                         $30,016                         $29,468
=================================================================================================================================
Yield Spread                                               4.45%                           4.83%                           4.89%
=================================================================================================================================
NET INTEREST INCOME
 TO EARNING ASSETS                                         5.22%                           5.55%                           5.53%
=================================================================================================================================

<FN>
--------------------
<Fa>  Tax exempt interest has been converted to a tax equivalent basis using 
      the Federal tax rate of 34%.
<Fb>  Includes nonaccruing loans.
</FN>
</TABLE>

The following table sets forth, for each major category of interest earning 
assets and interest bearing liabilities, the dollar amounts of fully taxable 
equivalent interest income and interest expense and changes therein for 1998 
as compared with 1997.

                         Merchants Bancshares, Inc.
     Analysis of Changes in Fully Taxable Equivalent Net Interest Income

<TABLE>
<CAPTION>
                                                                        1998 vs 1997
-------------------------------------------------------------------------------------------------------------
                                                                                              Due to(a)
                                                                          Increase       --------------------
(In thousands)                                   1998        1997        (Decrease)      Volume        Rate
-------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>           <C>            <C>         <C>
Fully Taxable Equivalent Interest Income:
  Loans(b)                                      $36,871     $38,528       $(1,657)       $ (233)     $(1,424)
  Investments                                    10,889       9,615         1,274         1,532         (258)
  Federal Funds Sold, Securities Sold Under
   Agreements to Repurchase and Interest
   Bearing Deposits with Banks                      338         111           227           226            1
-------------------------------------------------------------------------------------------------------------
      Total Interest Income                      48,098      48,254          (156)        1,525       (1,681)
-------------------------------------------------------------------------------------------------------------
Less Interest Expense:
  Savings, Money Market & NOW 
   Accounts                                       9,175       8,452           723           640           83
  Time Deposits                                   8,573       8,864          (291)         (269)         (22)
  Federal Funds Purchased                            42          54           (12)          (10)          (2)
  Demand Note-U.S. Treasury                         100         130           (30)          (27)          (3)
  Debt and Other Borrowings                         640         738           (98)         (135)          37
-------------------------------------------------------------------------------------------------------------
      Total Interest Expense                     18,530      18,238           292           198           94
-------------------------------------------------------------------------------------------------------------
      Net Interest Income                       $29,568     $30,016       $  (448)       $1,327      $(1,775)
=============================================================================================================

<CAPTION>
                                                                        1997 vs 1996
-------------------------------------------------------------------------------------------------------------
                                                                                              Due to(a)
                                                                          Increase       --------------------
(In thousands)                                   1997        1996        (Decrease)      Volume        Rate
-------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>           <C>            <C>         <C>
Fully Taxable Equivalent Interest Income:
  Loans(b)                                      $38,528     $40,089       $(1,561)       $    0      $(1,561)
  Investments                                     9,615       7,736         1,879           (30)       1,909
  Federal Funds Sold, Securities Sold Under
   Agreements to Repurchase and Interest
   Bearing Deposits with Banks                      111         315          (204)            -         (204)
-------------------------------------------------------------------------------------------------------------
      Total Interest Income                      48,254      48,140           114           (30)         144
-------------------------------------------------------------------------------------------------------------
Less Interest Expense:
  Savings, Money Market & NOW 
   Accounts                                       8,452       8,217           235             -          235
  Time Deposits                                   8,864       9,508           644            18          662
  Federal Funds Purchased                            54          32            22             -           22
  Demand Note-U.S. Treasury                         130         108            22            12           10
  Debt and Other Borrowings                         738         807           (69)          106         (175)
-------------------------------------------------------------------------------------------------------------
      Total Interest Expense                     18,238      18,672          (434)          136         (570)
-------------------------------------------------------------------------------------------------------------
      Net Interest Income                       $30,016     $29,468       $   548        $ (167)     $   715
=============================================================================================================

<FN>
--------------------
<Fa>      The dollar amount of changes in interest income and interest expense 
          attributable to changes in rate and volume has been allocated between 
          rate and volume based upon the changes in rates times the first 
          year's volume and the changes in volume times the current year's 
          rate.
<Fb>      Includes balances of non-accruing loans.
<FNote:>  Included in Interest Income are fees on loans totaling $1,570, $1,619 
          and $2,333 for the years ended December 31, 1998, 1997 and 1996, 
          respectively
</FN>
</TABLE>

The Bank's fees on loans continued to decrease in 1998, decreasing $50 
thousand from 1997 to 1998. This decrease is due primarily to a strategic 
decision made by the Bank's Asset/Liability Committee in 1996 to hold many 
of its originated mortgages in portfolio rather than sell them in the 
secondary market. The Bank has historically had a disproportionately low 
allocation of residential real estate mortgages in its portfolio. Management 
believes the retention of these credits in portfolio, while decreasing 
servicing revenue, will result in higher interest revenue than could be 
earned in the Bank's investment portfolio.

From 1996 to 1997, total interest and dividend income increased $154 
thousand (0.3%) and total interest expense decreased $434 thousand (2.32%). 
This resulted in an increase to net interest income before provision for 
possible loan losses of $588 thousand (1.97%) from $29.3 million in 1996 to 
$29.9 million in 1997. A number of factors contributed to these changes. 
First, the Company's portfolio of nonperforming loans continued to decrease, 
from $6.7 million at year-end 1996 to $3.3 million at year-end 1997, and the 
Company's other real estate owned (OREO) portfolio decreased by $1.3 million 
from $1.9 million at year-end 1996 to $591 thousand at year-end 1997. 
Second, the Bank's overall loan portfolio increased by $3.2 million (0.8%), 
while the Bank's investment portfolio increased by $11.4 million (7.87%). 
Finally, deposits decreased by $2.5 million from year-end 1996 to year-end 
1997 (see "Balance Sheet Analysis" for a more comprehensive discussion of 
changes in the balance sheet). The yield on total interest earning assets 
decreased from 9.03% for the year 1996 to 8.92% for the year 1997, as a 
result of the change in the composition of interest earning assets discussed 
above, and increased competition from both bank and non-bank competitors. 
The cost of interest bearing liabilities decreased slightly from 4.14% for 
the year 1996 to 4.09% for the year 1997. This decrease in cost results from 
the Bank's continuing strategies to encourage the movement of balances from 
time deposits to money market accounts and NOW accounts. The Bank's 
FreedomLYNX(r) accounts increased by $7.3 million over the course of 1997, 
at an average cost of funds of 1.76%. The combination of the changes 
discussed above led to a small increase in the overall net interest margin 
from 5.53% for the year 1996 to 5.55% for the year 1997.

RESERVE FOR POSSIBLE LOAN LOSSES

In the fourth quarter of 1998, the Bank recorded a $1.6 million credit 
provision for possible loan losses resulting in an overall credit provision 
of $1.7 million in 1998. This reduction of the loan loss reserve was 
primarily the result of an internal review of the Bank's loan loss reserve 
requirement, which considered the changing mix and improved quality of the 
loan portfolio, the impact of conservative underwriting standards 
implemented in previous periods, general economic conditions, and the 
resolution of a significant troubled credit. The Bank's analysis has been 
substantiated by a comprehensive assessment of its loan portfolio and review 
of its loan loss reserve requirement by its external loan review firm during 
the fourth quarter of 1998. For a more detailed discussion of the Bank's 
reserve for possible loan losses see "Credit Quality and Reserve for 
Possible Loan Losses".

NONINTEREST INCOME AND EXPENSES

Excluding net gains on the sale of investment securities of $44 thousand in 
1998 and $784 thousand in 1997 noninterest income increased $136 thousand 
(1.9%) from 1997 to 1998. The increase was primarily the result of increases 
in Trust Company income of $275 thousand, a 16.8% increase. Service charges 
on deposits decreased $319 thousand during 1998, a 10.4% decrease. The 
decrease in service charge revenue is primarily a result of the Bank's 
continued FreedomLYNX(r) sales campaign. These accounts currently charge no 
fees to customers who have a direct deposit, a debit card or an automatic 
loan payment. For a limited time beginning in February 1999, as part of the 
Bank's 150th birthday celebration, the Bank will drop all electronic 
qualifications for the FreedomLYNX(r) account and offer the account free for 
life. Although there are generally no fees on these accounts, the average 
interest cost at December 31, 1998 was approximately 1.52% and the average 
balance maintained by the customer is higher than a regular checking 
account. This account is representative of a strategic decision made by the 
Bank to deemphasize fee income in favor of collecting low interest checking 
account balances which will increase margin income over time, and also 
encourage customers to maximize use of the Bank's technology. Fees on 
merchants discounts on credit cards decreased by $93 thousand (6.1%) during 
1998, primarily a result of continuing decline in transaction volumes. Other 
noninterest income increased by $273 thousand during 1998, primarily due to 
the recognition of gains on the sales of certain loans of $213 thousand (see 
Balance Sheet Analysis).

Excluding the FDIC assistance received pursuant to the loss sharing 
agreement (since terminated) of $407 thousand during 1996, noninterest 
income decreased $1 million (11.6%) from 1996 to 1997. There were three one-
time events in the two years that effected this change. First, during 1997, 
the Bank recognized an $840 thousand gain on an investment it had with a 
zero basis. Second, during 1996, the Bank recognized a net gain on the sale 
of a bank branch of $300 thousand, and third, during 1996, the Bank received 
refunds of Vermont Franchise Tax paid in prior years of $885 thousand. Trust 
Company revenue increased $142 thousand (9.51%) in 1997 over 1996; the 
result of increased marketing efforts by the Trust Company. Service charges 
on deposits decreased $272 thousand from 1996 to 1997 as the Bank continued 
to increase FreedomLYNX(r) account balances. Fees received related to 
merchants discounts on credit cards decreased by $159 thousand as a result 
of lower transaction volumes during 1997.

Noninterest expenses decreased $3.0 million (10.1%) from 1997 to 1998. A 
significant contributing factor being a decrease of $1.5 million (37%) in 
legal and professional fees, from $3.9 million for the year ended December 
31, 1997 to $2.4 million for the year ended December 31, 1998. This decrease 
was due primarily to a decrease in expenses incurred by the Bank as it 
defended itself in litigation entitled "Pasquale and Vatsala Vescio, 
counterclaim Plaintiffs v. The Merchants Bank, Counterclaim Defendant", now 
pending in the United States Bankruptcy Court for the District of Vermont. 
For further information on this litigation see Part I, Item 3, Legal 
Proceedings. Losses on the disposition of fixed assets also decreased during 
1998. The $961 thousand (88%) decrease was primarily a result of $400 
thousand in expenses recognized during 1997 related to the Company's 
conversion to the Windows NT platform. Additionally, during 1997, the Bank 
wrote down the basis of its branch in Brattleboro, VT by $478 thousand in 
conjunction with the sale of the building. Substantially all of the 1998 
expense is related to the Bank's conversion of its teller system to the 
Windows NT platform during 1998. This change will enable our front line 
personnel to perform a multitude of tasks and access extensive customer 
information without leaving their stations, increasing efficiencies and 
improving overall customer service. Recognizing that technology changes 
almost daily in the current environment, the Company has made the decision 
to depreciate current investments in technology based fixed assets and 
related software over a three year schedule. Salaries and wages increased by 
$752 thousand (8.7%) from 1997 to 1998. This increase is primarily 
attributable to the Company's incentive program. This program is designed to 
compensate employees based on their individual performance, as well as the 
performance of their divisions. The program for 1998 focused on improved 
efficiency and profitability for employees in the service center, and on 
increased growth and sales in the branches and sales division. Other 
noninterest expenses decreased by $895 thousand during 1998, primarily the 
result of a decrease in the contribution made to the Merchants Bank 
Foundation during 1998, from $400 thousand during 1997 to $150 thousand 
during 1998. Finally, during 1997, an investment held by a subsidiary of the 
Bank was written down by $229 thousand.

Noninterest expenses increased $1.4 million (5.17%) in 1997 from 1996, 
excluding losses and write-downs on Segregated Assets reimbursed by the 
FDIC. There were several significant nonrecurring events contributing to 
this increase. The first such expense was the expense recognized in 
conjunction with the Company's conversion to the Windows NT platform. The 
significant expenses recognized in conjunction with this conversion were 
$395 thousand in costs associated with project management and training, and 
$400 thousand recognized in conjunction with the retirement of certain not 
yet fully depreciated assets. The second significant expense during 1997 was 
a $478 thousand write-down of the Bank's branch in Brattleboro VT when the 
Bank made the decision to sell the property and lease back the portion used 
for a branch office. A third expense recognized during 1997 was a $400 
thousand contribution to the Merchants Bank Foundation, a charitable 
organization established in the 1980s to support community activities in 
Vermont.

Another significant factor which contributed to the overall increase in 
noninterest expenses during 1997 was an increase of $2 million in legal and 
professional fees, from $1.5 million for the year ended December 31, 1996 to 
$3.5 million for the year ended December 31, 1997. The increase was due 
primarily to expenses incurred by the Bank as it defended itself in 
litigation entitled "Pasquale and Vatsala Vescio, counterclaim Plaintiffs v. 
The Merchants Bank, Counterclaim Defendant", now pending in the United 
States Bankruptcy Court for the District of Vermont. For further information 
on this litigation see Part I, Item 3, Legal Proceedings. The Bank saw a 
substantial decrease in its expenses associated with Other Real Estate Owned 
(OREO), from $3.4 million in 1996 to $314 thousand in 1997 (90.8%). The 
decrease was a direct result of the decrease in the OREO portfolio from $1.9 
million at year-end 1996 to $591 thousand at year-end 1997. Salaries and 
Wages, and associated benefits increased from $10 million for the year 1996 
to $10.7 million for the year 1997 (6.7%). This increase was primarily 
attributable to the Company's incentive program begun in 1996.

The Company recognized $1,328 thousand in low-income housing tax credits as 
a reduction in the provision for income taxes during 1998 and $1,089 
thousand during 1997. As of December 31, 1998, the Company has a cumulative 
deferred prepaid tax asset of approximately $4.3 million arising from timing 
differences between the Company's book and tax reporting. The prepaid tax 
asset is included in other assets.

BALANCE SHEET ANALYSIS

The Company's overall balance sheet grew by $51 million (8.7%) during 1998, 
while the Company's earning assets increased by $37.6 million (6.7%) from 
$548.4 million to $586 million. The investment portfolio grew by $20.4 
million (13%), and the loan portfolio increased by $15.1 million (3.9%). The 
increase in the loan portfolio is net of sales of primarily commercial real 
estate loans with an aggregate book value of $15.1 million, the Bank 
recognized a recovery of $119 thousand and a gain of $238 thousand in 
conjunction with the loan sales. The changes in the composition of the 
Bank's loan portfolio during 1998 are shown in the following table:

<TABLE>
<CAPTION>
                                                        As of December 31,
      Type of Loan                   1998         1997         1996         1995         1994
-----------------------------------------------------------------------------------------------
                                                          (In thousands)
      <S>                          <C>          <C>          <C>          <C>          <C>
      Commercial, Financial &
       Agricultural                $ 63,953     $ 73,523     $ 61,091     $ 76,925     $ 92,612
      Real Estate-Construction        8,091        8,695        3,420        9,644       21,992
      Real Estate-Commercial        170,892      181,018      203,022      225,884      235,104
      Real Estate-Residential       147,348      111,270      104,355      120,318      142,325
      Installment                    14,676       15,450       14,831       16,560      18,086
      Lease Financing                     -            -            -            -           -
      All Other Loan                    532          432          534          393         436
-----------------------------------------------------------------------------------------------
                                    $405,492    $390,388     $387,233     $449,724    $510,555
===============================================================================================
</TABLE>

Residential real estate loans increased by $36.1 million. The Bank 
introduced its new RealLYNX(tm) residential real estate loan product during 
the first quarter of 1998. This product shortens the turnaround time on 
residential mortgages by requiring reduced documentation from borrowers. The 
introduction of this product coupled with the high volume of refinancing of 
home mortgages during the low interest rate environment that was prevalent 
during much of 1998 helped to fuel much of the growth in the residential 
real estate portfolio. The Bank closed a total of 783 one-to-four family 
residential mortgage loans totaling $59.8 million during 1998; a significant 
increase from the 366 loans totaling $26.7 million that closed during 1997. 
Substantially all of the originations in the last two years were placed in 
the Bank's portfolio as the Bank currently does not sell home mortgages on 
the secondary market. The Bank currently services $132.0 million in 
residential mortgage loans for other investors such as federal government 
agencies (FNMA and FHLMC) and for financial investors such as insurance 
companies and pension funds located outside Vermont.

Commercial mortgages decreased by $10.1 million during 1998. This change 
reflects the Bank's continuing strategy to deemphasize higher risk 
commercial real estate loans as it more actively pursues small business and 
commercial credits, as well as residential real estate loans. During 1998, 
the Bank remained an active participant in the U.S. Small Business 
Administration guaranteed loan program. 18 new SBA loans totaling $3.5 
million were originated during 1998 with SBA guarantees ranging from 60% to 
90%. This volume of new lending activity represents a 3% increase from that 
experienced in 1997. Substantially all of the SBA loans originated in 1998 
have remained in portfolio. SBA guarantees are advantageous to the Bank 
because they reduce risk in the Bank's loan portfolio and allow the Bank to 
increase its commercial loan base and market share with minimal impact on 
capital. In 1998, the Bank's ALCO continued the strategy of holding most of 
its originated loans in portfolio instead of selling them on the secondary 
market. During 1998, the Bank originated 582 commercial and commercial real 
estate loans, throughout Vermont, totaling $98.2 million. This lending 
activity represented an increase of approximately 32% of new loan volume 
from that experienced in 1997. This significant increase was offset in part 
by amortization of the existing portfolio and the previously discussed loan 
sale. The sale of these performing assets was a continuation of the Bank's 
strategy to reduce the proportion of higher commercial real estate loans 
held in its portfolio.

The following table presents the distribution of the varying maturities or 
repricing opportunities of the loan portfolio at December 31, 1998. 

<TABLE>
<CAPTION>
                                                       Over One
                                          One Year     Through      Over Five
      Type of Loan                        Or Less      5 Years        Years        Total
      ------------------------------------------------------------------------------------
                                                           (In thousands)
      <S>                                 <C>          <C>          <C>           <C>
      Commercial Loans, Industrial
       Revenue Bonds, Lease Financing
       and All Other Loans                $ 39,059     $ 12,664     $ 12,763      $ 64,486
      Real Estate Loans                     99,631      118,713      107,986       326,330
      Installment Loans                      3,057        4,864        6,755        14,676
      ------------------------------------------------------------------------------------
                                          $141,747     $136,241     $127,504      $405,492
      ====================================================================================
</TABLE>

Loans maturing or repricing after one year which have predetermined interest 
rates totaled $262.9 million. Loans maturing or repricing after one year 
which have floating or adjustable interest rates totaled $1.1 million.

The Company's interest bearing liabilities increased by $36.5 million (8.2%) 
from $453.5 million to $480 million during 1998. This change is primarily a 
result of an increase in the Company's Savings, NOW and Money Market 
Accounts from $267 million at year end 1997 to $310 million at year end 
1998. During the third quarter of the year the Bank introduced its new 
MoneyLYNX(tm) and CommerceLYNX(tm) money market accounts. The balances pay 
interest at competitive rates based on a tiered balance structure. The 
average cost of funds on these new balances at December 31, 1998 was 4.3%. 
Balances in these accounts totaled $51 million at year end 1998. Balances in 
the Bank's FreedomLYNX(r) accounts continue to increase, with balances of 
$19.8 million at December 31, 1998 versus $10.4 million at December 31, 
1997. The FreedomLYNX(r) account bears interest at a slight premium to the 
NOW rate on balances over $1,500 and requires no minimum balance, the 
average cost of these funds at year end was 1.52%. The Bank's year end 
demand deposit balances increased by $9.3 million during 1998, a result of 
the overall larger customer base.

The following schedule shows the average balances of various classifications 
of deposits:

<TABLE>
<CAPTION>
      (In thousands)                   1998         1997         1996
      -----------------------------------------------------------------
      <S>                            <C>          <C>          <C>
      Demand Deposits                $ 80,541     $ 75,972     $ 78,873
      Savings, Money Market and
       Now Accounts                   285,489      265,578      264,611
      Time Deposits $100,000 and
       Greater                         24,130       19,750       20,059
      Other Time Deposits             135,300      144,687      150,380
      -----------------------------------------------------------------
      Total Average Deposits         $525,460     $505,987     $513,923
      =================================================================
</TABLE>

Time Deposits $100 thousand and greater at December 31, 1998 had the 
following schedule of maturities:

<TABLE>
<CAPTION>
      (In thousands)
      ----------------------------------------
      <S>                              <C>
      Three Months or Less             $ 5,452
      Three to Six Months                3,829
      Six to Twelve Months               4,679
      Over Twelve Months                 2,113
      Over Five Years                    6,673
      ----------------------------------------
                                       $22,746
      ========================================
</TABLE>

CREDIT QUALITY AND RESERVE FOR POSSIBLE LOAN LOSSES

Improving credit quality has been a major strategic focus of the Bank since 
1994. The success of this program is evidenced by the Bank's aggressive 
reduction in the level of problem assets over the last three years. The 
following tables summarize the Bank's nonperforming assets (NPAs) as of 
December 31, 1994 through 1998. Nonperforming assets, as a percentage of 
total loans, continued to decline, reflecting continued improvements in 
asset quality.

<TABLE>
<CAPTION>
(In thousands)                         1998       1997       1996       1995        1994
------------------------------------------------------------------------------------------
<S>                                   <C>        <C>        <C>        <C>         <C>
Nonaccrual Loans                      $2,103     $2,686     $4,091     $25,617     $32,200
Loans Past Due 90 Days or
 More and Still Accruing                 170        403        216         237         668
Restructured Loans                       320        215      2,403       1,430       5,083
------------------------------------------------------------------------------------------
      Total Nonperforming Loans:       2,593      3,304      6,710      27,284      37,951
------------------------------------------------------------------------------------------
Other Real Estate Owned                  470        591      1,925       7,772      13,231
------------------------------------------------------------------------------------------
      Total Nonperforming Assets:     $3,063     $3,895     $8,635     $35,056     $51,182
==========================================================================================
NPL to Total Loans                      0.64%      0.85%      1.70%       3.61%       3.90%
NPA to Total Loans plus OREO            0.75%      1.00%      2.20%       3.28%       1.97%
------------------------------------------------------------------------------------------
</TABLE>

Excluded from the 1998 balances above are approximately $3.0 million of 
internally classified loans. Management believes that these loans have well-
defined weaknesses which, if left unattended, could lead to collection 
problems. Management maintains an internal listing, which includes these 
loans, which is reviewed and updated monthly. The oversight process on these 
loans includes an active risk management approach. A management committee 
reviews the status of these loans each quarter and determines or confirms 
the appropriate risk rating and accrual status. The findings of this review 
process are instrumental in determining the adequacy of the loan loss 
reserve.

Discussion of 1998 Events affecting Nonperforming Assets

Historically, the Bank has worked closely with borrowers to collect 
obligations and pursued more vigorous collection efforts where necessary. 
The Bank's Credit Department and Loan Workout functions provide resources to 
address collection strategies for nonperforming assets.

<TABLE>
<CAPTION>
(In thousands)                12-31-98     9-30-98     6-30-98     3-31-98     12-31-97
---------------------------------------------------------------------------------------
<S>                            <C>         <C>         <C>         <C>          <C>
Nonaccrual Loans               $2,103      $4,752      $4,853      $3,700       $2,686
Loans Past Due 90 Days or
 More and Still Accruing          170         279         438         309          403
Restructured Loans                320         327         333         214          215
Other Real Estate Owned           470         818         377         599          591
---------------------------------------------------------------------------------------
      Total                    $3,063      $6,176      $6,001      $4,822       $3,895
=======================================================================================
</TABLE>

Significant events affecting NPAs are discussed below.

Nonaccrual Loans

Nonaccrual loans declined from $2.7 million at December 31, 1997 to $2.1 
million at December 31, 1998. The continued decline results from the Bank's 
efforts to proactively identify and resolve loans which present significant 
risk of loss to the Bank. As a result, during 1998, management identified 
approximately $6.5 million in accounts it perceived as having certain risks, 
which were transferred to nonaccrual status. These transfers were offset by 
continued resolution of nonaccrual accounts. Approximately $230 thousand in 
loans were returned to accrual status; principal payments of approximately 
$2.1 million were collected; nonaccruing loans totaling approximately $1.0 
million were sold during the second and fourth quarters; and charge-offs 
totaling $3.8 million further decreased the balance of nonaccruing loans.

Loans Past Due 90 Days or More and Still Accruing Interest

The Bank generally places loans that become 90 or more days past due in 
nonaccrual status. If, in the opinion of management, the ultimate 
collectibility of principal and interest is assured, loans may continue to 
accrue interest and be left in this category. Included in this category are 
loans which have reached maturity and have not been renewed on a timely 
basis, for reasons other than financial capacity to pay. Balances of loans 
90 or more days past due decreased $233 thousand from year end 1997 to year 
end 1998. Approximately 63% of these balances carry a guaranty from the U.S. 
Small Business Administration.

Restructured Loans

Restructured loans (TDRs) increased from $215 thousand at December 31, 1997 
to $320 thousand at December 31, 1998.

Other Real Estate Owned

The Bank continued its success in 1998 in disposing of Other Real Estate 
Owned ("OREO") and continues to aggressively market remaining OREO. The 
balance of OREO decreased from $591 thousand at December 31, 1997 to $470 
thousand at December 31, 1998. During the year, $973 thousand in loan 
balances were transferred to OREO, offset by sale proceeds during 1998 of 
$1.2 million, which included $101 thousand in gains. Of the sale proceeds, 
$1.0 million was derived from the sale of two properties housing operating 
branches of the Bank, portions of which are now leased back for branch 
operations purposes.

Policies and Procedures Related to the Accrual of Interest Income

The Bank normally recognizes income on earning assets on the accrual basis, 
which calls for the recognition of income as earned, rather than when it is 
collected. The Bank's policy is to classify a loan 90 days or more past due 
with respect to principal or interest as a nonaccruing loan, unless the 
ultimate collectibility of principal and interest is assured. Income 
accruals are suspended on all nonaccruing loans, and all previously accrued 
and uncollected interest is typically charged against current income. A loan 
remains in nonaccruing status until the factors which suggest doubtful 
collectibility no longer exist, the loan is liquidated, or when the loan is 
determined to be uncollectible and is charged off against the reserve for 
possible loan losses. In those cases where a nonaccruing loan is secured by 
real estate, the Bank can, and usually will, initiate foreclosure 
proceedings. The result of such action will either be to cause repayment of 
the loan with the proceeds of a foreclosure sale or to give the Bank  
possession of the collateral in order to manage a future resale of the real 
estate. Foreclosed property is recorded at the lower of its cost or 
estimated fair value, less any estimated costs to sell. Any cost in excess 
of the estimated fair value on the transfer date is charged to the reserve 
for possible loan losses, while further declines in market values are 
recorded as an expense in other noninterest expense in the statement of 
operations.

Loan Portfolio Monitoring

The Bank's Board of Directors grants each loan officer the authority to 
originate loans on behalf of the Bank. The Board also establishes 
restrictions regarding the types of loans that may be granted and the 
distribution of loan types within the Bank's portfolio, and sets loan 
authority limits for each lender. These authorized lending limits are 
established at least annually and are based upon the lender's knowledge and 
experience. Loan requests that exceed a lender's authority are referred to 
the Bank's credit department. 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 the Bank's Board of Directors.

Using a variety of management reports, the Bank's loan portfolio is 
regularly monitored by the Board of Directors and credit department. The 
loan portfolio as a whole, as well as individual loans, are reviewed for 
loan performance, creditworthiness, and strength of documentation. The Bank 
has hired an external loan review firm to assist in monitoring both the 
commercial and residential loan portfolios. Credit risk ratings are assigned 
to commercial loans and are routinely reviewed.

All loan officers are required to service their own loan portfolios and 
account relationships. As necessary, loan officers or the loan workout 
function takes remedial actions to assure full and timely payment of loan 
balances.

Reserve for Possible Loan Losses

The reserve for possible loan losses is based on management's estimate of 
the amount required to reflect the risks in the loan portfolio, based on 
circumstances and conditions known or anticipated at each reporting date. 
Merchants Bank reviews the adequacy of the Reserve for Possible Loan Losses 
("RPLL") at least quarterly. Factors considered in evaluating the adequacy 
of the reserve 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 RPLL is not 
based on maintaining a specific percentage of RPLL to total loans or total 
nonperforming assets. 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 RPLL when 
management believes that the collectibility of principal is doubtful. To the 
extent management determines the level of anticipated losses in the 
portfolio have significantly increased or diminished, the RPLL is adjusted 
through current earnings. As part of the Bank's analysis of specific credit 
risk, detailed and extensive reviews are done on larger credits and 
problematic credits identified on the watched asset list, nonperforming 
asset listings and internal credit rating reports. Loans deemed impaired at 
December 31, 1998 totaled $3.9 million. Impaired loans have been allocated 
$400 thousand of the RPLL.

Overall, management believes that the RPLL is maintained at an adequate 
level, in light of historical and current factors, to reflect the level of 
credit risk in the loan portfolio. Loan loss experience and nonperforming 
asset data are presented and discussed in relation to their impact on the 
adequacy of the RPLL.

The following table reflects the Bank's loan loss experience and activity in 
the RPLL for the past five years.

       Loan Losses and Reserve for Possible Loan Losses Reconciliation
                              December 31, 1998

<TABLE>
<CAPTION>
(In thousands)                            1998         1997         1996         1995         1994
----------------------------------------------------------------------------------------------------
<S>                                     <C>          <C>          <C>          <C>          <C>
Average Loans Outstanding               $391,814     $394,289     $406,514     $481,047     $514,843
RPLL Beginning of Year                    15,831       15,700       16,234       19,929       20,060
Charge-Off:
  Commercial, Lease Financing
   and all Other Loans                      (685)        (483)        (907)      (3,671)      (3,356)
  Real Estate-Construction                   (18)         (78)        (602)      (1,485)      (1,159)
  Real Estate-Mortgage                    (3,042)        (763)      (3,206)     (12,942)      (7,673)
  Installment & Credit Cards                (190)        (372)        (405)        (263)        (462)
----------------------------------------------------------------------------------------------------
      Total Loans Charged Off             (3,935)      (1,696)      (5,120)     (18,361)     (12,650)
----------------------------------------------------------------------------------------------------
Recoveries:
  Commercial, Lease Financing
   and all Other Loans                       554          615          391        1,232        1,187
  Real Estate-Construction                     -            -           63           32          400
  Real Estate-Mortgage                       451        2,996          856        1,224          769
  Installment & Credit Cards                 136           78          125           78          163
----------------------------------------------------------------------------------------------------
      Total Recoveries                     1,141        3,689        1,435        2,566        2,519
----------------------------------------------------------------------------------------------------
Net Loan Losses                           (2,794)       1,993       (3,685)     (15,795)     (10,131)
----------------------------------------------------------------------------------------------------
Provision for Possible Loan Losses:
  Charged to Operations(1)                (1,737)      (1,862)       3,150       12,100       10,000
----------------------------------------------------------------------------------------------------
RPLL End of Year                        $ 11,300     $ 15,831     $ 15,700     $ 16,234     $ 19,929
====================================================================================================
RPLL to Total Loans                         2.79%        4.06%        4.05%        3.61%        3.90%
Net Loan Losses to Average Loans            0.71%        0.51%        0.91%        3.28%        1.97%
----------------------------------------------------------------------------------------------------

<FN>
<F1>  The loan loss provision is charged to operating expense. When actual 
      losses differ from these estimates, and if adjustments are considered 
      necessary, they are reported in operations in the periods in which 
      they become known.
</FN>
</TABLE>

During the fourth quarter of 1998, the Bank recorded a $1.6 million credit 
provision for possible loan losses resulting in an overall credit provision 
of $1.7 million in 1998. This reduction of the RPLL was primarily the result 
of an internal review of the Bank's loan loss reserve requirement, which 
considered the changing mix and improved quality of the loan portfolio, the 
impact of conservative underwriting standards implemented in previous 
periods, general economic conditions, and the resolution of a significant 
troubled credit. The Bank's analysis has been substantiated by a 
comprehensive assessment of its loan portfolio and review of its loan loss 
reserve requirement by its external loan review firm during the fourth 
quarter of 1998. The credit provision reduced the unallocated portion of the 
RPLL from $5.2 million to $3.6 million. As of December 31, 1998 the 
Company's reserve balances and ratios were still conservatively stated with 
the reserve at 368% of nonperforming assets and 2.79% of total loans. The 
negative loan loss provision in 1997 resulted from $2.16 million of 
principal recovery received by the Bank during the fourth quarter of 1997 on 
two previously charged down credits.

The continued high level of the RPLL reflects management's current 
strategies and efforts to maintain the reserve at a level adequate to 
provide for loan losses based on an evaluation of known and inherent risks 
in the loan portfolio. Among the factors that management considers in 
establishing the level of the reserve 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.

The Company takes all appropriate measures to restore nonperforming assets 
to performing status or otherwise liquidate these assets in an orderly 
fashion so as to maximize their value to the Company. There can be no 
assurances that the Bank will be able to complete the disposition of 
nonperforming assets without incurring further losses, or that the Bank will 
continue to recognize substantial recoveries or credit provision for 
possible loan losses such as those received during 1998 and 1997.

RISK MANAGEMENT

Management and the Board of Directors are committed to sound risk management 
practices throughout the organization. The Company has developed and 
implemented a centralized risk management monitoring program. Risks 
associated with the Company's business activities and products are 
identified and measured as to probability of occurrence and impact on the 
Company (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 the 
Company's risk profile from a macro perspective, while also serving as a 
tool for assessing internal controls over financial reporting as required 
under the FDIC Improvement Act.

Market Risk

Market risk is the risk of loss in a financial instrument arising from 
adverse changes in market rates/prices such as interest rates, foreign 
currency exchange rates, commodity prices, and equity prices. The Company's 
primary market risk exposure is interest rate risk. The ongoing monitoring 
and management of this risk is an important component of the Company's 
asset/liability management process which is governed by policies established 
by its Board of Directors that are reviewed and approved annually. The Board 
of Directors delegates responsibility for carrying out the asset/liability 
management policies to the Asset and Liability Management Committee 
("ALCO"). In this capacity the ALCO develops guidelines and strategies 
impacting the Company's asset/liability management related activities based 
upon estimated market risk sensitivity, policy limits and overall market 
interest rate levels/trends.

Interest Rate Risk

Interest rate risk is the exposure to a movement in interest rates, which 
could affect the Company's net interest income. It is the responsibility of 
the Company's ALCO to manage interest rate risk which arises naturally from 
imbalances in repricing, maturity and/or cash flow characteristics of the 
Company's assets and liabilities. The ALCO is responsible for developing 
asset/liability management strategies and tactics, and for ensuring that the 
Board of Directors receives timely, accurate information regarding the 
Bank's interest rate risk position at least quarterly. Techniques used by 
the ALCO take into consideration the cash flow and repricing attributes of 
balance sheet and off-balance sheet items and their relation to possible 
changes in interest rates. The ALCO uses interest rate caps and floors to 
help minimize the Bank's exposure to changes in interest rates. Through the 
use of computerized modeling systems, and with the assistance of outside 
consultants, the effect on the Company's net interest income of a possible 
200 basis point change in interest rates, in rising and declining scenarios, 
is determined and evaluated by management. The Bank has established a target 
range for the change in net interest income, given a 200 basis point change 
in interest rates, of zero to 5%. As of December 31, 1998, through the use 
of such computer models, the change in net interest income for the 12 months 
ending December 31, 1999 from the Company's expected or "most likely" 
forecast is as follows:

<TABLE>
<CAPTION>
                                         Net Interest
           Rate Change                Income Sensitivity
      --------------------------------------------------
      <S>                                  <C>
      Up 200 basis points                  (1.34)%
      Down 200 basis points                 2.94%
      --------------------------------------------------
</TABLE>

The preceding sensitivity analysis does not represent a Company forecast and 
should not be relied upon as being indicative of expected operating results. 
These hypothetical estimates are based upon numerous assumptions including: 
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, reinvestment/replacement of asset and 
liability cash flows, and others. While assumptions are developed based upon 
current economic and local market conditions, the Company cannot make any 
assurances as to the predictive nature of these assumptions including how 
customer preferences or competitor influences might change.

Also, as market conditions vary from those assumed in the sensitivity 
analysis, actual results will also differ due to: prepayment/refinancing 
levels likely deviating from those assumed, the varying impact of interest 
change caps or floors on adjustable rate assets, the potential effect of 
changes in debt service levels of customers with adjustable rate loans, 
depositor early withdrawals and product preference changes, and other 
internal/external variables. Furthermore, the sensitivity analysis does not 
reflect all actions that ALCO might take in responding to or anticipating 
changes in interest rates.

The model used to perform the simulation assumes a parallel shift of the 
yield curve over twelve months and reprices every interest-bearing asset and 
liability on the Bank's 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 NOW 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, prepayment estimates are 
derived from the Office of Thrift Supervision Net Portfolio Value Model.

The Company has entered into interest rate cap and floor contracts to 
mitigate the effects on net interest income in the event interest rates on 
variable rate deposits rise or rates on variable rate loans decline. The 
notional principal amounts of contracts outstanding were $80 million, the 
amortized cost of such contracts was $302 thousand and the fair value of the 
contracts was $280 thousand as of December 31, 1998. The Company will 
receive payments under these contracts in the event of specified changes in 
certain interest rates. As of December 31, 1998 interest rate floors with a 
notional amount of $30 million were in the money. Payments were received in 
1999.

The Company's interest rate sensitivity gap ("gap") is pictured below. Gap 
is defined as the difference between assets and liabilities repricing or 
maturing within specified periods. An asset-sensitive position (positive 
gap) indicates that there are more rate-sensitive assets than rate-sensitive 
liabilities repricing or maturing within a specified time period, which 
would imply a favorable impact on net interest income during periods of 
rising interest rates. Conversely, a liability-sensitive position (negative 
gap) generally implies a favorable impact on net interest income during 
periods of falling interest rates. The Company's gap presentation may not 
reflect the degrees to which interest earning assets and interest bearing 
deposits respond to changes in market interest rates.

<TABLE>
<CAPTION>
                                                                 Repricing Date
--------------------------------------------------------------------------------------------------------
                                          One Day      Over Six      One Year
                                          To Six       Months To     To Five      Over Five
(In thousands)                            Months       One Year      Years          Years        Total
--------------------------------------------------------------------------------------------------------
<S>                                      <C>           <C>           <C>          <C>           <C>
Assets
  Loans                                  $ 106,571     $ 57,410      $186,070     $ 44,141      $394,192
  Mortgage Backed Securities                18,595       15,757        50,641       40,142       125,135
  US Treasury & Agency Securities           14,978          200        25,797        5,230        46,205
  Other Securities                           3,883          306         2,561        1,543         8,293
  Other Assets                               2,000            -             -       59,048        61,048
--------------------------------------------------------------------------------------------------------
Total Assets                             $ 146,027     $ 73,673      $265,069     $150,104      $634,873
========================================================================================================
Liabilities and Stockholders' Equity
  Noninterest-bearing Deposits                   -            -             -     $ 85,998      $ 85,998
  Interest-bearing Deposits              $ 238,150     $ 54,290      $165,351        6,673       464,464
  Borrowed Funds                             9,283            -             -        6,409        15,692
  Other Liabilities                              -            -             -        7,890         7,890
  Stockholders' Equity                           -            -             -       60,829        60,829
--------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders'
 Equity                                  $ 247,433     $ 54,290      $165,351     $167,799      $634,873
========================================================================================================
Cumulative Gap                           $(101,406)    $(82,023)     $ 17,695
Gap as a % of Total Earning Assets          (17.30)%     (13.99)%        3.02%
--------------------------------------------------------------------------------------------------------
</TABLE>

Based on historical experience and the Bank's internal repricing policies, 
it is the Bank's practice to present repricing of statement savings, savings 
deposits and NOW account balances in the "one to five year" category. The 
Bank's experience has shown that the rates on these deposits tend to be less 
rate-sensitive than other types of deposits.

Credit Risk

A network of loan officers manages credit risk, with review by the Bank's 
Credit Department and oversight by the Board of Directors. The Board of 
Directors grants each loan officer the authority to originate loans on 
behalf of the Bank and establishes policies regarding loan portfolio 
diversification and loan officer lending limits. The Bank's loan portfolio 
is continuously monitored, through the use of a variety of management 
reports and with the assistance of an external loan review firm, for 
performance, creditworthiness and strength of documentation. Credit ratings 
are assigned to commercial loans and are routinely reviewed. When necessary, 
loan officers or the loan workout function take remedial actions to assure 
full and timely payment of loan balances. The Bank's 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. Credit card balances 90 or more days 
past due are charged off and consumer installment loans are charged off when 
they reach 120 days past due.

Liquidity and Capital Resource Management

Liquidity, as it pertains to banking, can be defined as the ability to 
generate cash in the most economical way to satisfy loan and deposit 
withdrawal demand, and to meet other business opportunities that require 
cash. Sources of liquidity for banks include short-term liquid assets, cash 
generated from loan repayments and amortization, borrowing, deposit 
generation and earnings. The Merchants Bank has a number of sources of 
liquid funds, including $20 million in available Federal Funds lines of 
credit at year-end 1998; an overnight line of credit with the Federal Home 
Loan Bank ("FHLB") of $15 million; an estimated additional borrowing 
capacity with the FHLB of $48 million; and the ability to borrow $100 
million through the use of repurchase agreements, collateralized by the 
Bank's investments, with certain approved counterparties. Additionally, the 
Bank's investment portfolio is actively managed by the ALCO and is a strong 
source of cash flow for the Bank. The portfolio is fairly liquid, with a 
weighted average life of 5 years, and is available to be used as a source of 
funds, if needed.

YEAR 2000

Introduction: The Company, like most users of computers, computer software, 
and equipment utilizing computer software, faces a critical challenge 
regarding the Year 2000 date change. The Year 2000 issue, which is common to 
most corporations, and especially important to banks, concerns the inability 
of information systems, primarily computer software programs, to properly 
recognize and process date sensitive information as the Year 2000 
approaches. If not corrected, many computer applications could fail or 
create inaccurate results. The bank regulatory agencies which regulate the 
conduct of the Company, the Bank and the Trust Company, through the auspices 
of the Federal Financial Institutions Examination Council (FFIEC) have 
issued compliance guidelines requiring financial institutions to develop and 
implement plans to address the Year 2000 issue. During the past fifteen 
months, the Company has devoted substantial time and resources toward 
ensuring that the Company's and its subsidiaries' operations will not be 
adversely impacted by the pending date change. The Bank's primary regulator, 
the Federal Deposit Insurance Corporation, has been monitoring, and 
continues to monitor, the Bank's planning and implementation process on a 
regular basis. The Company has also contracted with a national accounting 
firm to perform an independent review of the Company's Year 2000 
preparations. These reviews commenced during the fourth quarter of 1998 and 
will continue into 1999. The Company's management remains committed to the 
continued deployment of the necessary internal and external resources toward 
addressing the Year 2000 issue.

State of Readiness: As required by the Company's and its subsidiaries' 
regulatory agencies, the Company, through its Year 2000 Committee (the 
Committee), has developed a Year 2000 compliance plan. The Company's plan 
addresses the five basic phases of achieving Year 2000 compliance; (i) 
project management, (ii) awareness, (iii) assessment, (iv) testing and (v) 
renovation and implementation. Project management began in the middle of 
1997 as the Committee was formed. Since its formation, the Committee has met 
on a regular basis to discuss and plan the specific actions that the 
Company, the Bank and the Trust Company need to take to verify that the 
Company and its subsidiaries will be prepared for the date change. In 
addition, the Company has developed a strategy to ensure that its software 
vendors are also taking steps to address the Year 2000 date change. The 
Committee is comprised of senior executive officers of the Company, the Bank 
and the Trust Company. The Committee is chaired by the Bank's Senior 
Operations Officer, and includes the Company's Chief Financial Officer, the 
Bank's Chief Auditor/Risk Management Officer, the Bank's Information Systems 
Manager, the Bank's Credit Manager, the Bank's Deposit Operations Manager, a 
Trust Company Officer and the Bank's Facilities/Administration Manager. The 
Committee provides progress reports to the Company's senior management and 
reports at least quarterly to the Company's Board of Directors. 

Through the Committee, the Company has also taken steps to promote awareness 
of the Year 2000 issue throughout its entire organization. In addition, the 
Company has sought to raise the awareness of its vendors, service providers 
and larger borrowing customers as to the Year 2000 issue in light of the 
critical role these entities play in the operations of the Company. The 
Committee has contacted each of these entities and requested a Year 2000 
plan and testing information. The Company has received responses from more 
than 98% of its vendors and service providers. The majority (92%) of the 
Company's significant borrowers have also responded. The Committee intends 
to follow-up with these customers throughout the next year and into the Year 
2000.

Assessment is the process of identifying all mission-critical applications 
that could be adversely affected by the date change. The Company's 
assessment phase is substantially complete. Throughout its history, 
independent of Year 2000 issues, the Company has sought to purchase its 
critical core hardware and software from vendors who it perceives as having 
strong reputations as leading financial industry service providers. The 
Company has received and installed Year 2000 compliant software upgrades 
from all mission critical vendors. Substantial progress has been made with 
respect to the fourth phase of the Company's Year 2000 plan, testing. 
Testing of the Company's core computer and peripheral equipment 
infrastructure has been successfully completed and substantial progress has 
been made in the testing of the infrastructure of the Company's personal 
computer desktop network. Testing of mission critical customer accounting 
software applications has begun and is targeted for completion in advance of 
the FFIEC suggested testing completion date. All other systems and 
applications have been scheduled for testing prior to September 30, 1999. In 
the Plan, each of these non-mission critical systems has an established 
target date by which steps must be taken to replace any non-compliant 
systems. The Company is confident that all tests will be completed in 
advance of those target dates.

The final phase of the Plan, renovation and implementation, involves 
obtaining and implementing renovated software applications provided by the 
Company's vendors. As noted above, this phase of the Plan has already 
commenced and will continue throughout 1999. To date, the Company has not 
identified any system which presents a material risk of not being Year 2000 
compliant in a timely fashion or for which a suitable alternative cannot be 
implemented.

Costs to Address the Year 2000 Issue: The total financial costs associated 
with the Year 2000 problem cannot be predicted at this time with absolute 
certainty. As may be expected, the Committee currently estimates that there 
will be costs associated with replacing certain non-compliant software 
and/or hardware. The Company has hired a full-time project coordinator to 
oversee the testing phase of the Year 2000 project. Although no other staff 
additions are currently planned, the Committee estimates that approximately 
30-35 people (about 10% of our staff) are spending some portion of their 
time working on the Year 2000 project. Additionally, the Company has hired a 
third party to evaluate the Bank's loan loss reserve adequacy in light of 
Year 2000 concerns. At this time, the Company does not anticipate a need for 
any additional loan loss provision related specifically to Year 2000 risks. 
The Company plans to replace many of the Bank's ATMs as well as upgrade 
certain software and equipment. Management had approved the replacement of 
the ATMs prior to Year 2000 budget planning since most were 15 to 20 years 
old. Out of the total estimated $1.22 million in capital costs $862 thousand 
is budgeted to upgrade the ATM network. The Bank has spent $680 thousand for 
ATM and other Year 2000 upgrades in 1998. These costs have been, and when 
incurred in the future will be, capitalized and depreciated over the 
estimated useful lives of the assets, as such assets represent replacement 
of existing equipment, which are not mainly being remediated for Year 2000. 
Direct (non-capital expenditures) Year 2000 expenses incurred year-to-date 
total approximately $163 thousand and have been charged to expense as 
incurred. Additional expenses related to the project are currently estimated 
to be $230 thousand and will be charged to expense as incurred.

Risks of Year 2000 Issues: The Year 2000 issue presents potential risks to 
the Company, its subsidiaries and their operations. As stated above, the 
Company purchases substantially all of its technology applications from 
third parties that face the same Year 2000 challenge as the Company. Thus, 
the Company's operations could be adversely affected if the operations of 
these third parties are adversely affected by the Year 2000 issue. Most 
significantly, the Company faces risks that are specific to the business of 
banking. Included among these risks is the risk that the Year 2000 date 
change may result in the inability to process and underwrite loan 
applications, to credit deposits and withdrawals from customer accounts, to 
credit loan payments or track delinquencies, to properly reconcile and 
record daily activity or to engage in similar normal banking activities. 
Additionally, if the Bank's commercial loan customers are not Year 2000 
compliant and suffer adverse effects with respect to their own operations, 
their ability to meet their obligations to the Bank could be adversely 
affected. Furthermore, as a commercial bank, the Bank could potentially 
experience deposit run-off prior to the Year 2000 date change as a result of 
customer concern about the potential availability of their funds or a change 
in interest rates. Moreover, to the extent that the risks posed by the Year 
2000 problem are pervasive in data processing and transmission and 
communications services worldwide, the Company cannot predict with any 
certainty that its operations will remain materially unaffected after 
January 1, 2000 or on dates preceding this date at which time post-January 
1, 2000 dates become significant within the Bank's systems. Finally, to the 
extent that certain utility and communication services used by the Company 
face Year 2000 problems, the Company's operations could be disrupted.

Contingency Plans: In light of these risks and uncertainties, the Company 
has developed and will continue to monitor contingency plans to mitigate the 
risks associated with the Year 2000 date change and to provide a business 
continuity strategy. The Company has developed these plans through building 
on its internal Disaster Recovery/Contingency plans, which were updated 
during the second quarter of 1998. This planning effort included a Business 
Impact Analysis relating to mission critical systems and is the foundation 
documentation that was used to finalize the Year 2000 mission critical 
service provider Contingency plans.

CAPITAL RESOURCES

Capital growth is essential to support deposit and asset growth and to 
ensure the strength and safety of the Company. Net income increased the 
Company's capital by $9.8 million in 1998, $8.8 million in 1997, and $6.2 
million in 1996.

The Bank and the Company are subject to various regulatory capital 
requirements administered by banking regulatory agencies. To be considered 
adequately capitalized under the regulatory framework for prompt corrective 
action, the Bank and the Company must maintain minimum Tier-1 Leverage, 
Tier-1 Risk-Based and Total Risk-Based Capital. The Bank and the Company 
were above all regulatory minimums and considered well capitalized by the 
regulators at December 31, 1998. The ratios for the Company are set forth 
below:

<TABLE>
<CAPTION>
                                                                Minimum to be
                                                               Well-Capitalized
                                                               Under Regulatory
      (In thousands)                Amount      Percentage        Guidelines
      -------------------------------------------------------------------------
      <S>                           <C>           <C>               <C>
      Tier-1 Risk-Based Capital     $58,677       14.45%             6.0%
      Total Risk-Based Capital       63,747       15.69%            10.0%
      Tier-1 Leverage Capital        58,677        9.49%             5.0%
      -------------------------------------------------------------------------
</TABLE>

During the third quarter of 1998 the Company's Board of Directors approved a 
stock repurchase program. Under the program the Company is authorized to 
repurchase, through September 4, 1999, up to $2.2 million of its own 
securities, approximately 2% of outstanding shares at that time. As of 
December 31, 1998 the Company had purchased 40,000 shares of stock on the 
open market, at a total cost of $960 thousand.

In July 1998, the Emerging Issues Task Force ("EITF") issued guidance on 
Issue No. 97-14, "Accounting for Deferred Compensation Arrangements Where 
Amounts Earned Are Held in a Rabbi Trust and Invested" (the "Guidance"). 
This Guidance establishes standards for reporting and accounting for certain 
deferred compensation agreements the Company and certain directors of the 
Company. This Guidance requires that the deferred compensation obligation be 
classified in the "Stockholders' Equity" section of the balance sheets. 
These amounts were previously classified as other liabilities in the 
"Liabilities" section of the Balance Sheets. The Company adopted this 
guidance prospectively on September 30, 1998 and on that date reclassified 
deferred compensation obligations totaling $2.13 million into the 
Stockholders' Equity section of the balance sheet as required. 

EFFECTS OF INFLATION

The financial nature of the Company's balance sheet and statement of 
operations is more clearly affected by changes in interest rates than by 
inflation, but inflation does affect the Company because as prices increase 
the money supply tends to increase, the size of loans requested tends to 
increase, total bank assets increase, and interest rates are affected by 
inflationary expectations. In addition, operating expenses tend to increase 
without a corresponding increase in productivity. There is no precise 
method; however, to measure the effects of inflation on the Company's 
financial statements. Accordingly, any examination or analysis of the 
financial statements should take into consideration the possible effects of 
inflation.

FORM 10-K

The following is a copy, except for the exhibits, of the Annual Report of 
Merchants Bancshares, Inc. (the "Company") on Form 10-K for the year ended 
December 31, 1998, filed with the Securities and Exchange Commission (the 
"Commission").

Certain information included herein is incorporated by reference from the 
Company's 1998 Annual Report to Shareholders ("Annual Report") as indicated 
below. Except for those portions of the Annual Report which are expressly 
incorporated herein by reference, the Annual Report is not to be deemed 
filed with the Commission. The Annual Report and Form 10-K have not been 
approved or disapproved by the Commission, nor has the Commission passed 
upon the accuracy or adequacy of the same.

                              TABLE OF CONTENTS

<TABLE>
<CAPTION>
Part I                                                                                           Page Reference
---------------------------------------------------------------------------------------------------------------
<S>                                                                                                  <C>
Item 1-Business                                                                                      51-56
Item 2-Properties                                                                                    56-57
Item 3-Legal Proceedings                                                                             57-58
Item 4-Submission of Matters to a Vote of Security Holders                                            58

Part II
---------------------------------------------------------------------------------------------------------------
Item 5-Market for Registrant's Common Equity and Related Stockholder Matters                          59
Item 6-Selected Financial Data                                                                        59
Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations         33-49
Item 7a-Quantitative and Qualitative Disclosures about Market Risk                                   44-46
Item 8-Financial Statements and Supplementary Data                                                    3-32
Item 9-Changes in and Disagreements with Accountants on Accounting and Financial Disclosures          61

Part III *
---------------------------------------------------------------------------------------------------------------
Item 10-Directors and Executive Officers of the Registrant                                            61
Item 11-Executive Compensation                                                                        61
Item 12-Security Ownership of Certain Beneficial Owners and Management                                61
Item 13-Certain Relationships and Related Party Transactions                                          61

Part IV **
---------------------------------------------------------------------------------------------------------------
Item 14-Exhibits, Financial Statement Schedules, and Reports on Form 8-K                             61-63
Signatures                                                                                            64

<FN>
--------------------
<F*>  The information required by Part III is incorporated herein by 
      reference from the Company's Proxy Statement for the Annual Meeting 
      of Shareholders to be held on April 20, 1999.
<F**> A list of exhibits in the Form 10-K is set forth on the Exhibit Index 
      included in the Form 10-K filed with the Commission and incorporated 
      herein by reference. Copies of any exhibit to the Form 10-K may be 
      obtained from the Company by contacting Shareholder Communications, 
      Merchants Bancshares, Inc., P.O. Box 1009, Burlington, VT 05402. All 
      financial statement schedules are omitted since the required 
      information is included in the consolidated financial statements of 
      the Company and notes thereto in the Annual Report.
</FN>
</TABLE>

                                   PART I

ITEM 1-BUSINESS

Merchants Bancshares, Inc. (the "Company") is a bank holding company 
originally organized under Vermont law in 1983 for the purposes of owning 
all of the outstanding capital stock of Merchants Bank (the "Bank") and 
providing greater flexibility in helping the Bank achieve its business 
objectives. Merchants Bank, which is the Company's primary subsidiary, is a 
Vermont commercial bank with 33 full-service offices.

Merchants Bank was organized in 1849 and assumed a national bank charter in 
1865, becoming The Merchants National Bank of Burlington, Vermont. On 
September 6, 1974, the Bank converted its national charter to a Vermont 
state commercial bank charter, adopting its current name, Merchants Bank. 
Since 1971, the Bank has acquired by merger seven Vermont banking 
institutions, and acquired the deposits of two other Vermont banks. As of 
December 31, 1998 the Bank operated one of the largest commercial banking 
operations in Vermont, with deposits totaling $550 million, loans of $405 
million, and total assets of $635 million, on a consolidated basis.

The Bank designs its products to provide customers a clear alternative to 
the local, regional and national financial service providers. The Bank's 
simplified LYNX product line was developed using the image of the lynx 
feline to connote speed and agility. Lynx also implies that a customer's 
accounts can be linked together to provide a comprehensive approach to 
their financial needs. The Bank's products have all been designed to be 
easy for the customer to understand and for the Bank's staff to deliver.

Merchants Trust Company (the "Trust Company"), a wholly owned subsidiary of 
the Bank, is a Vermont corporation chartered in 1870 for the purpose of 
offering fiduciary services including estate settlement, testamentary 
trust, guardianship, agency, intervivos trust and employee benefit plan 
services. The Trust Company also operates a discount brokerage office 
through Olde Discount Corporation, enabling investors to purchase or sell 
stocks and bonds on a discounted commission schedule. As of December 31, 
1998, the Trust Company had fiduciary responsibilities for assets having a 
market value in excess of $334 million, of which more than $207 million 
constituted managed assets. Total revenue of the Trust Company for 1998 was 
$1,910 thousand; total expenses were $1,118 thousand resulting in pretax 
net income of $877 thousand for the year. This net income is included in 
the consolidated tax return of its parent company, the Merchants Bank.

Merchants Properties, Inc., a wholly owned subsidiary of the Company, was 
organized for the purpose of developing and owning affordable rental 
housing units throughout the state of Vermont. As of December 31, 1998, 
Merchants Properties, Inc. owned one development located in Enosburg, 
Vermont, consisting of a 24-unit low-income family rental housing project. 
Total assets of this Merchants Properties, Inc. at December 31, 1998 were 
$1.2 million.

RETAIL SERVICES

The Bank offers a variety of consumer financial products and services 
designed to satisfy the deposit and loan needs of its retail customers. The 
Bank's retail products include interest-bearing and noninterest-bearing 
checking accounts, money market accounts, club accounts, and short-term and 
long-term certificates of deposit. The Bank also offers customary check 
collection services, wire transfers, safe deposit box rentals, and 
automated teller machine (ATM) cards and services.

In 1997, the Bank extended its commitment to automation by introducing a 
debit card and by expanding its automated overdraft protection. Using the 
BankLYNX[SM] Check Card, in addition to standard ATM transactions, 
customers can pay for purchases at locations that accept VISA and can also 
use the card for standard ATM transactions. With expanded automated 
overdraft protection, customers can use a savings account and/or a home 
equity line of credit as overdraft protection for a checking account. The 
customer may choose either or both accounts to cover overdrafts.

During 1998 the Bank converted all of its passbook savings account to 
statement savings accounts and introduced its MoneyLYNX[TM] Money Market 
Account as its primary savings vehicle. MoneyLYNX[TM] pays interest at 
tiered levels beginning with the first dollar in the account, and charges 
fees only under limited circumstances. Passbook savings accounts and 
statement savings accounts are no longer offered as new accounts.

FreedomLYNX[R] checking is available with no service charges to customers 
who have, at least monthly, an automatic deposit to the account or an 
automatic debit from the account to pay a Merchants Bank loan and to 
customers who qualify for a BankLYNX[SM] Check Card or who use 
PhoneLYNX[SM] or PCLYNX[R] Bill Payment Services. The account pays interest 
on higher balances with a tiered rate structure. No minimum balance is 
required. During 1999, to celebrate its 150th anniversary, the Bank will 
drop all electronic qualifications for the FreedomLYNX[R] account and offer 
the account free for life. This offer will begin on February 15 and ends on 
May 28. All existing FreedomLYNX[R] accounts will be converted to Free for 
Life on February 15. The Bank continues to offer Bottom Line Checking, an 
account that provides for a flat service charge up to a maximum number of 
checks.

The Bank continues to offer ATM cards, debit cards, ATF (automatic transfer 
of funds) to cover overdrafts, EFT (electronic funds transfer) to automate 
transfers between accounts, PCLYNX[R] bill payment services and the 
PhoneLYNX[SM] telephone banking system. In 1999, the Bank plans to expand 
its automated services by introducing a retail home banking system through 
the Internet.

The Bank continues to provide strong customer service. Each of the Bank's 
33 full-service branch offices is led by a branch president or manager who 
has consumer lending authority for the full range of retail credit 
services. Additionally, the Bank has  35 ATM locations throughout Vermont, 
and maintains a customer call center with expanded hours of operation.

COMMERCIAL SERVICES

Branch presidents are being given small business lending authority up to a 
prescribed limit. The eleven corporate banking officers and eight corporate 
banking administrators provide commercial credit services throughout the 
state of Vermont to customers requiring business credit above the 
prescribed authorities of the branch presidents.

In late 1998 the Bank developed a revitalized approach to small business 
markets in the state of Vermont. The retail branch network services 
approximately 75% of the commercial customers of the Bank. The Bank's 
Corporate Sales staff services the balance, primarily larger enterprises. 
Small business customers are being introduced to the Bank's new 
CommerceLYNX[TM] program. CommerceLYNX[TM] is a package of business banking 
services, including low cost electronic checking, investment accounts, 
streamlined credit application, and small business "Health Check". The 
Bank's philosophy of simplifying product offerings and minimizing fees has 
been applied to this program. Branch presidents are trained to offer this 
service, leading with the introduction of small business financing options 
and the value of utilizing the efficient transaction accounts. 
CommerceLYNX[TM] will be tested in 1999 in 10 pilot markets throughout the 
state. A dedicated Sales Manager will advance the program for more 
pervasive introduction throughout the state in the year 2000.

The Bank offers a variety of commercial checking accounts. Commercial 
Checking uses an earnings credit rate to help offset service charges. Small 
Business Checking is designed for the smaller business carrying lower 
balances and reduced account activity.  Investment opportunities are 
available to businesses in the form of savings accounts and money market 
accounts. The Bank's cash management services provide additional investment 
opportunities through the Cash Sweep Program. Other cash management 
services include funds concentration. The Bank offers on-line banking 
services through PCLYNX[R] Corporate and PCLYNX[R] Small Business. These 
products allow businesses to view their account histories, order stop 
payments, transfer between accounts, transmit ACH batches and order both 
domestic and foreign wire transfers.

Other miscellaneous commercial banking services include night depository, 
coin and currency handling, lockbox and balance reporting services. 
Employee benefits management and related fiduciary services are available 
through the Trust Company.

TYPES OF CREDIT OFFERINGS

Consumer Loans:
---------------

Financing is provided for new or used automobiles, boats, airplanes, 
recreational vehicles and new mobile homes. Home improvement and home 
equity lines of credit, Master Card credit cards and various collateral 
loans and personal loans are also available.

Real Estate Loans:
------------------

Financing is available for one-to-four-family residential mortgages; 
multifamily mortgages; residential construction; mortgages for seasonal 
dwellings; and commercial real estate mortgages. The Bank offers both fixed 
rate and adjustable rate mortgages for residential properties. The Bank 
closed over 750 mortgages in 1998 with an average loan of approximately $76 
thousand and a term of approximately 15 years. The process and the product 
have been streamlined to make the product easier to use and simpler for our 
33 branch presidents to deliver.

Commercial Loans:
-----------------

Financing for business inventory, accounts receivable, fixed assets, lines 
of credit for working capital, community development, irrevocable letters 
of credit, business credit cards and U.S. Small Business Administration 
loans are available.

COMPETITION

The Bank competes for deposit and loan business with numerous other 
commercial and savings banks, savings and loan associations, credit unions, 
and other non-bank financial providers. As of December 31, 1998, there were 
more than 25 state and national banking institutions operating in Vermont. 
In addition, the number of other non-bank financial service providers 
competing in Vermont has increased dramatically. As a bank holding company 
and state-chartered bank, respectively, the Company and the Bank are 
subject to extensive regulation and supervision, including, in many cases, 
regulation that limits the type and scope of their activities. These non-
financial institutions which compete with the Company and the Bank are not 
subject to such extensive regulation and supervision. Competition from 
nationwide banks, as well as local institutions continues to be aggressive

At year-end 1998, the Bank was one of the largest state chartered banks in 
Vermont, enjoying a strong competitive franchise within the state, with 33 
banking offices as identified in Item 2 (A).

Consolidation within the overall banking industry nationally continues to 
change the competitive environment in which we operate. Locally, the 
proposed merger between the Chittenden Bank and Vermont National Bank will 
consolidate two of the state's largest banks.. However, there may be 
opportunities for business development by the Bank in shared market 
communities as a result of the continued consolidation in the banking 
industry.

No material part of the Bank's business is dependent upon one, or a few, 
customers, or upon a particular market segment, the loss of which would 
have a materially adverse impact on the operations of the Bank.

NUMBER OF EMPLOYEES

As of December 31, 1998, the Company had three officers: Joseph L. Boutin, 
President and Chief Executive Officer; Janet Spitler, Treasurer; and 
Jennifer L. Varin, Secretary. No officer of the Company is on a salary 
basis.

As of December 31, 1998, the Bank employed 220 full-time and 47 part-time 
employees, representing a full-time equivalent complement of 246 employees; 
the Merchants Trust Company employed 14 full-time employees. The Bank and 
the Trust Company maintain comprehensive employee benefits programs which 
provide major medical insurance, hospitalization, dental insurance, long-
term and short-term disability insurance, life insurance and a 401(k) 
Employee Stock Ownership Plan.

REGULATION AND SUPERVISION

General

As a bank holding company registered under the Bank Holding Company Act of 
1956, as amended (the "BHCA"), the Company is subject to substantial 
regulation and supervision by the Federal Reserve Board. As a state-
chartered bank, the Bank is subject to substantial regulation and 
supervision by the Federal Deposit Insurance Corporation (the "FDIC") and 
by applicable state regulatory agencies. To the extent that the following 
information describes statutory or regulatory provisions, it is qualified 
in its entirety by reference to those particular statutory provisions. Any 
change in applicable law or regulation may have a material effect on the 
business and prospects of the Company and the Bank.

The Company is required by the BHCA to file with the Federal Reserve Board 
an annual report and such additional reports as the Federal Reserve Board 
may require. The Federal Reserve Board also makes periodic inspections of 
the Company and its subsidiaries. The BHCA requires every bank holding 
company to obtain the prior approval of the Federal Reserve Board before it 
may acquire substantially all of the assets of any bank, or ownership or 
control of any voting shares of a bank, if, after such acquisition, it 
would own or control, directly or indirectly, more than 5% of the voting 
shares of such bank. Additionally, as a bank holding company, the Company 
is prohibited from acquiring ownership or control of 5% or more of any 
company not a bank or from engaging in activities other than banking or 
controlling banks except where the Federal Reserve Board has determined 
that such activities are so closely related to banking as to be a "proper 
incident thereto."

Dividends

General. The Company is a legal entity separate and distinct from the Bank 
and its other non-bank subsidiaries. The revenue of the Company (on a 
parent company only basis) is derived primarily from interest and dividends 
paid to the corporation by its subsidiaries. The right of the Company, and 
consequently the right of stockholders of the Company, to participate in 
any distribution of the assets or earnings of any subsidiary through the 
payment of such dividends or otherwise is necessarily subject to the prior 
claims of creditors of the subsidiary (including depositors, in the case of 
banking subsidiaries), except to the extent that certain claims of the 
Company in a creditor capacity may be recognized.

The payment of dividends by the Company is determined by its board of 
directors based on the consolidated Company's liquidity, asset quality 
profile, capital adequacy, and recent earnings history, as well as economic 
conditions and other factors, including applicable government regulations 
and policies and the amount of dividends payable to the Company by its 
subsidiaries.

It is the policy of the Federal Reserve Board that banks and bank holding 
companies, respectively, should pay dividends only out of current earnings 
and only if after paying such dividends the bank or bank holding company 
would remain adequately capitalized. Federal banking regulators also have 
authority to prohibit banks and bank holding companies from paying 
dividends if they deem such payment to be unsafe or unsound practice. In 
addition, it is the position of the Federal Reserve Board that a bank 
holding company is expected to act as a source of financial strength to its 
subsidiary banks.

State law requires the approval of state bank regulatory authorities if the 
dividends declared by state banks exceed prescribed limits. The payment of 
any dividends by the Company's subsidiaries will be determined based on a 
number of factors, including the subsidiary's liquidity, asset quality 
profile, capital adequacy and recent earnings history.

Legislation and Related Matters

General. In addition to extensive existing government regulation, federal 
and state statutes and regulations are subject to changes that may have 
significant impact on the way in which banks may conduct business. The 
likelihood and potential effects of any such changes cannot be predicted. 
Legislation enacted in recent years has substantially increased the level 
of competition among commercial banks, thrift institutions and non-banking 
institutions, including insurance companies, brokerage firms, mutual funds, 
investment banks, finance companies and major retailers. In addition, the 
existence of banking legislation such as the Federal Deposit Insurance 
Corporation Improvement Act of 1991 ("FDICIA") have affected the banking 
industry by, among other things, broadening the regulatory powers of the 
federal banking agencies in a number of areas. The following summary is 
qualified in its entirety by the text of the relevant statutes and 
regulations.

FDICIA. The FDICIA, which was enacted on December 19, 1991, provides for, 
among other things, increased funding for the Bank Insurance Fund ("BIF") 
of the FDIC and expanded regulation of depository institutions and their 
affiliates, including parent holding companies. A summary of certain 
material provisions of FDICIA and its regulations is provided below.

Prompt Corrective Action. The FDICIA provides the federal banking agencies 
with broad powers to take prompt corrective action to resolve problems of 
insured depository institutions, depending upon a particular institution's 
level of capital. The FDICIA establishes five tiers of capital measurement 
for regulatory purposes ranging from "well-capitalized" to "critically 
undercapitalized." A depository institution may be deemed to be in a 
capitalization category that is lower than is indicated by its actual 
capital position under certain circumstances. As of December 31, 1997, the 
Bank was classified as "well-capitalized" under the applicable prompt 
corrective action regulations.

Brokered Deposits. Under the FDICIA, a depository institution that is well-
capitalized may accept brokered deposits. A depository institution that is 
adequately capitalized may accept brokered deposits only if it obtains a 
waiver from the FDIC, and may not offer interest rates on deposits 
"significantly higher" than the prevailing rate in its market. An 
undercapitalized depository institution may not accept brokered deposits.

Safety and Soundness Standards. The FDICIA, as amended, directs each 
federal banking agency to prescribe safety and soundness standards for 
depository institutions relating to internal controls, information systems, 
internal audit systems, loan documentation, credit underwriting, interest 
rate exposure, asset growth, compensation, asset-quality, earnings and 
stock valuation. The Community Development and Regulatory Improvement Act 
of 1994 amended FDICIA by allowing federal banking activities to publish 
guidelines rather than regulations concerning safety and soundness.

The Federal Reserve Board has finalized these safety and soundness 
guidelines. These guidelines relate to the management policies of financial 
institutions and are designed, in large part, to implement the safety and 
soundness criteria outlined in FDICIA. These guidelines will be published 
after the other federal bank regulatory agencies have developed their 
guidelines. At this time, it is not known what effect the applicable 
guidelines will have on the current practices of the Company or the Bank.

FDICIA also contains a variety of other provisions that may affect the 
Company's and the Bank's operations, including reporting requirements, 
regulatory guidelines for real estate lending, "truth in savings" 
provisions, and the requirement that a depository institution give 90 days' 
prior notice to customers and regulatory authorities before closing any 
branch. Certain of the provisions in FDICIA have recently been or will be 
implemented through the adoption of regulations by the various federal 
banking agencies and, therefore, their precise impact cannot be assessed at 
this time.

Capital Guidelines. Under the uniform capital guidelines adopted by the 
federal banking agencies, a well-capitalized institution must have a 
minimum ratio of total capital to risk-adjusted assets (including certain 
off-balance sheet items, such as standby letters of credit) of 10%, a 
minimum Tier 1 (comprised of common equity, retained earnings, minority 
interests in the equity accounts of consolidated subsidiaries and a limited 
amount of noncumulative perpetual preferred stock, less deductible 
intangibles) capital-to-total risk based assets of 6% and a minimum 
leverage ratio (Tier 1 capital to average quarterly assets, net of 
goodwill), of 5%.

Under federal banking laws, failure to meet the minimum regulatory capital 
requirements could subject a banking institution to a variety of 
enforcement remedies available to federal regulatory authorities, including 
the termination of deposit insurance by the FDIC and seizure of the 
institution.

Community Investment Act. Pursuant to the Community Reinvestment Act 
("CRA") and similar provisions of Vermont law, regulatory authorities 
review the performance of the Company and the Bank in meeting the credit 
needs of the communities served by the Bank. The applicable regulatory 
authorities consider compliance with this law in connection with the 
applications for, among other things, approval of branches, branch 
relocations and acquisitions of banks and bank holding companies. The Bank 
received a "satisfactory" rating at its most recent CRA examination.

Interstate Banking As of September 29, 1995, the Riegle-Neal Interstate 
Banking and Branching Efficiency Act of 1994 (the "RNA") permitted 
adequately capitalized and managed bank holding companies to acquire 
control of banks in any state. Additionally, beginning on June 1, 1997, the 
RNA provides for banks to branch across state lines, although individual 
states are authorized to permit interstate branches earlier or to elect to 
opt out entirely.

Other Proposals

Other legislative and regulatory proposals regarding changes in banking, 
and the regulation of banks and other financial institutions, are regularly 
considered by the executive branch of the federal government, Congress and 
various state governments, including Vermont, and state and federal 
regulatory authorities. It cannot be predicted what additional legislative 
and/or regulatory proposals, if any, will be considered in the future, 
whether any such proposals will be adopted or, if adopted, how any such 
proposals would affect the Company or the Bank.

ITEM 2-PROPERTIES 

A.  SCHEDULE OF BANKING OFFICES BY LOCATION

Merchants Bank operates thirty-three banking facilities as indicated in 
Schedule A below. Administrative offices and the operations data processing 
center are located at 275 Kennedy Drive, South Burlington, Vermont.

<TABLE>

      <S>                  <C>                                   <S>
      Barre                105 North Main Street(2)              Branch office

      Bennington           406 Main Street, Putnam Square(2)     Branch office

      North Bennington     5 Bank Street                         Branch office

      Bradford             1 Main Street(2)                      Branch office

      Brattleboro          205 Main Street(2)                    Branch office

      Bristol              15 West Street                        Branch office

      Burlington           164 College Street                    Merchants Trust Company
                                                                 Corporate Offices
                           172 College Street                    Branch office
                           1014 North Avenue                     Branch office

      Colchester           22 Bissette Drive(2)                  Branch office

      Enosburg             371 Main Street                       Branch office

      Essex Junction       54 Pearl Street                       Branch office

      Fair Haven           97 Main Street                        Branch office

      Fairlee              501 U.S. Route 5 North(2)             Branch office

      Groton               258 Scott Highway                     Branch office

      Hardwick             84 VT Route 15 West                   Branch office

      Hinesburg            26 Ballards Corner                    Branch office

      Jericho              205 VT Route 15                       Branch office

      Johnson              103 Lower Main Street                 Branch office

      Manchester Center    4996 Main Street                      Branch office

      Newbury              4976 Main Street South                Branch office

      Northfield           70 Depot Square(2)                    Branch office

      St. Johnsbury        481 Portland Street                   Branch office

      South Burlington     50 White Street                       Branch office
                           929 Shelburne Road(1)                 Branch office
                           275 Kennedy Drive                     Service Center

      South Hero           301 Route 2                           Branch office

      Springfield          2 Chester Road, Suite 15(2)           Branch office

      East Thetford        332 Route 113(2)                      Branch office

      Vergennes            25 Monkton Road                       Branch office

      Wallingford          137B North Main Street(2)             Branch office

      Wilmington           24 West Main Street                   Branch office

      Windsor              160 Main Street                       Branch office

      Winooski             364 Main Street                       Branch office

<FN>
--------------------
<F1>  Facilities owned by the Bank are located on leased land.
<F2>  Facilities located on leased land with improvements also leased.
</FN>
</TABLE>

ITEM 3-LEGAL PROCEEDINGS

The Bank is a counterclaim defendant in a litigation entitled "Pasquale and 
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim 
Defendant", now pending in the United States Bankruptcy Court for the 
District of Vermont.

In this litigation, the Vescios have made a number of "lender liability" 
claims dealing with a commercial development known as Brattleboro West in 
Brattleboro, Vermont. The pending litigation arose out of a suit to 
foreclose on several real estate mortgages and personal property originally 
delivered to the Bank as collateral by the Vescios in connection with the 
financing of a supermarket in the Brattleboro West project and various 
other projects.

Among other things, the Vescios have alleged that the Bank or its 
representatives violated supposed oral promises in connection with the 
origination and funding of the financing, and have claimed that the Bank is 
liable to them for damages based on the Bank's supposed "control" of the 
project and its alleged breach of covenants of "good faith" which the 
plaintiffs believe are to be implied from the loan documents. In addition, 
the plaintiffs have contended that the Bank breached a duty of care they 
believe it owed to them, and have claimed that the Bank should not have 
exercised its contract rights when the loan went into default, but should 
have worked out the default in a way that was more favorable to the 
borrowers. Trial concluded in United States Bankruptcy Court in November 
1998. Although it is not possible at this stage to predict the outcome of 
this litigation, the Bank believes that it has meritorious defenses to the 
plaintiffs' allegations. The Bank intends to vigorously defend itself 
against these claims.

The Company, the Bank, the Trust Company (the "Companies") and certain of 
their directors are defendants in a lawsuit filed in November of 1994 (the 
"Vermont Proceedings"). The Vermont Proceedings arose from certain 
investments managed for Trust company customers and placed in the Piper 
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In 
December of 1994, the Companies made payments to the Trust Company 
customers in amounts that the Companies believed reimbursed those customers 
fully for Portfolio losses. The United States District Court for the 
District of Vermont has dismissed the Plaintiff's claims in the Vermont 
Proceedings with prejudice, as moot, and ordered payment of approximately 
$99,000 in attorney's fees. The Plaintiff and his attorneys appealed those 
District Court orders to the Second Circuit Court of Appeals, and the 
Companies appealed on certain limited issues. By Order dated January 28, 
1999 the Second Circuit Court affirmed those District Court orders in all 
material respects and remanded the case to the District Court with 
instructions to clarify whether the dismissal of the claims as moot was to 
be with prejudice. Still pending before the Second Circuit is a separate 
appeal from the District Court's denial of Plaintiff's requests for 
sanctions and other relief based on asserted improprieties in the defense 
of the litigation. The Companies believe the Plaintiff's assertions in that 
regard are groundless and will continue to seek denial of Plaintiff's 
requests.

The Companies have separately pursued claims against others on account of 
the losses suffered as a result of the investments in the Portfolio. Claims 
against Piper Jaffray Companies, Inc. were joined with the claims of others 
in a class action in the United States District Court for the District of 
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were 
settled by the parties and in February of 1997 the District Court ordered 
the net share of the settlement proceeds attributable to the Trust 
Company's investments to be paid to the Trust Company, starting 
approximately 60 days after the Court's order becomes final, except to the 
extent, if at all, any other court with jurisdiction has sooner given leave 
for some or all of those payments to be deposited with such other court 
pursuant to applicable rules. The attorneys representing the Plaintiff in 
the Vermont Proceedings and also representing, in the Minnesota 
Proceedings, the beneficiaries of four other Trust Company accounts, 
appealed that order to the Eighth Circuit Court of Appeals. By Per Curiam 
decision filed July 25, 1998, the Eighth Circuit denied that appeal. The 
attorneys for the Plaintiffs have filed a petition for certiorari to the 
United States Supreme Court, which has not yet acted upon it. The same 
attorneys also have announced an intention to initiate separate proceedings 
to seek to intercept at least a portion of any payments coming from the 
Minnesota Proceedings, in order to seek to deprive the Companies of at 
least a portion of the reimbursement that otherwise could be available. Any 
recovery by the Companies from the Minnesota Proceedings is subject to the 
terms of an agreement between the Companies and their insurance carrier, 
which reimbursed the Companies, in part, for the December, 1994 payments.

The Company and certain of its subsidiaries have been named as defendants 
in various legal proceedings arising from their normal business activities. 
Although the amount of any ultimate liability with respect to such 
proceedings cannot be determined, in the opinion of management, based upon 
the opinion of counsel on the outcome of such proceedings, any such 
liability will not have a material effect on the consolidated financial 
position of the Company and its subsidiaries.

ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of calendar year 1998 no matters were submitted 
to a vote of security holders through a
solicitation of proxies or otherwise.

                                   PART II

ITEM 5-MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 
       MATTERS

The common stock of the Company is traded on the over-the-counter market 
and the price is quoted on the NASDAQ National Market Stock Exchange under 
the trading symbol MBVT. Quarterly stock prices during the last eight 
quarters are as indicated below based upon quotations as provided by the 
National Association of Securities Dealers, Inc. Prices of transactions 
between private parties may vary from the ranges quoted below.

<TABLE>
<CAPTION>
      Quarter Ended           High         Low
      ------------------------------------------
      <S>                    <C>         <C>
      December 31, 1998      $26.500     $17.000
      September 30, 1998      34.625      21.250
      June 30, 1998           34.875      32.000
      March 31, 1998          34.625      30.750
      December 31, 1997       33.500      26.000
      September 30, 1997      29.000      20.500
      June 30, 1997           21.125      18.000
      March 31, 1997          21.250      18.250
      ------------------------------------------
</TABLE>

As of February 23, 1999 the Company had 1,260 registered shareholders. The 
Company declared and distributed dividends totaling $0.71 per share during 
1998. In January 1999 the Company declared a dividend of $0.19 per share. 
Future dividends will depend upon the financial condition and earnings of 
the Company and its subsidiaries, their need for funds and other factors, 
including applicable government regulations.

ITEM 6-SELECTED FINANCIAL DATA

The supplementary financial data presented in the following table contains 
information highlighting certain significant trends in the Company's 
financial condition and results of operations over an extended period of 
time.

The following information should be analyzed in conjunction with 
Management's Discussion and Analysis of Financial Condition and Results of 
Operations and with the year-end audited consolidated financial statements 
as contained in the 1998 Annual Report to Shareholders, a copy of which is 
attached as an addendum to this Form 10-K.

                         Merchants Bancshares, Inc.
                       Five Year Summary of Operations
          (Not Covered by Report of Independent Public Accountants)

<TABLE>
<CAPTION>
                                                          For the Years Ended December 31,
(In thousands except per share data)               1998         1997         1996         1995         1994
-------------------------------------------------------------------------------------------------------------
<S>                                              <C>          <C>          <C>          <C>          <C>
INCOME STATEMENT
Interest and Investment Income                   $ 48,023     $ 48,158     $ 48,004     $ 51,315     $ 53,319
Interest Expense                                   18,530       18,238       18,672       23,002       22,377
-------------------------------------------------------------------------------------------------------------
Net Interest Income                                29,493       29,920       29,332       28,313       30,942
Provision for Possible Loan Losses                 (1,737)      (1,862)       3,150       12,100       10,000
-------------------------------------------------------------------------------------------------------------
Net Interest Income after Provision for Loan 
 Losses                                            31,230       31,782       26,182       16,213       20,942
-------------------------------------------------------------------------------------------------------------
Other Income                                        7,312        7,916        9,363       12,766       15,038
Other Expense                                      25,472       28,482       27,489       36,606       41,712
-------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES                  13,070       11,216        8,056       (7,627)      (5,732)
Provision (benefit) for Income Taxes                3,248        2,383        1,832       (3,785)      (2,842)
-------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS)                                $  9,822     $  8,833     $  6,224     $ (3,842)    $ (2,890)
=============================================================================================================

SELECTED AVERAGE BALANCES
-------------------------------------------------------------------------------------------------------------
Total Assets                                     $603,312     $578,090     $580,860     $642,487     $709,077
Average Earning Assets                            566,126      540,830      533,192      575,551      620,070
Loans                                             391,814      394,289      406,514      481,047      514,843
Total Deposits                                    525,460      505,987      513,923      556,242      598,305
Long-Term Debt                                      6,890        6,418        8,925       28,707       45,433
Shareholders' Equity                               56,243       49,140       43,111       40,848       46,331
Shareholders' Equity plus Loan Loss Reserve        71,033       65,407       59,094       58,794       65,322
-------------------------------------------------------------------------------------------------------------

SELECTED RATIOS
-------------------------------------------------------------------------------------------------------------
Net Income (Loss) to:
  Average Shareholders' Equity                      17.46%       17.98%       14.44%       (9.41)%      (6.24)%
  Average Assets                                     1.63         1.53         1.07        (0.60)       (0.41)
Average Shareholders' Equity to
 Average Total Assets                                9.32         8.50         7.42        (6.36)       (6.53)
Common Dividend Payout Ratio                           32           25            -            -            -
Loan Loss Reserve to Total Loans at Year End         2.79         4.06         4.05         3.61         3.90
Net Charge-Offs to Average Loans                     0.71        (0.66)        1.26         3.28         1.97
-------------------------------------------------------------------------------------------------------------

PER SHARE
-------------------------------------------------------------------------------------------------------------
Basic Earnings per Common Share                     $2.22        $2.00        $1.45       $(0.90)      $(0.68)
Diluted Earnings Per Common Share                    2.21         1.99         1.45        (0.90)       (0.68)
Cash Dividends Paid                                  0.71         0.50            -            -            -
Year End Book Value                                 13.84        11.95        10.78         9.38        10.00
-------------------------------------------------------------------------------------------------------------

OTHER
-------------------------------------------------------------------------------------------------------------
Cash Dividends Paid                              $  3,051     $  2,141     $      -     $      -     $      -
-------------------------------------------------------------------------------------------------------------
</TABLE>

ITEM 7-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RE-
       SULTS OF OPERATIONS

Please refer to pages 33-49 for Management's Discussion and Analysis of 
Financial Condition and Results of Operations.

ITEM 8-FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated balance sheets of Merchants Bancshares, Inc. as of 
December 31, 1998 and 1997, and the related consolidated statements of 
operations, changes in stockholders' equity and cash flows for each of the 
three years in the period ended December 31, 1998, together with the 
related notes and the opinion of Arthur Andersen LLP, independent public 
accountants, all as contained on pages 3 through 32 of the Company's 1998 
Annual Report to Shareholders on Form 10-K, are incorporated herein by 
reference.

ITEM 9-CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
       FINANCIAL DISCLOSURES

None.

                                  Part III

ITEM 10-DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

ITEM 11-EXECUTIVE COMPENSATION

ITEM 12-SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13-CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

Reference is hereby made to pages 3-5, pages 8-10, page 13 and page 15 of 
the Company's Proxy Statement to Shareholders dated March 18, 1999, wherein 
pursuant to Regulation 14 A information concerning the above subjects 
(Items 10 through 13) is incorporated by reference.

Pursuant to Rule 12b-23, definitive copies of the Proxy Statement will be 
filed within 120 days subsequent to the end of the Company's fiscal year 
covered by Form 10-K.

                                   PART IV

ITEM 14-EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(1)   The following consolidated financial statements, as included in the 
      1998 Annual Report to Shareholders, are incorporated herein by 
      reference:

      Consolidated Balance Sheets, December 31, 1998 and December 31, 1997.

      Consolidated Statements of Operations for years ended December 31, 
      1998, 1997 and 1996.

      Consolidated Statements of Changes in Stockholders' Equity for years 
      ended December 31, 1998, 1997 and 1996.

      Consolidated Statements of Cash Flows for the years ended December 
      31, 1998, 1997 and 1996.

      Notes to Consolidated Financial Statements, December 31, 1998.

(2)   The following exhibits are either filed or attached as part of this 
      report, or are incorporated herein by reference.

Exhibit     Description
-------------------------------------------------------------------------------

   3.1      Restated Certificate of Incorporation of the Company 
            (Incorporated by reference to Exhibit B to Pre-Effective 
            Amendment No. 1 to Company's Definitive Proxy Statement for the 
            Annual Meeting of the Stockholders of the Company, filed on 
            April 25, 1987)

   3.2      Amended By-Laws of the Company (Incorporated by reference to 
            Exhibit C to Company's Definitive Proxy Statement for the 
            Annual Meeting of the Stockholders of the Company, filed on 
            April 25, 1987).

     4      Instruments defining the rights of security holders, including 
            indentures:

   4.1      Specimen of the Company's Common Stock Certificate 
            (Incorporated by Reference to Exhibit 7 to the Company's 
            Registration Statement on Form S-14 (Registration Number 2-
            86108) filed on August 22, 1983)

   4.2      Description of the rights of holders of the Company's Common 
            Stock (appearing on page 9 of the Company's Registration 
            Statement on Form S-14 (Registration No. 2-86108) filed on 
            August 22, 1983)

  10.1      Merchants Bancshares, Inc. Dividend Reinvestment and Stock 
            Purchase Plan (Incorporated by reference to Exhibit 4.1 to 
            Company's Registration Statement on Form S-3 (Registration No. 
            333-20375) filed on January 22, 1997)

  10.2      401(k) Employee Stock Ownership Plan of the Company, dated 
            January 1, 1990, as amended (Incorporated by reference to 
            Company's Registration Statement on Form S-8 (Registration 
            Number 33-3274) filed on November 16, 1989)

  10.3      Amended and Restated Merchants Bank Pension Plan dated as of 
            January 1, 1994 (Incorporated by Reference to Exhibit 10.6 to 
            Post-Effective Amendment Number 1 to Company's Registration 
            Statement on Form S-8 (Registration Number 333-18845) filed on 
            December 26, 1996)

  10.5      Employment Agreement dated as of January 1, 1997, by and 
            between the Company, Merchants Bank and Joseph L. Boutin 
            (Incorporated by reference to the Registrant's Annual Report on 
            Form 10-K for the Year Ended December 31, 1996)

  10.7      Employment Agreement dated as of January 1, 1997, by and 
            between Merchants Bank and Michael R. Tuttle (Incorporated by 
            reference to the Registrant's Annual Report on Form 10-K for 
            the Year Ended December 31, 1996)

  10.9      Employment Agreement dated as of January 1, 1997, by and 
            between Merchants Bank and Thomas R. Havers (Incorporated by 
            reference to the Registrant's Annual Report on Form 10-K for 
            the Year Ended December 31, 1996)

 10.11      Employment Agreement dated as of January 1, 1997, by and 
            between Merchants Bank and Thomas S. Leavitt (Incorporated by 
            reference to the Registrant's Annual Report on Form 10-K for 
            the Year Ended December 31, 1996)

 10.12      Employment Agreement, dated as of January 1, 1998 by and 
            between Merchants Bank and Janet P. Spitler (Incorporated by 
            reference to the Registrant's Annual Report on Form 10-K for 
            the Year Ended December 31, 1997)

 10.13      Employment Agreement, dated as of January 1, 1997, by and 
            between Merchants Bank and Merchants Trust Company and William 
            R. Heaslip  (Incorporated by reference to the Registrant's 
            Annual Report on Form 10-K for the Year Ended December 31, 
            1996).

 10.14      The Merchants Bank Amended and Restated Deferred Compensation 
            Plan for Directors (Incorporated by reference to the 
            Registrant's Annual Report on Form 10-K for the Year Ended 
            December 31, 1997)

            10.14.1   Trust Under the Merchants Bank Amended and Restated 
                      Deferred Compensation Plan for Directors 
                      (Incorporated by reference to the Registrant's Annual 
                      Report on Form 10-K for the Year Ended December 31, 
                      1997)

 10.15      Agreement among the Merchants Bank and Kathryn T. Boardman, 
            Thomas R. Havers and Susan D. Struble dated as of December 20, 
            1995 (Incorporated by reference to the Registrant's Annual 
            Report on Form 10-K for the Year Ended December 31, 1996).

            10.15.1   Trust Under the Agreement among the Merchants Bank 
                      and Kathryn T. Boardman, Thomas R. Havers and Susan 
                      D. Struble dated as of December 20, 1995 
                      (Incorporated by reference to the Registrant's Annual 
                      Report on Form 10-K for the Year Ended December 31, 
                      1996).

 10.16      Agreement between the Merchants Bank and Dudley H. Davis dated 
            December 20, 1995  (Incorporated by reference to the 
            Registrant's Annual Report on Form 10-K for the Year Ended 
            December 31, 1996).

            10.16.1   Fixed Trust under Agreement between the Merchants 
                      Bank and Dudley H. Davis dated December 20, 1995  
                      (Incorporated by reference to the Registrant's Annual 
                      Report on Form 10-K for the Year Ended December 31, 
                      1996).

            10.16.2   Variable Trust under Agreement between the Merchants 
                      Bank and Dudley H. Davis dated December 21, 1995 
                      (Incorporated by reference to the Registrant's Annual 
                      Report on Form 10-K for the Year Ended December 31, 
                      1996).

    11      Statement re: computation of per share earnings. See 1998 
            Annual Report to Shareholders Note 11.

    13      1998 Annual Report to Shareholders

    21      Subsidiaries of the Company

    23      Consent of Arthur Andersen LLP

    27      Financial Data Schedule

(3)   Reports on Form 8-K: NONE

                                 SIGNATURES

Pursuant to the requirement of Section 13 or 15 (d) of the Securities 
Exchange Act of 1934 the registrant has duly caused this report to be 
signed on it's behalf by the undersigned, thereunto duly authorized.

Merchants Bancshares, Inc.

Date February 18, 1999                 By /s/ Joseph L. Boutin
     -------------------------            ---------------------------------
                                          Joseph L. Boutin, President & CEO

Pursuant to the requirement of the Securities Exchange Act of 1934, this 
report has been signed below by the following persons on behalf of 
MERCHANTS BANCSHARES, INC., and in the capacities and on the date as 
indicated.


By /s/ Joseph L. Boutin                By /s/ Raymond C. Pecor, Jr.
       -----------------------            ---------------------------------
       Joseph L. Boutin, Director,            Raymond C. Pecor, Jr. Director
       President & CEO of the Company         Chairman of the Board of 
       and the Bank                           Directors

By /s/ Peter A. Bouyea                 By /s/ Charles A. Davis
       -----------------------            ---------------------------------
       Peter A. Bouyea, Director              Charles A. Davis, Director


By /s/ Robert A. Skiff                 By /s/ Jeffrey L. Davis
       -----------------------            ---------------------------------
       Robert A. Skiff, Director              Jeffrey L. Davis, Director


By /s/ Michael G. Furlong              By
       -----------------------            ---------------------------------
       Michael G. Furlong, Director           Benjamin F. Schweyer, Director


By /s/ Janet P. Spitler                By /s/ Leo O'Brien, Jr.
       -----------------------            ---------------------------------
       Janet P. Spitler, Treasurer            Leo O'Brien, Jr., Director
       of the Company, Vice President, 
       Controller, and Treasurer of the
       Bank


By /s/ Patrick S. Robins
       -----------------------
       Patrick S. Robins, Director