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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

(Mark One)
 [X]           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
                  For the fiscal year ended December 31, 1999

 [_]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

  For the transition period from                     to

                        Commission file number 0-26016

                           PALMETTO BANCSHARES, INC.

            (Exact name of registrant as specified in its charter)

            South Carolina                           74-2235055
   (State or other jurisdiction of        (IRS Employer Identification No.)
    incorporation or organization)


                                                        29360
 301 Hillcrest Drive, Laurens, South                  (Zip Code)
               Carolina

   (Address of principal executive
               offices)
                 Registrant's telephone number--(864) 984-4551

                               palmettobank.com
                     (Registrant's subsidiary's web site)

          Securities registered pursuant to Section 12(b) of the Act:

                                     None


          Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, par value $5.00 per share
                               (Title of class)

   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.

   State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference
to the price at which the stock was sold, or the average bid and asked prices
of such stock, as of February 16, 2000, $124,493,066--based on the most recent
sales price of $23.00 per share. There is no established public trading market
for the shares. See Part II, Item 5.

   Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 6,232,834--
February 16, 2000.

                      DOCUMENTS INCORPORATED BY REFERENCE

   The Company's Proxy Statement dated March 17, 2000 with respect to an
Annual Meeting of Shareholders to be held April 18, 2000: Incorporated by
reference in Part III of this Form 10-K.

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                                    Part I

 (Dollars in Thousands, except share and per share data, throughout document)

Item 1. Business

   Palmetto Bancshares, Inc. ("Bancshares" or the "Company") is a bank holding
company organized in 1982 under the laws of South Carolina. Through its
wholly-owned subsidiary, The Palmetto Bank (the "Bank"), and the Bank's
wholly-owned subsidiary, Palmetto Capital, Inc. ("Palmetto Capital"),
Bancshares engages in the general banking business in the upstate South
Carolina market of Laurens, Greenville, Spartanburg, Greenwood, Anderson,
Cherokee and Abbeville counties. The Bank is a state, non-member bank that was
organized and chartered under South Carolina law in 1906. There are 28 full
service branch offices in addition to the headquarters located in Laurens,
South Carolina.

   The Bank performs a full range of banking activities, including such
services as checking, savings, money market, and other time deposits of
various types of consumer and commercial depositors; loans for business, real
estate, and personal uses; safe deposit box rental and various electronic
funds transfer services. The Bank also offers both individual and commercial
trust services through an active trust department. Palmetto Capital is a
brokerage subsidiary of the Bank, which offers customers stocks, treasury and
municipal bonds, mutual funds and insurance annuities, as well as college and
retirement planning. The Bank's Dealer Finance Department establishes
relationships with Upstate automobile dealers to provide customer financing of
automobile purchases. In the later part of 1995, the Bank started a mortgage
banking operation to continue to meet a broader range of its customers'
financial service needs. By March 1996, this mortgage banking operation was in
full operation: originating, selling, and servicing mortgage loans. Due to
reorganization in the Bank's mortgage servicing department in 1997, the Bank
did not actively purchase and originate loans to be sold in 1997. The Bank re-
engaged in these originating and selling activities in 1998. The Bank
continues to service its portfolio of loans sold.

Financial Information

   See Item 8, "Financial Statements and Supplementary Data."

Competition

   The upstate South Carolina market is a highly competitive banking market in
which all of the largest financial institutions in the state are represented.
The competition among the various financial institutions is based upon
interest rates offered on deposit accounts, interest rates charged on loans,
credit and service charges, the quality of service rendered and the
convenience of banking facilities. The Bank believes it has competed
effectively in its market.

Interstate Banking

   In 1986, South Carolina adopted legislation that permits banks and bank
holding companies in certain southern states to acquire banks in South
Carolina to the extent that such other states have reciprocal legislation
applicable to South Carolina banks and bank holding companies. The legislation
resulted in a number of the Bank's competitor banks being purchased by large,
out-of-state bank holding companies. Size gives the larger banks certain
advantages in competing for business from larger corporations. These
advantages include higher lending limits and the ability to offer services in
other areas of South Carolina and the region. As a result, the Bank does not
generally attempt to compete for the banking relationships of larger
corporations, but concentrates its efforts on small and medium-size businesses
and individuals. The Bank believes it has competed effectively in this market
segment by offering quality, personalized service. It is management's
intention to remain a locally based, independent, South Carolina Bank.

                                       3
<PAGE>

Customers

   The majority of the Bank's customers are individuals and small to medium-
sized businesses headquartered within its service area. The Bank is not
dependent upon a single or a very few customers, the loss of which would have
a material adverse effect on the Bank. No customer accounts for more than 5%
of the Bank's total deposits at any time. Management does not believe that the
Bank's loan portfolio is dependent on a single customer or group of customers
concentrated in a particular industry whose loss or insolvency would have a
material adverse effect on the Bank.

Growth

   For a discussion of growth in the current year, please see the "General"
heading in Management's Discussion and Analysis, page 12.

   Management continually reviews opportunities to expand in the upstate South
Carolina market that it believes to be in the best interest of the Bank and
its customers.

Systems

   On July 7, 1999, the Bank introduced Internet banking services to its
customers. Reached through the bank's web site at www.palmettobank.com, the
Bank's customers can now access accounts for multiple purposes in a virtual
banking environment--and a secure one. Customers can obtain balances, review
account histories, transfer money between accounts and even pay bills via the
Internet banking service. This Internet Banking System brings together a
combination of industry-approved security technologies to protect data for the
Bank and its customers. It features password-controlled system entry, a
VeriSign-issued Digital ID for the Bank's server, Secure Sockets Layer
protocol for data encryption, and a router loaded with a firewall to regulate
the inflow and outflow of server traffic. Investment in new technology has
long been a tradition with the Palmetto Bank and it is essential to remaining
competitive and growing a strong customer base.

   The Company also installed a wide area network to enhance the Company's
ability to manage its complex data communications with its branch system and
user departments.

Employees

   At December 31, 1999, the Bank had 327 full-time equivalent employees, none
of whom are subject to a collective bargaining agreement. Management believes
its relationship with its employees is excellent.

Monetary Policy

   The results of operations of Bancshares and the Bank are affected by credit
policies of monetary authorities, particularly the Federal Reserve. The
instruments of monetary policy employed by the Federal Reserve include open
market operations in U.S. Government securities, changes in the discount rate
on member bank borrowings, changes in reserve requirements against member bank
deposits and limitations on interest rates which member banks may pay on time
and savings deposits. In view of changing conditions in the national economy
and in the money markets, as well as the effect of action by monetary and
fiscal authorities, including the Federal Reserve, no prediction can be made
as to possible future changes in interest rates, deposit levels, loan demand
or the business and earnings of Bancshares and the Bank.

Regulatory Environment

 General

   Bancshares and its subsidiaries are extensively regulated under federal and
state law. To the extent that the following information describes statutory or
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. Any change in applicable laws
may have a material effect on the business and prospects of Bancshares. The
operations of Bancshares may be affected by possible legislative and
regulatory changes and by the monetary policies of the United States.

                                       4
<PAGE>

   Bancshares. As a bank holding company registered under the Bank Holding
Company Act of 1956, as amended (the "BHCA"), Bancshares is subject to
regulation and supervision by the Federal Reserve. Under the BHCA, Bancshares'
activities and those of its subsidiaries are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiaries or engaging in any other activity that the Federal Reserve
determines to be so closely related to banking, managing or controlling banks
as to be a proper incident thereto. The BHCA also restricts the ability of
Bancshares to acquire ownership or control of more than 5% of the outstanding
voting stock of any bank or certain other nonbanking businesses.

   There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss exposure to the depositors
of such depository institutions and to the Federal Deposit Insurance
Corporation ("FDIC") insurance funds in the event the depository institution
becomes in danger of defaulting or in default under its obligations to repay
deposits. For example, under current federal law, to reduce the likelihood of
receivership of an insured depository institution subsidiary, a bank holding
company is required to guarantee the compliance of any insured depository
institution subsidiary that may become "undercapitalized:" with the terms of
any capital restoration plan filed by such subsidiary with its appropriate
federal banking agency up to the lesser of (i) an amount equal to 5% of the
institution's total assets at the time the institution became
undercapitalized, or (ii) the amount that is necessary (or would have been
necessary) to bring the institution into compliance with all applicable
capital standards as of the time the institution fails to comply with such
capital restoration plan. Under a policy of the Federal Reserve with respect
to bank holding company operations, a bank holding company is required to
serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
also has the authority under the BHCA to require a bank holding company to
terminate any activity or relinquish control of a nonbank subsidiary (other
than a nonbank subsidiary of a bank) upon the Federal Reserve's determination
that such activity or control constitutes a serious risk to the financial
soundness or stability of any subsidiary depository institution of the bank
holding company. Further, federal law grants federal bank regulatory
authorities additional discretion to require a bank holding company to divest
itself of any bank or nonbank subsidiary if the agency determines that
divestiture may aid the depository institution's financial condition.

   As a bank holding company registered under the South Carolina Bank Holding
Company Act, Bancshares also is subject to regulation by the State Board of
Financial Institutions ("State Board"). Bancshares must file with the State
Board periodic reports with respect to its financial condition and operations,
management and intercompany relationships between Bancshares and its
subsidiaries.

   The Bank. The Bank is a FDIC-insured, South Carolina-chartered banking
corporation and is subject to various statutory requirements and rules and
regulations promulgated and enforced primarily by the State Board and the
FDIC. These statutes, rules and regulations relate to insurance of deposits,
required reserves, allowable investments, loans, mergers, consolidations,
issuance of securities, payment of dividends, establishment of branches and
other aspects of the business of the Bank. The FDIC has broad authority to
prohibit the Bank from engaging in what it determines to be unsafe or unsound
banking practices. In addition, federal law imposes a number of restrictions
on state-chartered, FDIC-insured banks and their subsidiaries. These
restrictions range from prohibitions against engaging as a principal in
certain activities to the requirement of prior notification of branch
closings. The Bank also is subject to various other state and federal laws and
regulations, including state usury laws, laws relating to fiduciaries,
consumer credit and equal credit and fair credit reporting laws. The Bank is
not a member of the Federal Reserve System.

   Dividends. The holders of Bancshares common stock are entitled to receive
dividends when and if declared by the Board of Directors out of funds legally
available therefor. Bancshares is a legal entity separate and distinct from
the Bank and Palmetto Capital and depends for its revenues on the payment of
dividends from the Bank. Current federal law would prohibit, except under
certain circumstances and with prior regulatory approval, an insured
depository institution, such as the Bank, from paying dividends or making any
other capital distribution if, after making the payment or distribution, the
institution would be considered "undercapitalized,"

                                       5
<PAGE>

as that term is defined in applicable regulations. In addition, as a South
Carolina-chartered bank, the Bank is subject to legal limitations on the
amount of dividends it is permitted to pay. In particular, the Bank must
receive the approval of the South Carolina Commissioner of Banking prior to
paying dividends to Bancshares.

 Capital Adequacy

   Bancshares. The Federal Reserve has adopted risk-based capital guidelines
for bank holding companies. Under these guidelines, the minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier 1 capital," principally consisting of
common shareholders' equity, noncumulative preferred stock, a limited amount
of cumulative perpetual preferred stock and minority interest in the equity
accounts of consolidated subsidiaries, less certain goodwill items. The
remainder (Tier 2 capital) may consist of a limited amount of subordinated
debt and intermediate-term preferred stock, certain hybrid capital instruments
and other debt securities, perpetual preferred stock and a limited amount of
the general loan loss allowance. In addition to the risk-based capital
guidelines, the Federal Reserve has adopted a minimum Tier 1 (leverage)
capital ratio under which a bank holding company must maintain a minimum level
of Tier 1 capital (as determined under applicable rules) to average total
consolidated assets of at least 3% in the case of bank holding companies which
have the highest regulatory examination ratios and are not contemplating
significant growth or expansion. All other bank holding companies are required
to maintain a ratio of at least 100 to 200 basis points above the stated
minimum. At December 31, 1999, Bancshares was in compliance with both the
risk-based capital guidelines and the minimum leverage capital ratio.

   The Bank. As a state-chartered, FDIC-insured institution that is not a
member of the Federal Reserve System, the Bank is subject to capital
requirements imposed by the FDIC. The FDIC requires state-chartered nonmember
banks to comply with risk-based capital standards substantially similar to
those required by the Federal Reserve, as described above. The FDIC also
requires state-chartered nonmember banks to maintain a minimum leverage ratio
similar to that adopted by the Federal Reserve. Under the FDIC's leverage
capital requirement, state nonmember banks that (a) receive the highest rating
during the examination process and (b) are not anticipating or experiencing
any significant growth are required to maintain a minimum leverage ratio of 3%
of Tier 1 capital to total assets; all other banks are required to maintain a
minimum leverage ratio of not less than 4%. As of December 31, 1999, the Bank
was in compliance with both the risk-based capital guidelines and the minimum
leverage capital ratio. For further discussion on the Bank's current capital
rating, see note 17 to consolidated financial statements.

 Insurance

   As a FDIC-insured institution, the Bank is subject to insurance assessments
imposed by the FDIC. Under current law, the insurance assessment to be paid by
insured institutions shall be as specified in a schedule required to be issued
by the FDIC that specifies, at semiannual intervals, target reserve ratios
designed to increase the FDIC insurance fund's reserve ratio to 1.25% of
estimated insured deposits (or such higher ratio as the FDIC may determine in
accordance with the statute) in 15 years. Further, the FDIC is authorized to
impose one or more special assessments in any amount deemed necessary to
enable repayment of amounts borrowed by the FDIC from the United States
Department of the Treasury (the "Treasury Department").

   Effective January 1, 1993, the FDIC implemented a risk-based assessment
schedule, having assessments ranging from 0.23% to 0.31% of an institution's
average assessment base. The actual assessment to be paid by each FDIC-insured
institution is based on the institution's assessment risk classification,
which is determined based on whether the institution is considered "well
capitalized," "adequately capitalized" or "undercapitalized," as such terms
have been defined in applicable federal regulations adopted to implement the
prompt corrective action provisions of the Federal Deposit Insurance
Corporation Insurance Act ("FDICIA") (see "Other Safety and Soundness
Regulations--Prompt Corrective Action" below), and whether such institution is
considered by its supervisory agency to be financially sound or to have
supervisory concerns. In

                                       6
<PAGE>

August 1995, the FDIC approved a reduction in the insurance assessments for
Bank Insurance Fund ("BIF") deposits. This reduction decreased the Bank's
insurance assessment for BIF deposits from 0.26% to 0.04% of the average
assessment base. During 1996, the insurance assessment for the Bank's BIF
deposits was set at zero (although banks pay a $2 annual fee) due to the fact
that it was "well capitalized." In 1997 and most of 1998, the Bank was
"adequately capitalized," and paid insurance premiums ranging from 0.00% to
0.27% of the average assessment base. Now the Bank has returned to the "well
capitalized" category and the FDIC insurance premium decreased from $206 in
1998 to $132 in 1999.

   Under the Deposit Insurance Fund Act, BIF-assessable deposits are subject
to assessment for payment on the $780 million annual Financing Corporation
("FICO") bond obligation at 1/5 the rate of Savings Association Insurance
Fund-assessable deposits. Accordingly, the FDIC has estimated that the annual
FICO rate will be 1.30 basis points per $100 of BIF-assessable deposits in the
years 1997-1999. Starting in the year 2000 until the FICO bonds are retired,
banks and thrifts will pay the assessment on a pro rata basis (estimated at
2.5 basis points for banks).

 Other Safety and Soundness Regulations

   Prompt Corrective Action. Current law provides the federal banking agencies
with broad powers to take prompt corrective action to resolve problems of
insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized." Under uniform regulations defining such capital
levels issued by each of the federal banking agencies, a bank is considered
"well capitalized" if it has (i) a total risk-based capital ratio of 10% or
greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a
leverage ratio of 5% or greater, and (iv) is not subject to any order or
written directive to meet and maintain a specific capital level for any
capital measure. An "adequately capitalized" bank is defined as one that has
(i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-
based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or
greater (or 3% or greater in the case of a bank with a composite CAMELS rating
of 1). A CAMELS rating is a rating given to a financial institution by its
primary regulator which represents a composite rating of the various areas
examined: Capital adequacy, Asset quality, Management, Earnings, Liquidity and
Sensitivity to market risk. A bank is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-
based capital ratio of less than 4% or (iii) a leverage ratio of less than 4%
(or 3% in the case of a bank with a composite CAMELS rating of 1);
(B) "significantly undercapitalized" if the bank has (i) a total risk-based
capital ratio of less than 6%, or (ii) a Tier 1 risk-based capital ratio of
less than 3%, or (iii) a leverage ratio of less than 3%; and (C) "critically
undercapitalized" if the bank has a ratio of tangible equity to total assets
equal to or less than 2%. At December 31, 1999, Bancshares and the Bank each
currently meet the definition of well capitalized.

   Brokered Deposits. Current federal law also regulates the acceptance of
brokered deposits by insured depository institutions to permit only a "well
capitalized" depository institution to accept brokered deposits without prior
regulatory approval. Under FDIC regulations, "well capitalized" insured
depository institutions may accept brokered deposits without restriction,
"adequately capitalized" insured depository institutions may accept brokered
deposits with a waiver from the FDIC (subject to certain restrictions on
payments of interest rates), while "undercapitalized" insured depository
institutions may not accept brokered deposits. The regulations provide that
the definitions of "well capitalized," "adequately capitalized" and
"undercapitalized" are the same as the definitions adopted by the agencies to
implement the prompt corrective action provisions of FDICIA (as described in
the previous paragraph). Bancshares does not believe that these regulations
will have a material adverse effect on its current operations.

   Other FDICIA Regulations. To facilitate the early identification of
problems, FDICIA required the federal banking agencies to prescribe more
stringent reporting requirements. The FDIC final regulations implementing
those provisions, among other things, require that management report on the
institution's responsibility for preparing financial statements and
establishing and maintaining an internal control structure and procedures for
financial reporting and compliance with designated laws and regulations
concerning safety and soundness, and

                                       7
<PAGE>

that independent auditors attest to and report separately on assertions in
management's reports concerning compliance with such laws and regulations,
using FDIC approved audit procedures. These regulations apply to financial
institutions with greater than $500 million in assets at the beginning of
their fiscal year. Accordingly, the Bank is now subject to these regulations.

 Community Reinvestment Act

   The Bank is subject to the requirements of the Community Reinvestment Act
("CRA"). The CRA requires that financial institutions have an affirmative and
ongoing obligation to meet the credit needs of their local communities,
including low-income and moderate-income neighborhoods, consistent with the
safe and sound operation of those institutions. Each financial institution's
efforts in meeting community credit needs are evaluated as part of the
examination process pursuant to twelve assessment factors. These factors are
also considered in evaluating mergers, acquisitions and applications to open a
branch or facility. The Bank received an "outstanding" rating in its most
recent evaluation dated May 3, 1999.

 Transactions Between Bancshares, Its Subsidiaries and Affiliates

   Bancshares' subsidiaries are subject to certain restrictions on extensions
of credit to executive officers, directors, principal shareholders or any
related interest of such persons. Extensions of credit (i) must be made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with unaffiliated
persons; and (ii) must not involve more than the normal risk of repayment or
present other unfavorable features. Aggregate limitations on extensions of
credit also may apply. Bancshares' subsidiaries also are subject to certain
lending limits and restrictions on overdrafts to such persons.

   Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on extensions of credit to the
bank holding company or its nonbank subsidiary, on investments in their
securities and on the use of their securities as collateral for loans to any
borrower. Such restrictions may limit Bancshares' ability to obtain funds from
its bank subsidiary for its cash needs, including funds for acquisitions,
interest and operating expenses.

   In addition, under the BHCA and certain regulations of the Federal Reserve,
a bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease
or sale of property or furnishing of services. For example, a subsidiary may
not generally require a customer to obtain other services from any other
subsidiary or Bancshares, and may not require the customer to promise not to
obtain other services from a competitor, as a condition to an extension of
credit to the customer.

Item 2. Properties

   The corporate headquarters, the telephone banking center, and the finance,
operations, data processing, trust, human resources, loan administration,
internal audit and marketing departments are located in a facility at 301
Hillcrest Drive, Laurens, South Carolina ("Corporate Center"). The main office
of the Bank is located in a facility at 101 West Main Street, Laurens, South
Carolina, which also contains a three lane drive-in facility.

   The Bank has twenty-eight full-service branches in the Upstate region of
South Carolina in the following locations: Laurens (3), Duncan, Clinton,
Greenwood (2), Ninety-Six, Fountain Inn, Hodges, Mauldin, Simpsonville,
Anderson (2), Greenville (5), Pendleton, Spartanburg (3), Inman, Blacksburg,
Gaffney, Abbeville and Greer.

   The Bank has automatic teller machines at the following branches: Church
Street (Laurens), Clinton, Montague Avenue (Greenwood), South Main
(Greenwood), Ninety-Six, Abbeville, Fountain Inn, Mauldin, Simpsonville,
Woodruff Road (Greenville), Haywood Road (Greenville), East North Street at
Howell Road (Greenville), Grove Road (Greenville), Blackstock Road
(Spartanburg), Hillcrest (Spartanburg), Duncan, Inman, Greer, Blacksburg,
Gaffney, Pendleton, Anderson and North Anderson branches. The Bank also has
ATM's at

                                       8
<PAGE>

three non-branch locations: the Flour Daniel office complex (Greenville), the
Cato Corners Shopping Center (Laurens) and the Westwood Plaza Shopping Center
(Greenwood). In addition, the Bank owns five limited service branches in
various retirement centers located in the Upstate region of South Carolina.

   The Bank owns all of its facilities except the following leased facilities,
which have annual rental expenses from $1 to $115:

  East North Street, Haywood Road, East North Street at Howell Road, Woodruff
  Road, Greer offices--Greenville

  Spartan Centre, Blackstock Road, Fernwood, Hillcrest offices--Spartanburg

  Gaffney office--Gaffney

  South Main Street and Ninety-Six offices--Greenwood

  North Main office--North Anderson

   Offices range in size from branch locations of approximately 800 to 10,000
square feet, to the Corporate Center location of approximately 55,000 square
feet. The Corporate Center houses the corporate offices, finance department,
and telephone banking center. All facilities are protected by alarm and
security systems, which meet or exceed regulatory standards. Each facility is
in good condition and capable of handling increased volume. All of the
locations are considered suitable and adequate for their intended purposes.

Item 3. Legal Proceedings

   Bancshares is not currently engaged in legal proceedings. From time to time
the Bank is involved in legal proceedings incidental to its normal course of
business as a bank. Management believes none of these proceedings is likely to
have a materially adverse effect on the business of Bancshares or the Bank.

                                       9
<PAGE>

                                    Part II

Item 5. Market for Registrant's Common Stock and Related Shareholder Matters

   On December 14, 1999, the Board of Directors approved a two-for-one stock
split effected in the form of a 100% stock dividend to shareholders of record
as of January 3, 2000. All number of common shares outstanding and per share
amounts contained in this report have been retroactively adjusted to give
effect to the stock split.

   There is no public market for the common stock of Bancshares or the Bank.
The last known selling price of Bancshares' common stock, based on information
available to Bancshares' management, was $23.00 per share on February 16,
2000. As of February 16, 2000, the Company had 837 shareholders with 6,232,834
shares outstanding.

   Bancshares, or its predecessor, the Bank, has paid regular dividends on
common stock since 1909. For the years ended December 31, 1999, 1998 and 1997,
Bancshares paid cash dividends of $1,956 or $0.32 per share, $1,544 or $0.25
per share, and $1,165 or $0.19 per share, respectively. These dollars equate
to dividend payout ratios (dividends declared divided by net income) of
24.24%, 22.54% and 19.66% in 1999, 1998 and 1997, respectively. Certain other
information concerning dividends and historical trading prices is set forth
below.

Quarterly Common Stock Data

   Set forth below is information concerning high and low sales prices by
quarter for each of the last two fiscal years and dividend information for the
last two fiscal years. The Company's common stock is not traded on any
established public trading market. The Company acts as its own transfer agent,
and the information concerning sales prices set forth below is derived from
the Company's stock transfer records. As of December 31, 1999, there were 826
shareholders of record.

                            Sales Prices by Quarter
<TABLE>
<CAPTION>
   Fiscal Year 1999                                                 High   Low
   ----------------                                                ------ ------
   <S>                                                             <C>    <C>
   First Quarter.................................................. $20.00 $18.50
   Second Quarter................................................. $21.00 $20.00
   Third Quarter.................................................. $22.50 $21.00
   Fourth Quarter................................................. $22.50 $20.00

   Fiscal Year 1998
   ----------------
   First Quarter.................................................. $14.50 $14.00
   Second Quarter................................................. $17.50 $14.50
   Third Quarter.................................................. $18.50 $17.50
   Fourth Quarter................................................. $18.50 $17.50
</TABLE>

                           Dividends Paid Per Share

<TABLE>
   <C>                                <C>  <S>                                <C>
   Fiscal Year 1999                        Fiscal Year 1998
   ----------------                        ----------------
   March 30.........................  $.07 March 31.......................... $.06
   June 29..........................  $.08 June 30........................... $.06
   September 30.....................  $.08 September 30...................... $.06
   December 27......................  $.09 December 28....................... $.07
</TABLE>

   The ability of Bancshares to pay dividends depends upon the amount of
dividends that is received from the Bank. The Company and the Bank are subject
to certain regulatory restrictions on the amount of dividends they are
permitted to pay. The Bank's current total risk-based capital ratio is 10.64%.
At December 31, 1999, the Bank had $6.8 million of excess retained earnings
available to pay out for dividends and still be considered "well-capitalized."
The Bank plans to continue its quarterly dividend payments.

                                      10
<PAGE>

Item 6. Selected Financial Data (Dollars in thousands)

<TABLE>
<CAPTION>
                                              5 Year Summary
                          ----------------------------------------------------------
                             1999        1998        1997        1996        1995
For the Year              ----------  ----------  ----------  ----------  ----------
<S>                       <C>         <C>         <C>         <C>         <C>
Total interest income...  $   43,142      40,829      36,969      32,191      26,268
Total interest expense..      16,399      16,440      15,841      13,810      10,842
Net interest income.....      26,743      24,389      21,128      18,381      15,426
Provision for loan
 losses.................       2,431       1,877       1,331       1,450       1,140
Total non-interest
 income.................       8,069       6,468       5,628       5,018       4,192
Total non-interest
 expense................      21,274      19,130      17,085      15,544      13,630
Income before income
 taxes..................      11,107       9,850       8,340       6,405       4,848
Income tax provision....       3,038       3,000       2,415       1,652       1,246
Net income..............       8,069       6,850       5,925       4,753       3,602
Per Common Share (3)
Net income per share-
 basic, not subject to
 put/call...............  $     1.30        1.05        0.98        0.77        0.60
Net income per share-
 dilutive, not subject
 to put/call............        1.26        1.02        0.97        0.76        0.59
Cash dividends
 declared...............        0.32        0.25        0.19        0.14        0.11
Book value at year end
 (1)....................        7.35        6.81        6.00        5.23        4.64
Average common shares
 outstanding (1)........   6,208,750   6,178,318   6,109,754   6,015,322   6,020,640
At Year End
<CAPTION>
Total assets............  $  625,198     577,400     513,207     468,377     376,241
<S>                       <C>         <C>         <C>         <C>         <C>
Investment securities...     106,772     112,542      97,731      82,447      83,404
Loans...................     445,757     413,266     367,585     332,986     255,187
Total deposits..........     537,687     499,673     449,390     412,386     329,659
Total shareholders'
 equity (2).............      45,627      42,085      36,616      31,438      27,909
Total shareholders'
 equity.................      45,627      37,353      32,832      28,124      25,138
Common shares
 outstanding............   6,226,834   6,199,390   6,179,104   6,047,682   6,029,880
Full-time equivalent
 employees..............         327         306         281         257         219
Average Balances
<CAPTION>
Assets..................  $  595,678     541,799     493,737     430,718     342,374
<S>                       <C>         <C>         <C>         <C>         <C>
Investment securities...     110,546     102,635      97,136      86,655      73,395
Loans...................     430,960     390,776     350,493     301,839     230,908
Deposits................     512,405     467,749     432,031     373,244     294,608
Total shareholders'
 equity (2).............      45,094      39,552      33,858      29,131      26,142
Key Ratios (1)
Return on average
 assets.................        1.35%       1.26%       1.20%       1.10%       1.05%
Return on average
 equity.................       17.89%      17.32%      17.50%      16.32%      13.78%
Primary capital to
 assets at year end.....        8.23%       8.21%       8.06%       7.65%       8.33%
Net interest margin
 (fully tax-
 equivalent)............        5.09%       5.06%       4.80%       4.88%       5.23%
Allowance for loan
 losses to total loans..        1.43%       1.40%       1.40%       1.42%       1.45%
Nonperforming assets to
 total assets...........        0.49%       0.33%       0.25%       0.24%       0.20%
Net charge-offs to
 average loans..........        0.43%       0.32%       0.26%       0.14%       0.20%
Average equity to
 average asset ratio....        7.57%       7.30%       6.86%       6.76%       7.64%
</TABLE>
--------

(1) These numbers are calculated using balances and shares of total common
    stock outstanding excluding reclassification of ESOP stock, for which
    Bancshares had issued a put option, totaling $4,732, and $3,784 at
    December 31, 1998 and 1997, respectively. This put option expired in 1999.

(2) Excluding reclassification of ESOP stock, for which Bancshares had issued
    a put option, totaling $4,732, and $3,784 at December 31, 1998 and 1997,
    respectively.

(3) Certain share and per share amounts have been retroactively restated to
    reflect the two-for-one stock split effected in the form of a 100% stock
    dividend to shareholders of record as of January 3, 2000.

                                      11
<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

   The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto. The consolidated
financial statements of Palmetto Bancshares, Inc. and subsidiaries (the
"Company"), represent account balances for Palmetto Bancshares, Inc., (the
"Parent Company"), and its wholly-owned subsidiary, The Palmetto Bank, (the
"Bank"), and the Bank's wholly-owned subsidiary, Palmetto Capital, Inc.

General

   On September 14, 1999, the Palmetto Bank opened its 27th office in
Abbeville, South Carolina. This retail location was acquired from Carolina
First and added approximately $14 million in deposits and $1.8 million in
loans to the Bank's balance sheet. On November 15, 1999, the Bank opened its
28th office in Greer, South Carolina.

   The Company's assets grew $47,798, or 8%, total loans grew $32,491, or 8%,
and deposits grew $38,014, or 8% in 1999 as a result of expansion, acquisition
and general growth in all geographic markets. In 1998, total assets grew
$64,193, or 13%, total loans grew $45,681, or 12%, and deposits grew $50,283,
or 11% in 1998 as a result of growth in all geographic markets.

                             Results of Operations
              Three Years Ended December 31, 1999, 1998 and 1997

   Net income for 1999 was $8,069, an increase of 18% from the $6,850 reported
in 1998. Net income in 1998 increased 16% from the $5,925 reported in 1997.
Net income per common share-basic, not subject to put/call was $1.30 in 1999,
compared with $1.05 in 1998, and $0.98 in 1997. Net income per common share-
dilutive, not subject to put/call was $1.26 in 1999, compared with $1.02 in
1998, and $0.97 in 1997. Return on average assets was 1.35% in 1999 compared
with 1.26% in 1998 and 1.20% in 1997.

Net Interest Income

   The largest component of the Company's net income is the Bank's net
interest income, defined as the difference between gross interest and fees on
earning assets (primarily loans and investment securities), and interest paid
on deposits and borrowed funds. Net interest income is affected by the
interest rate earned or paid and by volume changes in loans, securities,
deposits and borrowed funds.

   In 1999, net interest income was $26,743, which represented a 10% increase
over the $24,389 earned in 1998. This increase is due to increases in the
volume of earning assets and an increase in the net interest margin. In 1998,
net interest income increased $3,261 or 15%, over the $21,128 earned in 1997.

   During 1999, the average tax equivalent yield on all interest-earning
assets was 8.08%, down from 8.36% and 8.29% in 1998 and 1997, respectively.
The average prime interest rate was 8.00% for 1999, compared to an average
prime rate of 8.25% and 8.5% for 1998 and 1997, respectively. The Bank's
average effective rate paid on all interest-bearing liabilities decreased in
1999 to 3.53%, from 3.86% and 4.06% in 1998 and 1997, respectively. The Bank's
net tax equivalent yield on interest-earning assets (net interest margin) was
5.09%, 5.06% and 4.80% in 1999, 1998 and 1997, respectively. The Company was
able to increase its net interest margin through strategic asset-liability
management as discussed on pages 13 and 14.

   Interest and fees on loans increased $2,159, or 6% from 1998 to 1999, and
increased $3,840, or 12% from 1997 to 1998 due to loan growth of 8% in 1999
and 12% in 1998. Interest on investment securities increased $75 or 1% from
1998 to 1999 due to an increase in the average balances outstanding during the
year, offset by a decrease in the fully tax-equivalent weighted average rate
on the security portfolio from 6.59% in 1998 to 6.49% in 1999. Interest on
investment securities increased $38 or 1% from 1997 to 1998 due to a 15%
growth in securities, offset by a decrease in the fully tax-equivalent
weighted-average rate on the security portfolio from

                                      12
<PAGE>

6.72% in 1997 to 6.59% in 1998. Interest income on federal funds sold
increased $58 or 27% due to higher average balances invested. This compares to
a decrease of $80, or 27%, from 1997 to 1998 due to lower average balances
invested.

   Total interest expense decreased 0.25% or $41 from 1998 to 1999 and
increased 4% or $599 from 1997 to 1998. The largest component of total
interest expense is interest expense on deposits, which decreased $6 or 0.04%
from 1998 to 1999 due to effective management of the cost of deposits, offset
by an 8% growth in deposits. Interest expense on deposits increased $341 or 2%
from 1997 to 1998 due to an 11% growth in deposits, offset by effective
management of the cost of deposits. The average cost of deposits was 2.96%,
3.24% and 3.43% in 1999, 1998 and 1997, respectively.

   Interest on securities sold under agreements to repurchase decreased $75,
or 12% from 1998 to 1999 due to maintained average balances outstanding,
offset by a decrease in the average rate paid from 3.97% to 3.40%. This
compares to an increase of $81, or 15% from 1997 to 1998 due to an increase in
the average balances outstanding, offset by a decrease in the average rate
paid from 4.01% to 3.97%. Interest on commercial paper increased $5, or 1%,
from 1998 to 1999 due to an decrease in the average rate paid from 4.11% to
3.44%, offset by an increase in the average balances outstanding during the
year. This compares to an increase of $140, or 37%, from 1997 to 1998 due to
an increase in the average rate paid from 4.06% to 4.11% and an increase in
the average balances outstanding during the year. For more information on
short-term borrowings, please see notes to consolidated financial statements
number 9.

Rate/Volume Analysis

   Table 1 (on page 15) includes, for the years ended December 31, 1999, 1998
and 1997 interest income on earning assets and related average yields, as well
as interest expense on liabilities and related average rates paid. Also shown
are the dollar amounts of change due to rate and volume variances. The effect
of the combination of rate and volume change has been divided equally between
the rate change and volume change.

Asset-Liability Management and Market Risk Sensitivity

   Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises principally from interest rate risk
inherent in its lending, deposit, borrowing and investing activities.
Management actively monitors and manages its inherent rate risk exposure.
Although the Company manages other risks, as in credit quality and liquidity
risk, in the normal course of business, management considers interest rate
risk to be its most significant market risk and could potentially have the
largest material effect on the Company's financial condition and results of
operations. Other types of market risks, such as foreign currency exchange
rate risk and commodity price risk, do not arise in the normal course of the
Company's business activities.

   The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings. A sudden and substantial increase in
interest rates may adversely impact the Company's earnings to the extent that
the interest rates on interest-earning assets and interest-bearing liabilities
do not change at the same speed, to the same extent or on the same basis. The
Company monitors the impact of changes in interest rates on its net interest
income using several tools.

   The Bank's goal is to minimize interest rate risk between interest bearing
assets and liabilities at various maturities through its Asset-Liability
Management (ALM). ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic
outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be
controlled by management. Understanding the current position and implications
of past decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.

   Interest sensitivity management is part of the asset-liability management
process. Interest sensitivity gap (GAP) is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period. The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year. Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction

                                      13
<PAGE>

accounts, time deposits and borrowings. The profitability of the Company is
influenced significantly by management's ability to manage the relationship
between rate sensitive assets and liabilities. At December 31, 1999,
approximately 25% of the Company's earning assets could be repriced within one
year compared to approximately 95% of its interest-bearing liabilities. This
compares to 27% and 92%, respectively, in 1998 and 26% and 95%, respectively,
in 1997.

   The Company's current GAP analysis reflects that in periods of increasing
interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities. The Company's GAP analysis also shows that at the interest
repricing of one year, the Company's net interest margin would be adversely
impacted. This analysis, however, does not take into account the dynamics of
the marketplace. GAP is a static measurement that assumes if the prime rate
increases by 100 basis points, all assets and liabilities that are due to
reprice will increase by 100 basis points at the next opportunity. However,
the Company historically has experienced a benefit from rising rates in the
short term because deposit rates generally do not follow the national money
market. Usually, they are controlled by the local market. Traditionally, loans
do follow the money market; so when rates increase they reprice immediately,
but the Company is able to manage the deposit side. The Company generally does
not raise deposit rates as fast or as much. The Company also has the ability
to manage its funding costs by choosing alternative sources of funds.

   The Company's current GAP position would also be interpreted to mean that
in periods of declining interest rates, the Company's net interest margin
would benefit. However, competitive pressures in the local market may not
allow the Company to lower rates on deposits, but force the Company to lower
rates on loans.

   Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset-liability
strategies, which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point change over twelve months. At
December 31, 1999, this model shows that if interest rates rose by 300 basis
points over the next twelve months, net interest margin would be adversely
affected by approximately 9%. This model also shows that if interest rates
rose by only 100 or 200 basis points over the next twelve months, net interest
margin would be adversely affected by approximately 3% and 6%, respectively.
The asset-liability committee meets weekly to address interest pricing issues,
and this model is reviewed monthly. Management will continue to monitor its
liability sensitive position in times of higher interest rates, which might
adversely affect its net interest margin.

   Computation of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan prepayments and deposit decay rates, and should not be
relied upon as indicative of actual results. Further, the computations do not
contemplate any actions the Company could undertake in response to changes in
interest rates.

   A market risk that does not directly affect net interest margin is the risk
of realizing the unrealized loss on the investment securities portfolio ($2.4
million at December 31, 1999). This unrealized loss exists because the current
market rates are higher that the weighted average rate on the investment
security portfolio. The portfolio consists of longer-term securities, as well.
Currently management is looking for opportunities to shorten the duration and
increase the weighted average rate of the portfolio. Management does not
intend to liquidate the entire investment security portfolio, and therefore
the unrealized loss will not be realized. The Company has plenty of liquidity
without selling off the investment security portfolio (please see Liquidity
discussion on page 24). The Company sees the investment security portfolio as
mainly an income source, not a liquidity source.

   On page 16, Table 2 shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity and
the instruments' fair values at December 31, 1999. Market risk sensitive
instruments are generally defined as on- and off-balance sheet derivatives and
other financial instruments.

                                      14
<PAGE>

                                    TABLE 1
                             Rate Volume Analysis

<TABLE>
<CAPTION>
                                                        1999                                      1998
                                       -----------------------------------------  ---------------------------------------
                                       Average            Yield/ Volume   Rate    Average   Income/        Volume   Rate
                                       Balances  Interest  Rate  Change  Change   Balances  Expense Yield  Change  Change
                                       --------  -------- ------ ------  -------  --------  ------- -----  ------  ------
Assets:
<S>                                    <C>       <C>      <C>    <C>     <C>      <C>       <C>     <C>    <C>     <C>
Interest-earning
deposits........                       $    211  $    11   5.21% $    6  $     0  $     99  $     5 5.05%  $    3  $   3
Federal funds
sold............                          5,287      269   5.09%     74      (16)    3,876      211 5.44%     (86)     6
Federal Home
Loan Bank
stock...........                          1,691      128   7.57%     13        2     1,520      113 7.43%      54      3
Taxable
investment
securities......                         40,596    2,573   6.34%   (828)      44    53,756    3,357 6.24%    (452)   (85)
Non-taxable
investment
securities (1)..                         69,950    4,606   6.58%  1,428     (230)   48,879    3,408 6.97%     902   (131)
Loans, net of
unearned
discount (2)....                        430,960   36,759   8.53%  3,493   (1,334)  390,776   34,600 8.85%   3,551    289
<CAPTION>
                                                       1997
                                       ----------------------------------------
                                       Average   Income/        Volume   Rate
                                       Balances  Expense Yield  Change  Change
                                       --------- ------- ------ ------- -------
Assets:
<S>                                    <C>       <C>     <C>    <C>     <C>
Interest-earning
deposits........                       $    --   $   --  0.00%  $  --   $ --
Federal funds
sold............                          5,465      291 5.32%     197      1
Federal Home
Loan Bank
stock...........                            779       56 7.19%      28     28
Taxable
investment
securities......                         60,915    3,894 6.39%     293    283
Non-taxable
investment
securities (1)..                         36,221    2,637 7.28%     450   (396)
Loans, net of
unearned
discount (2)....                        350,493   30,760 8.78%   4,299   (391)

 Total earning
 assets.........                        548,695   44,346   8.08%  4,092   (1,440)  498,906   41,694 8.36%   3,749    307
 Total earning
 assets.........                        453,873   37,638 8.29%   5,315   (523)

Cash and due
from banks......                         25,205                                     22,145
Allowance for
loan losses.....                         (6,085)                                    (5,393)
Premises and
equipment, net..                         15,230                                     14,255
Accrued
Interest........                          4,344                                      4,065
Other assets....                          8,289                                      7,821
                                       --------                                   --------
 Total assets...                       $595,678                                   $541,799
                                       ========                                   ========
<CAPTION>
Liabilities and
Shareholders'
Equity:
<S>                                    <C>       <C>      <C>    <C>     <C>      <C>       <C>     <C>    <C>     <C>
Interest-bearing
demand
deposits........                        165,370    3,079   1.86%    334      (43)  147,580    2,788 1.89%     392   (334)
Savings
deposits........                         31,308      615   1.96%     55     (103)   28,718      663 2.31%      26    (39)
Time deposits...                        232,806   11,457   4.92%    752   (1,001)  218,185   11,706 5.37%     444   (148)
Federal funds
purchased and
securities
sold under agreements to repurchase..    19,295      722   3.74%     21      (61)   18,747      762 4.06%     144    (26)
Commercial
paper...........                         15,273      526   3.44%     98      (93)   12,668      521 4.11%     134      6
                                       --------  -------   ----  ------  -------  --------  ------- ----   ------  -----
 Total interest-
 bearing
 liabilities....                        464,052   16,399   3.53%  1,411   (1,452)  425,898   16,440 3.86%   1,407   (808)
Cash and due
from banks......                         20,098
Allowance for
loan losses.....                         (4,876)
Premises and
equipment, net..                         12,679
Accrued
Interest........                          3,563
Other assets....                          8,400
                                       ---------
 Total assets...                       $493,737
                                       =========
<CAPTION>
Liabilities and
Shareholders'
Equity:
<S>                                    <C>       <C>     <C>    <C>     <C>
Interest-bearing
demand
deposits........                        128,098    2,730 2.13%     277   (240)
Savings
deposits........                         27,639      676 2.45%      32     (9)
Time deposits...                        209,961   11,410 5.43%   2,018     13
Federal funds
purchased and
securities
sold under agreements to repurchase..    15,279      644 4.21%    (103)   (25)
Commercial
paper...........                          9,382      381 4.06%      52     16
                                       --------- ------- ------ ------- -------
 Total interest-
 bearing
 liabilities....                        390,359   15,841 4.06%   2,021      9

Non-interest
bearing demand
deposits........                         82,921                                     73,266
Other
liabilities.....                          3,611                                      3,083
Shareholders'
equity..........                         45,094                                     39,552
                                       --------                                   --------
 Total
 liabilities and
 shareholders'
 equity.........                       $595,678                                   $541,799
                                       ========                                   ========
Net interest
income on a
fully taxable
equivalent basis
(1)
Net yield on
interest-earning
assets (FTE)....                                  27,947   5.09%                             25,254 5.06%
Non-interest
bearing demand
deposits........                         66,333
Other
liabilities.....                          3,187
Shareholders'
equity..........                         33,858
                                       ---------
 Total
 liabilities and
 shareholders'
 equity.........                       $493,737
                                       =========
Net interest
income on a
fully taxable
equivalent basis
(1)
Net yield on
interest-earning
assets (FTE)....                                  21,797 4.80%
</TABLE>
----
(1) Yields on non-taxable investment securities are stated on a fully taxable
    equivalent basis, assuming a federal tax rate of 34% for the three years
    reported on. The adjustments made to convert to a fully taxable equivalent
    basis were $1,204, $865 and $669 for 1999, 1998 and 1997, respectively.
(2) The effect of foregone interest income as a result of loans on non-accrual
    was not considered in the above analysis. All loans and deposits are
    domestic.

                                       15
<PAGE>

                                TABLE 2
                            Market Risk Sensitivity
     Expected Maturity/Repricing/Principal Repayments at December 31, 1999

<TABLE>
<CAPTION>
                                                              2000
                    ------------------------------------------------------------------------------------------------
                                        2 Days
                    Average              to 3     3 to 6   6 to 12                                           There-   Carrying
                     Rate     1 Day     Months    Months    Months     2001      2002      2003      2004     after    Value
                    ------- ---------  --------  --------  --------  --------  --------  --------  --------  -------  --------
<S>                 <C>     <C>        <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>      <C>
Interest-sensitive
 assets:
 Federal funds
  sold............   5.09%  $   1,371       --        --        --        --        --        --        --       --     1,371
 Federal Home Loan
  Bank stock......   7.57%        --        --        --        --        --        --      1,733       --       --     1,733
 Mortgage-backed
  investment
  securities......   6.27%        --      2,098       142       301     1,099     3,247     4,140    13,153    3,482   27,662
 Other investment
  securities......   7.09%        128       850       569       457     4,531     4,147     6,469     4,534   57,425   79,110
 Loans
  receivable......   8.53%     59,870    26,937    25,961    18,821    50,412    34,710    90,298    43,947  105,801  445,757
                     ----   ---------  --------  --------  --------  --------  --------  --------  --------  -------  -------
  Total interest-
   earning
   assets.........          $  61,369    29,885    26,672    19,579    56,042    42,140   102,640    50,634  166,708  555,633
                            =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
Interest-sensitive
 liabilities:
 Interest-bearing
  demand..........   1.24%    120,173       --        --        --        --        --        --        --       --   120,173
 Insured money
  markets.........   2.96%     59,768       --        --        --        --        --        --        --       --    59,768
 Savings
  deposits........   1.96%     30,975       --        --        --        --        --        --        --       --    30,975
 Time deposits
  over $100.......                --     21,451    17,901    10,717     2,213     1,041       514       --       --    53,837
 Other time
  deposits........                 11    76,572    50,452    38,506    10,710     5,575     3,727     1,506       79  187,138
                     ----   ---------  --------  --------  --------  --------  --------  --------  --------  -------  -------
  Total time
   deposits.......   4.92%         11    98,023    68,353    49,223    12,923     6,616     4,241     1,506       79  240,975
                     ====   =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
 Short-term
  borrowings......   3.61%     39,394       --        --        --        --        --        --        --       --    39,394
                     ----   ---------  --------  --------  --------  --------  --------  --------  --------  -------  -------
  Total interest-
   bearing
   liabilities....          $ 250,321    98,023    68,353    49,223    12,923     6,616     4,241     1,506       79  491,285
                            =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
 Interest rate
  sensitivity
  gap.............          $(188,952)  (68,138)  (41,681)  (29,644)   43,119    35,488    98,399    49,128  166,629   64,348
                            =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
 Cumulative
  interest rate
  sensitivity
  gap.............          $(188,952) (257,090) (298,771) (328,415) (285,296) (249,808) (151,409) (102,281)  64,348      --
                            =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
 Cumulative
  interest rate
  sensitive gap as
  a % of total
  interest-earning
  assets..........             -34.01%   -46.27%   -53.77%   -59.11%   -51.35%   -44.96%   -27.25%   -18.41%   11.58%    0.00%
                            =========  ========  ========  ========  ========  ========  ========  ========  =======  =======
Off-balance sheet
 items:
 Commitments to
  extend credit*..                --        --        --        --        --        --        --        --    71,592   71,592
 Unused lines of
  credit..........   7.95%        --        --        --        --        --        --        --        --    13,763   13,763
<CAPTION>
                     Fair
                     Value
                    -------
<S>                 <C>
Interest-sensitive
 assets:
 Federal funds
  sold............    1,371
 Federal Home Loan
  Bank stock......    1,733
 Mortgage-backed
  investment
  securities......   27,662
 Other investment
  securities......   79,110
 Loans
  receivable......  443,820
                    -------
  Total interest-
   earning
   assets.........  553,696
                    =======
Interest-sensitive
 liabilities:
 Interest-bearing
  demand..........  120,173
 Insured money
  markets.........   59,768
 Savings
  deposits........   30,975
 Time deposits
  over $100.......
 Other time
  deposits........
  Total time
   deposits.......  241,038
                    =======
 Short-term
  borrowings......   39,394
                    -------
  Total interest-
   bearing
   liabilities....  491,348
                    =======
 Interest rate
  sensitivity
  gap.............
 Cumulative
  interest rate
  sensitivity
  gap.............
 Cumulative
  interest rate
  sensitive gap as
  a % of total
  interest-earning
  assets..........
Off-balance sheet
 items:
 Commitments to
  extend credit*..   71,592
 Unused lines of
  credit..........   13,763
</TABLE>
-----

* There is no way to determine the rates on the commitments because they have
 not been set yet. The rates will vary according to prime.

Please see Notes to Market Risk Sensitivity table on page 17.

NOTE: For information regarding how fair values were determined, please see
 notes to consolidated financial statements, number 15.

                                       16
<PAGE>

Notes to Market Risk Sensitivity table:

  .  Expected maturities are contractual maturities adjusted for prepayments
     of principal when possible. The Company uses certain assumptions to
     estimate fair values and expected maturities.

  .  For loans, the Company has used contractual maturities due to the fact
     that the Company has no historical information on prepayment speeds.
     Since most of these loans are consumer and commercial loans, and since
     the Company's customer base is community-based, the Company feels its
     prepayment rates are insignificant.

  .  For mortgage-backed securities, expected maturities are based upon
     contractual maturity, projected repayments and prepayment of principal.
     The prepayment experience herein is based on industry averages as
     provided by the Company's investment trustee.

  .  Loans receivable includes non-performing loans and unamortized deferred
     loan costs, and is reduced by unamortized discounts. It does not include
     Loans Held for Sale as those are not considered to be interest-sensitive
     given that the Bank already has commitments to sell these loans at
     agreed upon rates.

  .  Interest-bearing liabilities are included in the period in which the
     balances are expected to be withdrawn as a result of contractual
     maturities. For accounts with no stated maturities, the balances are
     included in the one-day category.

  .  The interest rate sensitivity gap represents the difference between
     total interest-earning assets and total interest-bearing liabilities.

   An important aspect of achieving satisfactory net interest income is the
composition and maturities of rate sensitive assets and liabilities. Table 2
generally reflects that in periods of rising interest rates, rate sensitive
liabilities will reprice faster than rate sensitive assets, thus having a
negative effect on net interest income. It must be understood, however, that
such an analysis is only a snapshot picture and does not reflect the dynamics
of the market place. Therefore, management reviews simulated earnings
statements on a monthly basis to more accurately anticipate its sensitivity to
changes in interest rates.

   The following table shows the amounts of loans included in Table 2, except
for real estate-mortgage and installment loans to individuals, due to mature
and available for repricing within the time period stated.

                                    TABLE 3
   Maturities and Sensitivity of Selected Loans to Changes in Interest Rates

<TABLE>
<CAPTION>
                                                    After 1 Year After
                                            1 Year    Through      5
                                            or Less  Five Years  Years   Total
                                            ------- ------------ ------ -------
<S>                                         <C>     <C>          <C>    <C>
Commercial, financial and agricultural..... $47,020    45,463    15,451 107,934
Real estate-construction...................   5,086     7,728       559  13,373
                                            -------    ------    ------ -------
 Total..................................... $52,106    53,191    16,010 121,307
                                            =======    ======    ====== =======
</TABLE>

   The amounts of the preceding loans with maturity over one year, which have
a predetermined interest rate or a floating, or adjustable interest rate are
as follows:

<TABLE>
<CAPTION>
                                                               December 31, 1999
                                                               -----------------
   <S>                                                         <C>
   Predetermined interest rate...............................       $69,201
   Floating or adjustable interest rate......................           --
                                                                    -------
    Total....................................................       $69,201
                                                                    =======
</TABLE>

   Thirty percent of total loans are repricable within one year.

                                      17
<PAGE>

Provision For Loan Losses

   The allowance for loan losses is established through charges to expense in
the form of a provision for loan losses. The provision for loan losses was
$2,431, $1,877 and $1,331, respectively, for the years ended December 31,
1999, 1998 and 1997. The provision in 1999 reflects replenishing the allowance
for loan losses to cover net charge-offs of $1,864, plus providing for the 8%
increase in total loans outstanding. Net charge-offs to average loans are
0.43% for 1999 as compared to 0.32% for 1998 and 0.26% for 1997. The increase
in net charge-offs is largely due to charge-offs in the sales finance
portfolio of $613. Management expects increased levels of charge-offs in the
sales finance portfolio to continue in 2000. The allowance for loan losses
totaled $6,362, $5,795 and $5,152 at December 31, 1999, 1998 and 1997,
respectively. The level of the allowance for loan losses to total loans
outstanding is 1.43% at December 31, 1999. This compares to 1.40% as of
December 31, 1998 and 1997.

Allowance for Loan Losses

   Management maintains an allowance for loan losses, which it believes, is
adequate to cover inherent losses in the loan portfolio. The allowance for
loan losses is all allocated. The allowance for loan losses is comprised of
the allowance needed for specific loans and specific loan portfolios. The
Company performs periodic reviews of its loan portfolios to identify and
assess the overall risk in the portfolios. Homogeneous portions of the loan
portfolio, including residential mortgage loans, consumer loans, credit card
receivables and sales finance loans, are generally evaluated as a group based
on loan type. A risk factor is determined for each loan type based on
historical loss levels, delinquency data, economic trends, market conditions
and concentrations of credit. The allowance for the commercial loan portfolio
is based on loan grades. All loans in the commercial loan portfolio are graded
at inception and are reviewed on a periodic basis on performance, size and
other factors. Commercial loans are then assigned a risk factor based on the
loan grade, economic trends and other factors determined by management. The
risk factors are applied to the individual loans and loan portfolios in order
to provide a basis for establishing an adequate level of allowance for loan
losses. At December 31, 1999, management has increased its allocation of the
allowance to the installment loan portfolio as a result of increased charge-
offs. In addition, at December 31, 1999, the allocation to the real estate-
mortgage portfolio has decreased after a reconsideration by management of
historical charge-off patterns of this specific portfolio.

   The process by which the Company determines the allowance for loan losses
requires considerable judgment. Factors considered in determining the
allowance for loan losses include lending trends, geographic and industry
concentrations, changes in type and mix of loans originated and overall
economic trends. Management's judgment is based upon a number of assumptions
about future events which are believed to be reasonable, but which may or may
not prove valid. Thus, there can be no assurance that charge-offs in future
periods will not exceed the allowance for loan losses or that additional
increases in the allowance for loan losses will not be required. The allowance
for loan losses is also subject to periodic evaluation by various regulatory
authorities and may be subject to adjustment, based upon information that is
available to them at the time of their examination.

   During 1999, the Bank redirected its emphasis on indirect-lending in the
sales finance area to purchasing higher-quality indirect loans and reducing
the number of lower-quality loans in the portfolio. Activities associated with
this process, as expected, contributed to the increase of charge-offs as these
lower quality loans were eliminated. Charge-offs are expected to return to a
lower level when this process is complete.

   Management feels the 1.43% allowance for loan losses to total loans at
December 31, 1999 is adequate even when considering that charge-offs have
increased in 1999 because the allowance model described above takes into
account the risk grades of loans, delinquency trends, charge-off ratios and
loan growth.

                                      18
<PAGE>

                                    TABLE 4

                  Summary of Loan Loss and Recovery Experience
                             (Dollars in Thousands)

   The following table summarizes the activity in the allowance for loan losses
for the years indicated:

<TABLE>
<CAPTION>
                                   1999     1998     1997     1996     1995
                                 --------  -------  -------  -------  -------
<S>                              <C>       <C>      <C>      <C>      <C>
Average loans, net of unearned
 discount....................... $430,960  390,776  350,493  301,839  230,908
                                 ========  =======  =======  =======  =======
Allowance for loan losses:
 Beginning balance.............. $  5,795    5,152    4,729    3,700    3,016
 Add provision for loan losses..    2,431    1,877    1,331    1,450    1,140
Loan charge-offs:
 Commercial, financial and
  agricultural..................      532      344      158      131      262
 Real estate--construction......      --       --       --       --       --
 Real estate--mortgage..........      --       --       --        92       14
 Installment loans to
  individuals...................    1,441    1,018      891      487      337
                                 --------  -------  -------  -------  -------
Total loan charge-offs..........    1,973    1,362    1,049      710      613
Recoveries of loans previously
 charged-off:
 Commercial, financial and
  agricultural..................       22        5       56       42       60
 Real estate--construction......      --       --       --       --       --
 Real estate--mortgage..........      --       --       --        65       33
 Installment loans to
  individuals...................       87      123       85      182       64
                                 --------  -------  -------  -------  -------
Total recoveries of loans
 previously charged-off.........      109      128      141      289      157
                                 --------  -------  -------  -------  -------
    Net charge-offs.............    1,864    1,234      908      421      456
                                 --------  -------  -------  -------  -------
Ending balance.................. $  6,362    5,795    5,152    4,729    3,700
                                 ========  =======  =======  =======  =======
Net charge-offs to average
 loans, net.....................     0.43%    0.32%    0.26%    0.14%    0.20%
Allowance for loan losses to
 average loans, net.............     1.48     1.48     1.47     1.57   1 1.60
Allowance for loan losses to
 total loans at period-end......     1.43     1.40     1.40     1.42     1.45
</TABLE>

   Losses and recoveries are charged or credited to the allowance at the time
realized.

   The following table summarizes the allocation of the allowance for loan
losses at December 31:

<TABLE>
<CAPTION>
                              1999           1998          1997          1996          1995
                         --------------  ------------  ------------  ------------  ------------
                                  % of          % of          % of          % of          % of
                          Total  Total   Total Total   Total Total   Total Total   Total Total
                         ------- ------  ----- ------  ----- ------  ----- ------  ----- ------
<S>                      <C>     <C>     <C>   <C>     <C>   <C>     <C>   <C>     <C>   <C>
Balance applicable to:
 Commercial, financial
  and agricultural...... $ 2,022  31.78% 1,309  22.59% 1,145  22.22%   974  20.61%   658  17.78%
 Real estate--
  construction..........      31   0.49    145   2.50    123   2.39    136   2.88     79   2.14
 Real estate--mortgage..     778  12.23  3,025  52.20  2,739  53.17  2,582  54.59  2,161  58.40
 Installment loans to
  individuals...........   3,531  55.50  1,316  22.71  1,145  22.22  1,037  21.92    802  21.68
                         ------- ------  ----- ------  ----- ------  ----- ------  ----- ------
   Total................ $ 6,362 100.00% 5,795 100.00% 5,152 100.00% 4,729 100.00% 3,700 100.00%
                         ======= ======  ===== ======  ===== ======  ===== ======  ===== ======
</TABLE>

                                       19
<PAGE>

Non-Interest Income

   Non-interest income for 1999 increased by $1,601 or 25% over 1998, as
compared to an increase in 1998 of $840 or 15% over 1997. These increases
generally resulted from increased fees for trust services, which continued to
increase in 1999 to $1,968 from $1,343 in 1998 and $986 in 1997. Fees for
trust services increased 47% as a result of the generation of new trust
business, a new fee structure and additional assets under management, which
increased 10%. The trust department had assets under management of $209,107,
$190,866 and $152,968 at December 31, 1999, 1998 and 1997, respectively.

   A significant contributor to non-interest income is service charges on
deposit accounts, which increased 12% as a result of increases in the volume
of deposit relationships. Management views deposit fee income as a critical
influence on profitability. Periodic monitoring of competitive fee schedules
and examination of alternative opportunities insure that the Company realizes
the maximum contribution to profits from this area.

   There were $32, $150 and $40 of gains from sales of investment securities
during 1999, 1998 and 1997, respectively. These gains are reflective of the
stock market activity in recent years. The larger gain in 1998 was due to a
conscientious restructuring of the investment portfolio. In 1998, the Company
sold $6 million of "over-priced" U.S. Treasury notes in order to reinvest in
more economically-priced, shorter-term municipal securities.

Non-Interest Expense

   Non-interest expense totaled $21,274 in 1999 as compared to $19,130 in 1998
and $17,085 in 1997. This represented an 11% increase from 1998 to 1999, and a
12% increase from 1997 to 1998. The overall increases during the year were due
to growth in all geographic markets, which is evidenced by the growth in
deposits of 8% from 1998 to 1999 and 11% from 1997 to 1998. Salaries and other
personnel expense, which comprised 48% of total non-interest expense for 1999,
were up $827 or 9% over 1998 due to normal salary increases and increased
personnel due to the two new branches. During 1998 and 1997, salaries and
other personnel expense accounted for 49% and 50%, of total other operating
expense, respectively.

   Combined net occupancy and furniture and equipment expenses increased $442,
or 12% from 1998 to 1999, as compared to an increase of $381, or 12%, in 1998.
The increases in 1999 and 1998 are due to the opening of two new branches in
each year.

   Postage and supplies expense increased 7% from $1,081 in 1998 to $1,155 in
1999. This increase can be attributed to growth in all geographical markets,
as well as the opening of two new branches in 1999. Postage and supplies
expense increased by 22% from 1997 to 1998 due to two new branches opened in
that year as well.

Income Taxes

   Income tax expense totaled $3,038 in 1999 as compared to $3,000 in 1998 and
$2,415 in 1997. The amounts expensed represented effective tax rates of
approximately 27%, 31% and 29% for the years ended December 31, 1999, 1998 and
1997, respectively. The changes in income tax expense for all three years were
due to changes in taxable income for each respective year. Net income, income
on tax-exempt investment securities and loans, and the provision for loan
losses affect taxable income. For tax purposes, the Bank can only recognize
actual loan losses. The Company works actively with outside tax consultants to
minimize tax expense.

                              Financial Condition
                    As of December 31, 1999, 1998 and 1997

   At December 31, 1999, Bancshares had total assets of $625.2 million, loans
outstanding of $445.8 million and deposits of $537.7 million. This compares
with total assets of $577.4 million, loans outstanding of $413.3 million and
deposits of $499.7 million, at December 31, 1998; and with total assets of
$513.2 million, loans outstanding of $367.6 million and deposits of $449.4
million, at December 31, 1997. The table on the following page shows the
average balances and distributions of the Company's assets and liabilities for
each of the last four years.

                                      20
<PAGE>

                                    TABLE 5
                     Distribution of Assets and Liabilities
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                           Years Ended December 31,
                         -------------------------------------------------------------------
                           1999     1999    1998     1998    1997     1997    1996     1996
                         Average    % of   Average   % of   Average   % of   Average   % of
                         Balance   Total   Balance  Total   Balance  Total   Balance  Total
                         --------  ------  -------  ------  -------  ------  -------  ------
<S>                      <C>       <C>     <C>      <C>     <C>      <C>     <C>      <C>
ASSETS
Cash and due from
 banks.................. $ 25,416    4.27%  22,244    4.11%  20,098    4.07%  23,743    5.51%
Federal funds sold......    5,287    0.89%   3,876    0.72%   5,465    1.11%   1,758    0.41%
Federal Home Loan Bank
 stock..................    1,691    0.28%   1,520    0.28%     779    0.16%     --      --
Taxable investment
 securities.............   40,596    6.82%  53,756    9.92%  60,915   12.34%  56,145   13.04%
Non-taxable investment
 securities.............   69,950   11.74%  48,879    9.02%  36,221    7.34%  30,510    7.08%
Loans, net of unearned
 discount...............  430,960   72.35% 390,776   72.13% 350,493   70.99% 301,839   70.08%
 Less: allowance for
  loan losses...........   (6,085)  -1.02%  (5,393)  -1.00%  (4,876)  -0.99%  (4,088)  -0.95%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Net loans.............  424,875   71.33% 385,383   71.13% 345,617   70.00% 297,751   69.13%
                         --------  ------  -------  ------  -------  ------  -------  ------
Premises and equipment,
 net....................   15,230    2.56%  14,255    2.63%  12,679    2.57%  11,670    2.71%
Accrued Interest........    4,344    0.73%   4,065    0.75%   3,563    0.72%   3,260    0.76%
Other assets............    8,289    1.39%   7,821    1.44%   8,400    1.70%   5,881    1.37%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Total assets.......... $595,678  100.00% 541,799  100.00% 493,737  100.00% 430,718  100.00%
                         ========  ======  =======  ======  =======  ======  =======  ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits:
 Non-interest-bearing
  deposits..............   82,921   13.92%  73,266   13.52%  66,333   13.43%  58,440   13.57%
 Interest-bearing
  demand................  165,370   27.76% 147,580   27.24% 128,098   25.94% 115,674   26.86%
 Savings................   31,308    5.26%  28,718    5.30%  27,639    5.60%  26,331    6.11%
 Time...................  232,806   39.08% 218,185   40.27% 209,961   42.52% 172,799   40.12%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Total deposits........  512,405   86.02% 467,749   86.33% 432,031   87.50% 373,244   86.66%
                         --------  ------  -------  ------  -------  ------  -------  ------
Federal funds purchased
 and securities sold
 under agreements to
 repurchase.............   19,295    3.24%  18,747    3.46%  15,279    3.09%  17,668    4.10%
Commercial paper........   15,273    2.56%  12,668    2.34%   9,382    1.90%   8,075    1.87%
Other liabilities.......    3,611    0.61%   3,083    0.57%   3,187    0.65%   2,600    0.60%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Total liabilities.....  550,584   92.43% 502,247   92.70% 459,879   93.14% 401,587   93.24%
                         --------  ------  -------  ------  -------  ------  -------  ------
Shareholders equity:
 Common stock--$5.00 par
  value.................   31,042    5.21%  30,890    5.70%  30,576    6.19%  30,330    7.04%
 Capital surplus........      --      --        19     --       206    0.04%     356    0.08%
 Retained earnings......   14,277    2.40%   8,385    1.55%   2,932    0.59%  (1,516)  -0.35%
 Less: Treasury stock...      --      --       --      --       (37)  -0.01%    (312)  -0.07%
 Accumulated other
  comprehensive income
  (loss)................     (225)  -0.04%     258    0.05%     181    0.04%     273    0.06%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Total shareholders'
   equity...............   45,094    7.57%  39,552    7.30%  33,858    6.86%  29,131    6.76%
                         --------  ------  -------  ------  -------  ------  -------  ------
  Total liabilities and
   shareholders'
   equity............... $595,678  100.00% 541,799  100.00% 493,737  100.00% 430,718  100.00%
                         ========  ======  =======  ======  =======  ======  =======  ======
</TABLE>

                                       21
<PAGE>

Loans and Asset Quality

   Management of the Company believes that the loan portfolio is adequately
diversified. Commercial loans are spread through numerous types of businesses
with no particular industry concentrations. Loans to individuals are made
primarily to finance consumer goods purchased. At December 31, 1999, total
loans, net of unearned discounts, were 80% of total earning assets. Loans
secured by real estate accounted for 55% of total loans as of December 31,
1999. Most of the loans classified as real estate-mortgage are commercial
loans where real estate provides additional collateral.

   At December 31, 1999, the sales finance portfolio was $36,760 compared to
$31,238 at December 31, 1998. The sales finance portfolio includes loans with
more inherent risk than the loans in the Bank's direct lending portfolio.
During mid 1999, management noted a deterioration in the performance of the
portfolio which resulted in increased charge-offs as previously discussed. In
late 1999, management made certain organizational changes in the sales finance
department to improve the asset quality. However, management believes there
will be increased levels of charge-offs arising from these loans in 2000. In
estimating the allowance for loan losses at December 31, 1999 and in
allocating portions of the allowance to specific portions of the loan
portfolio, management has taken these factors into consideration.

   Non-accrual loans are those loans which management, through its continuing
evaluation of loans, has determined offer a more than normal risk of
collectability of future interest. Interest income on non-accrual loans is
recognized only as received. Interest on past due loans continues to accrue
until such time that the loans are either charged-off or placed in non-accrual
status. The non-accrual loan policy provides that it is the responsibility of
the chief credit officer to administer the placing of loans on non-accrual
status. Loans that become ninety days past due will be placed on non-accrual.
Loans on which bankruptcy notices are received will also be placed on non-
accrual. In addition, other loans on which repayment appears doubtful may be
placed on non-accrual at the discretion of the chief credit officer.

   Non-performing loans (which consist of loans on non-accrual and loans
greater than 90 days, but still accruing) for 1999, 1998 and 1997 were
approximately $1,630 or 0.37% (of total loans), $1,572 or 0.38% and $862 or
0.23%, respectively. The majority of these non-performing loans are smaller-
balance homogeneous consumer loans. For information on impaired loans, please
see footnote number 5.

   Table 6 on page 23 sets forth, for each loan category, the amounts of total
loans 90 days or more past due and on non-accrual, the amounts of total loans
90 days or more past due and accruing, total loans outstanding, the percentage
of each type of loan 90 days or more past due and the amount of foregone
interest income for each of the five years for December 31, 1995 through
December 31, 1999.

                                      22
<PAGE>

                                    TABLE 6
                              Nonperforming Loans
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                      90 Days or
                                     More Past Due              Percentage   Foregone Interest
                                      and not on   Total Loans  90 Days or   Income From Non-
                         Non-Accrual  Non-Accrual  Outstanding More Past Due      Accrual
                         ----------- ------------- ----------- ------------- -----------------
<S>                      <C>         <C>           <C>         <C>           <C>
December 31, 1999:
 Commercial, financial
  and agricultural......   $  805         --         107,934       0.75%             98
 Real estate--
  construction..........      --          --          13,373       0.00             --
 Real estate--mortgage..      329         --         231,637       0.14              21
 Installment loans to
  individuals...........      387         109         92,813       0.53             121
                           ------         ---        -------       ----             ---
  Total.................   $1,521         109        445,757       0.37%            240
                           ======         ===        =======       ====             ===
December 31, 1998:
 Commercial, financial
  and agricultural......   $  223         --          93,343       0.24%             26
 Real estate--
  construction..........      --          --          10,341       0.00             --
 Real estate--mortgage..      445         --         215,709       0.21              22
 Installment loans to
  individuals...........      817          87         93,873       0.96              82
                           ------         ---        -------       ----             ---
  Total.................   $1,485          87        413,266       0.38%            130
                           ======         ===        =======       ====             ===
December 31, 1997:
 Commercial, financial
  and agricultural......       63         --          81,678       0.08               2
 Real estate--
  construction..........      --          --           8,799       0.00             --
 Real estate--mortgage..      256         --         195,462       0.13              26
 Installment loans to
  individuals...........      399         144         81,646       0.67              38
                           ------         ---        -------       ----             ---
  Total.................   $  718         144        367,585       0.23%             66
                           ======         ===        =======       ====             ===
December 31, 1996:
 Commercial, financial
  and agricultural......      140         --          68,617       0.20               4
 Real estate--
  construction..........      --          --           9,598       0.00             --
 Real estate--mortgage..      428         --         181,775       0.24              25
 Installment loans to
  individuals...........      545         --          72,996       0.75              23
                           ------         ---        -------       ----             ---
  Total.................   $1,113         --         332,986       0.33%             52
                           ======         ===        =======       ====             ===
December 31, 1995:
 Commercial, financial
  and agricultural......      146         --          45,377       0.32              20
 Real estate--
  construction..........      --          --           5,453       0.00             --
 Real estate--mortgage..      241         --         149,017       0.16              11
 Installment loans to
  individuals...........      409           3         55,340       0.74              35
                           ------         ---        -------       ----             ---
  Total.................   $  796           3        255,187       0.31%             66
                           ======         ===        =======       ====             ===
</TABLE>

                                       23
<PAGE>

Deposits

   For the average balances and average rates paid by category of deposit for
the years ended December 31, 1999, 1998 and 1997, please see Table 1 on page
15. The company has no foreign deposits.

   The following table sets forth, by time remaining to maturity, domestic
certificates of deposit over $100, as of December 31, 1999, 1998 and 1997.

                                    TABLE 7
                     Maturities of Time Deposits Over $100

<TABLE>
<CAPTION>
                                                            1999    1998   1997
                                                           ------- ------ ------
<S>                                                        <C>     <C>    <C>
Maturities:
 3 months or less......................................... $21,451 21,467 23,062
 3 through 6 months.......................................  17,901  9,609 12,206
 6 through 12 months......................................  10,717  8,490 11,004
 Over 12 months...........................................   3,768  7,146  3,680
                                                           ------- ------ ------
                                                           $53,837 46,712 49,952
                                                           ======= ====== ======
</TABLE>

Liquidity

   The liquidity ratio is an indication of a company's ability to meet its
short-term funding obligations. The Company's policy is to maintain a
liquidity ratio between 15%-25%. At December 31, 1999, the Company's liquidity
ratio was approximately 18%.

   The Company's liquidity position is dependent upon its debt servicing needs
and dividends declared. The Company had no outstanding debt at December 31,
1999 and 1998, respectively.

   During 1991 the Company began selling commercial paper as an alternative
investment tool for its commercial customers (Master note program). The
commercial paper is issued only in conjunction with the automated sweep
account customer agreement on deposits at the Bank level. At December 31,
1999, the Company had $12,573 in commercial paper with a weighted average rate
of 3.44%, as compared to $10,859 in 1998 with a weighted average of 3.06% and
$11,289 in 1997 with a weighted average rate of 3.69%.

   The Parent Company's liquidity needs are met through the payment of
dividends from the Bank. At December 31, 1999, the Bank had available retained
earnings of $6,814 for payment of dividends to remain "well-capitalized."
Prior approval of the Office of the Commissioner of Banking, State Board of
Financial Institutions is required for any payment of dividends by a state
bank.

   The Bank's liquidity is affected by its ability to attract deposits, the
maturity of its loan portfolio, the flexibility of its investment securities,
lines of credit from correspondent banks, and current earnings. Sufficient
liquidity must be available to meet continuing loan demand and deposit
withdrawal requirements. Competition for deposits is intense in the markets
served by the Bank. However, the Bank has been able to attract deposits as
needed through pricing adjustments and expansion of its geographic market
area. The deposit base is comprised of diversified customer deposits with no
one deposit or type of customer accounting for a significant portion.
Therefore, withdrawals are not expected to fluctuate from historical levels.
The loan portfolio of the Bank is a source of liquidity through maturities and
repayments by existing borrowers. The investment securities portfolio is a
source of liquidity through scheduled maturities and sales of securities, and
prepayment of principal on mortgage-backed securities. Approximately 75% of
the securities portfolio was pledged to secure liabilities as of December 31,
1999, as compared to 62% at December 31, 1998. Management believes that its
sources of liquidity are adequate to meet operational needs. Additional
sources of short-term liquidity are existing lines of credit from
correspondent banks totaling $85 million, all of which are available. The Bank
has also completed the necessary borrowing agreements with the Federal Reserve
Bank of Richmond giving the Bank access to the Federal Reserve Discount window
to borrow as needed for liquidity purposes. Loan demand has been constant and
loan originations can be controlled through pricing decisions.

                                      24
<PAGE>

Capital Resources

   At December 31, 1999 and 1998 the Company and the Bank were each
categorized as "well capitalized," under the regulatory framework for prompt
corrective action. There are no current conditions or events that management
believes would change the Company's or the Bank's category. Please see notes
to consolidated financial statements number 17 for the Company's and the
Bank's various capital ratios at December 31, 1999.

   The stock in the Company's Employee Stock Ownership Plan ("ESOP") had a put
and a call feature because the Company's stock is not listed on a national
securities exchange. Accordingly, the shares that had been distributed from
the ESOP were recorded outside of shareholders equity at their fair value,
which is determined annually by an independent valuation. The Company's Board
of Directors had voted to terminate the ESOP effective February 28, 1997. Per
the Plan document, the shares distributed in 1998 due to the termination of
the ESOP were subject to the put/call until June 29, 1999. Now that the
put/call has expired, the current year balance sheet and income statements are
absent the put/call effect of the ESOP. The distributed shares are now
included in shareholders' equity.

Effect of Inflation and Changing Prices

   The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in
relative purchasing power over time due to inflation. Virtually all of the
assets and liabilities of the Bank are monetary in nature and, as a result,
its operations can be significantly affected by interest rate fluctuations as
discussed above. Therefore, inflation will affect the Bank only to the extent
that interest rates change and according to the Bank's sensitivity to such
changes. The Company attempts to manage the effects of inflation through its
asset/liability management as described above in "Asset-Liability Management
and Market Risk Sensitivity."

Accounting and Reporting Changes

   The Financial Accounting Standards Board has not released any accounting
pronouncements that have not been adopted and that affect the Company or the
Bank.

Industry Developments

   Certain recently enacted and proposed legislation could have an effect on
both the costs of doing business and the competitive factors facing the
financial institution's industry. Because of the uncertainty of the final
terms and likelihood of passage of the proposed legislation, the Company is
unable to assess the impact of any proposed legislation on its financial
condition or operations at this time.

Item 8. Financial Statements and Supplementary Data

   The information that is required by this item is set forth on the following
pages, 26 through 51.

                                      25
<PAGE>

                         Independent Auditors' Report

The Board of Directors
Palmetto Bancshares, Inc. and subsidiary:

   We have audited the accompanying consolidated balance sheets of Palmetto
Bancshares, Inc. and subsidiary (the "Company") as of December 31, 1999 and
1998, and the related consolidated statements of operations, changes in
shareholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 1999. 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 Palmetto
Bancshares, Inc. and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally
accepted accounting principles.

   As discussed in Note 1 to the consolidated financial statements, on January
1, 1999, the Company adopted the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities."

KPMG LLP

[KPMG LLP LOGO]
Greenville, South Carolina
February 9, 2000

                                      26
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                          Consolidated Balance Sheets
                           December 31, 1999 and 1998
            (Dollars in Thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                               1999     1998
                                                             --------  -------
<S>                                                          <C>       <C>
                           Assets
Cash and due from banks..................................... $ 42,446   27,929
Federal funds sold..........................................    1,371      110
Federal Home Loan Bank stock, at cost.......................    1,733    1,541
Investment securities held to maturity (fair value of
 $68,737 in 1998)...........................................      --    66,455
Investment securities available for sale (amortized cost of
 $110,670 and $45,551 in 1999 and 1998, respectively).......  106,772   46,087
Loans held for sale.........................................    1,169    2,122
Loans.......................................................  445,757  413,266
 Less allowance for loan losses.............................   (6,362)  (5,795)
                                                             --------  -------
   Loans, net...............................................  439,395  407,471
                                                             --------  -------
Premises and equipment, net.................................   16,319   14,347
Accrued interest............................................    4,648    4,499
Other assets................................................   11,345    6,839
                                                             --------  -------
   Total assets............................................. $625,198  577,400
                                                             ========  =======
            Liabilities and Shareholders' Equity
Liabilities:
 Deposits:
  Non-interest-bearing...................................... $ 85,796   83,788
  Interest-bearing..........................................  451,891  415,885
                                                             --------  -------
   Total deposits...........................................  537,687  499,673
 Securities sold under agreements to repurchase.............   19,021   21,630
 Commercial paper (Master notes)............................   12,573   10,859
 Federal funds purchased....................................    7,800      --
 Other liabilities..........................................    2,490    3,153
                                                             --------  -------
   Total liabilities........................................  579,571  535,315
                                                             --------  -------
Common stock subject to put/call option (ESOP)..............      --     4,732
Shareholders' equity:
 Common stock--$5.00 par value. Authorized 10,000,000
  shares; issued and outstanding 6,226,834 in 1999; issued
  and outstanding 6,199,390 in 1998;........................   31,134   30,997
 Capital surplus (deficit)..................................      --       (19)
 Retained earnings..........................................   16,890   10,777
 Accumulated other comprehensive income (loss)..............   (2,397)     330
 Common stock subject to put/call option, 540,768 shares at
  $8.75 per share in 1998...................................      --    (4,732)
                                                             --------  -------
   Total shareholders' equity...............................   45,627   37,353
                                                             --------  -------
   Total liabilities and shareholders' equity............... $625,198  577,400
                                                             ========  =======
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       27
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                     Consolidated Statements of Operations
                  Years ended December 31, 1999, 1998 and 1997
            (Dollars in Thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                   1999      1998       1997
                                                ---------- ---------  ---------
<S>                                             <C>        <C>        <C>
Interest income:
 Interest and fees on loans...................  $   36,759    34,600     30,760
 Interest and dividends on investment
  securities available for sale:
 U.S. Treasury and U.S. Government agencies...         953       682        909
 State and municipal..........................       3,402       591        373
 Mortgage-backed securities...................       1,620       333        --
 Interest and dividends on investment
  securities held to maturity:
 U.S. Treasury and U.S. Government agencies...         --        934      1,282
 State and municipal..........................         --      1,952      1,595
 Mortgage-backed securities...................         --      1,408      1,703
 Interest on federal funds sold...............         269       211        291
 Dividends on FHLB stock......................         139       118         56
                                                ---------- ---------  ---------
  Total interest income.......................      43,142    40,829     36,969
                                                ---------- ---------  ---------
Interest expense:
 Interest on deposits.........................      15,151    15,157     14,816
 Interest on securities sold under agreements
  to repurchase...............................         564       639        558
 Interest on federal funds purchased..........         158       123         86
 Interest on commercial paper (Master notes)..         526       521        381
                                                ---------- ---------  ---------
  Total interest expense......................      16,399    16,440     15,841
                                                ---------- ---------  ---------
  Net interest income.........................      26,743    24,389     21,128
Provision for loan losses.....................       2,431     1,877      1,331
                                                ---------- ---------  ---------
  Net interest income after provision for loan
   losses.....................................      24,312    22,512     19,797
                                                ---------- ---------  ---------
Non-interest income:
 Service charges on deposit accounts..........       3,878     3,449      3,215
 Fees for trust services......................       1,968     1,343        986
 Gains on sales of loans......................         230       269         14
 Investment securities gains..................          32       150         40
 Other income.................................       1,961     1,257      1,373
                                                ---------- ---------  ---------
  Total non-interest income...................       8,069     6,468      5,628
                                                ---------- ---------  ---------
Non-interest expense:
 Salaries and other personnel.................      10,255     9,428      8,468
 Net occupancy................................       1,922     1,793      1,501
 Furniture and equipment......................       2,081     1,768      1,679
 FDIC assessment..............................         132       206        177
 Postage and supplies.........................       1,155     1,081        885
 Marketing and advertising....................         776       720        629
 Telephone....................................         792       601        518
 Other expense................................       4,161     3,533      3,228
                                                ---------- ---------  ---------
  Total non-interest expense..................      21,274    19,130     17,085
                                                ---------- ---------  ---------
  Income before income taxes..................      11,107     9,850      8,340
Income tax provision..........................       3,038     3,000      2,415
                                                ---------- ---------  ---------
  NET INCOME..................................  $    8,069     6,850      5,925
                                                ========== =========  =========
  Increase in fair value of ESOP stock........         --       (948)      (470)
                                                ---------- ---------  ---------
  Net income on common shares not subject to
   put/call...................................  $    8,069     5,902      5,455
                                                ========== =========  =========
Per share data:
 Net income per common share-basic, not
  subject to put/call.........................  $     1.30      1.05       0.98
                                                ========== =========  =========
 Net income per common share-dilutive, not
  subject to put/call.........................  $     1.26      1.02       0.97
                                                ========== =========  =========
 Cash dividends declared......................  $     0.32      0.25       0.19
                                                ========== =========  =========
 Weighted average common shares outstanding--
  basic.......................................   6,208,750 6,178,318  6,109,754
                                                ========== =========  =========
 Weighted average common shares outstanding--
  basic, not subject to put/call..............   6,208,750 5,631,040  5,544,596
                                                ========== =========  =========
 Weighted average common shares outstanding--
  dilutive, not subject to put/call...........   6,386,912 5,776,208  5,649,338
                                                ========== =========  =========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       28
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

  Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
                                     Income
                  Years ended December 31, 1999, 1998 and 1997
                   (Dollars in Thousands, except share data)

<TABLE>
<CAPTION>
                                                                Accumulated    Common
                                                                   Other       Stock
                                    Capital                    Comprehensive Subject to
                          Common    Surplus  Retained Treasury    Income      Put/call
                           Stock   (Deficit) Earnings  Stock    (Loss), Net    Option   Total
                          -------  --------- -------- -------- ------------- ---------- ------
<S>                       <C>      <C>       <C>      <C>      <C>           <C>        <C>
Balance at December 31,
 1996...................  $30,330     356        620    (34)         166       (3,314)  28,124
Net income..............      --      --       5,925    --           --           --     5,925
Other comprehensive
 income, net of tax:
 Unrealized holding
  gains arising during
  period, net of tax
  effect of $33.........      --      --         --     --           --           --        52
 Less: reclassification
  adjustment for gains
  included in net
  income, net of tax
  effect of $15.........      --      --         --     --           --           --       (25)
 Net unrealized gains on
  securities............      --      --         --     --            27          --       --
                                                                                        ------
Comprehensive income....      --      --         --     --           --           --     5,952
                                                                                        ------
Cash dividends
 declared...............      --      --      (1,165)   --           --           --    (1,165)
Issuance of 113,200
 shares in connection
 with stock options.....      566    (300)       --     --           --           --       266
Sale of 18,222 shares of
 treasury stock.........      --      --          91     34          --           --       125
Change in fair value of
 common stock subject to
 put/call option........      --      --         --     --           --          (470)    (470)
                          -------    ----     ------    ---       ------       ------   ------
Balance at December 31,
 1997...................   30,896      56      5,471    --           193       (3,784)  32,832
                          =======    ====     ======    ===       ======       ======
Net income..............      --      --       6,850    --           --           --     6,850
Other comprehensive
 income, net of tax:
 Unrealized holding
  gains arising during
  period, net of tax
  effect of $143........      --      --         --     --           --           --       229
 Less: reclassification
  adjustment for gains
  included in net
  income, net of tax
  effect of $58.........      --      --         --     --           --           --       (92)
Net unrealized gains on
 securities.............      --      --         --     --           137          --       --
                                                                                        ------
Comprehensive income....      --      --         --      --          --           --     6,987
                                                                                        ------
Cash dividends
 declared...............      --      --      (1,544)   --           --           --    (1,544)
Issuance of 29,200
 shares in connection
 with stock options.....      146     (42)       --     --           --           --       104
Retirement of 8,914
 shares of common
 stock..................      (45)    (33)       --     --           --           --       (78)
Change in fair value of
 common stock subject to
 put/call option........      --      --         --     --           --          (948)    (948)
                          -------    ----     ------    ---       ------       ------   ------
Balance at December 31,
 1998...................   30,997     (19)    10,777    --           330       (4,732)  37,353
                          =======    ====     ======    ===       ======       ======
Net income..............      --      --       8,069    --           --           --     8,069
Other comprehensive
 income (loss), net of
 tax:
 Unrealized holding
  losses arising during
  period, net of tax
  effect of $1,695......      --      --         --     --           --           --    (2,707)
 Less: reclassification
  adjustment for gains
  included in net
  income, net of tax
  effect of $12.........      --      --         --     --           --           --       (20)
 Net unrealized losses
  on securities.........      --      --         --     --        (2,727)         --       --
                                                                                        ------
Comprehensive income....      --      --         --     --           --           --     5,342
                                                                                        ------
Cash dividends
 declared...............      --      --      (1,956)   --           --           --    (1,956)
Issuance of 27,444
 shares in connection
 with stock options.....      137      19        --     --           --           --       156
Expiration of put/call
 option on common stock
 subject to put/call....      --      --         --     --           --         4,732    4,732
                          -------    ----     ------    ---       ------       ------   ------
Balance at December 31,
 1999...................  $31,134     --      16,890    --        (2,397)         --    45,627
                          =======    ====     ======    ===       ======       ======
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       29
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                     Consolidated Statements of Cash Flows
                  Years ended December 31, 1999, 1998 and 1997
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                    1999      1998      1997
                                                  --------  --------  --------
<S>                                               <C>       <C>       <C>
Cash flows from operating activities:
 Net income.....................................  $  8,069     6,850     5,925
 Adjustments to reconcile net income to net cash
  provided by operating activities:
 Depreciation and amortization..................     2,580     2,758     2,221
 Gain on sale of investment securities..........       (32)     (150)      (40)
 Gain on sale of loans..........................      (230)     (269)      (14)
 Provision for loan losses......................     2,431     1,877     1,331
 Origination/acquisition of loans held for
  sale..........................................   (28,520)  (33,927)  (25,077)
 Sale of loans held for sale....................    29,703    32,074    29,166
 Provision (credit) for deferred taxes..........       (57)      (42)      259
 Change in accrued interest receivable..........      (149)     (509)     (553)
 Change in other assets.........................    (3,174)   (2,581)   (1,609)
 Change in other liabilities, net...............     1,101       921      (311)
                                                  --------  --------  --------
  Net cash provided by operating activities.....    11,722     7,002    11,298
                                                  --------  --------  --------
Cash flows from investing activities:
 Purchase of investment securities held to
  maturity......................................       --     (1,559)  (29,594)
 Purchase of investment securities available for
  sale..........................................   (41,032)  (38,971)  (10,956)
 Proceeds from maturities of investment
  securities held to maturity...................       --      6,533    12,170
 Proceeds from maturities of investment
  securities available for sale.................    12,865     1,717     6,000
 Proceeds from sale of investment securities
  available for sale............................    21,359     8,594     3,614
 Principal paydowns on mortgage-backed
  securities available for sale.................     8,116     8,480     3,537
 Principal paydowns on mortgage-backed
  securities held to maturity...................       --        656       --
 Purchase of Federal Home Loan Bank stock.......      (192)      (89)   (1,452)
 Net increase in loans outstanding..............   (34,690)  (43,850)  (35,595)
 Increase in premises and equipment, net........    (3,574)   (2,345)   (2,310)
                                                  --------  --------  --------
  Net cash used in investing activities.........   (37,148)  (60,834)  (54,586)
                                                  --------  --------  --------
Cash flows from financing activities:
 Net increase in deposits.......................    23,463    47,957    36,723
 Acquisition of deposits, net...................    12,636     2,029       --
 Net increase (decrease) in securities sold
  under agreements to repurchase................    (2,609)    9,406       588
 Net increase (decrease) in commercial paper....     1,714      (430)    3,854
 Increase (decrease) in federal funds
  purchased.....................................     7,800    (1,500)   (1,500)
 Proceeds from issuance of common stock.........       156       104       266
 Retirement of common stock.....................       --        (78)      --
 Proceeds from sale of treasury stock...........       --        --        125
 Dividends paid.................................    (1,956)   (1,544)   (1,165)
                                                  --------  --------  --------
  Net cash provided by financing activities.....    41,204    55,944    38,891
                                                  --------  --------  --------
Net increase (decrease) in cash and cash
 equivalents....................................    15,778     2,112    (4,397)
Cash and cash equivalents at beginning of year..    28,039    25,927    30,324
                                                  --------  --------  --------
Cash and cash equivalents at end of year........  $ 43,817    28,039    25,927
                                                  ========  ========  ========
Supplemental information:
Cash paid during the year for:
 Interest.......................................  $ 16,300    16,470    15,697
                                                  ========  ========  ========
 Income taxes...................................  $  3,423     2,622     2,385
                                                  ========  ========  ========
Supplemental schedule of non-cash investing and
 financing transactions:
 Change in unrealized gain (loss) on investment
  securities available for sale, before tax.....  $ (4,434)      223        44
                                                  ========  ========  ========
 Transfer of investment securities held to
  maturity to available for sale................  $ 66,455       --        --
                                                  ========  ========  ========
 Loans transferred to other real estate owned...  $    335       189        88
                                                  ========  ========  ========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       30
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Summary of Significant Accounting Policies (Dollars in Thousands, except
   share and per share data, in all notes)

   The following is a description of the more significant accounting policies
used in preparing the consolidated financial statements. The accounting and
reporting policies of Palmetto Bancshares, Inc. (the "Company") conform to
generally accepted accounting principles ("GAAP") and to general practices
within the banking industry. The preparation of the financial statements in
conformity with GAAP requires management to make estimates and assumptions.
These estimates and assumptions affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements. In addition, they affect the reported
amounts of income and expense during the reporting period. Actual results
could differ from these estimates and assumptions.

Basis of Presentation

   The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Palmetto Bank (the "Bank"). The Bank provides
a full range of banking services, including the taking of deposits and the
making of loans. Palmetto Capital, Inc. ("Palmetto Capital"), a wholly owned
subsidiary of Palmetto Bank, was incorporated February 26, 1992. Palmetto
Capital offers the brokerage of stocks, bonds, mutual funds and unit
investment trusts. Palmetto Capital also offers advisory services and variable
rate annuities. The Company's primary market area is the upstate of South
Carolina. All significant intercompany accounts and transactions have been
eliminated in consolidation. The Company operates as one business segment.

   Assets held by the Company or its subsidiary in a fiduciary or agency
capacity for customers are not included in the consolidated financial
statements as such items are not assets of the Company or its subsidiary.

   Certain amounts for prior years have been reclassified to conform to the
1999 presentation. These reclassifications have no effect on shareholders'
equity or net income as previously reported.

   On December 14, 1999, the Board of Directors approved a two-for-one stock
split effected in the form of a 100% stock dividend to shareholders of record
as of January 3, 2000. All number of common shares outstanding and per share
amounts contained in this report have been retroactively adjusted to give
effect to the stock split.

Cash and Cash Equivalents

   Cash and cash equivalents include cash, due from banks and federal funds
sold. Generally, both cash and cash equivalents are considered to have
maturities of three months or less, and accordingly, the carrying amount of
such instruments is deemed to be a reasonable estimate of fair value. To
comply with Federal Reserve regulations, the Bank is required to maintain
certain average cash reserve balances on-hand as vault cash and/or at the
Federal Reserve as compensating balances. There were no compensating balances
at December 31, 1999 or 1998.

Federal Home Loan Bank Stock

   During 1997, the Bank joined the Federal Home Loan Bank ("FHLB") of Atlanta
to increase the Bank's available liquidity. As a FHLB member, the Bank is
required to acquire and retain shares of capital stock in the FHLB of Atlanta
in an amount equal to the greater of (1) 1.0% of the aggregate outstanding
principal amount of the residential mortgage loans, home purchase contracts
and similar obligations, or (2) 0.3% of total assets at the beginning of each
year. The Bank is in compliance with this requirement with an investment in
FHLB stock of $1,733 and $1,541 at December 31, 1999 and 1998, respectively.
No ready market exists for this stock and it has


                                      31
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(1) Summary of Significant Accounting Policies, Continued

no quoted market value. However, redemption of this stock has historically
been at par value. The Bank has available $48,000 in lines of credit from the
FHLB. There were no advances on these lines at December 31, 1999 or 1998.

Investment Securities

   The Bank accounts for its investment securities in accordance with SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities. SFAS
No. 115 addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values--other than those
accounted for under the equity method or as investments in consolidated
subsidiaries--and all investments in debt securities. Under SFAS No. 115,
investments are classified into three categories as follows: (1) Held to
Maturity--debt securities that the Company has the positive intent and ability
to hold to maturity, which are reported at amortized cost; (2) Trading--debt
and equity securities that are bought and held principally for the purpose of
selling them in the near term, which are reported at fair value, with
unrealized gains and losses included in earnings; and (3) Available for Sale--
debt and equity securities that may be sold under certain conditions, which
are reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity, net of
income taxes. The Company does not have any trading securities.

   In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The statement is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000, with earlier
adoption permitted, as amended by SFAS No. 137. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities. The statement requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. The Company adopted SFAS No. 133 in
its entirety effective January 1, 1999. On January 1, 1999, the Company
transferred 100% of its held-to-maturity investment securities, with an
amortized cost of $66,455, to the available-for-sale category at fair value
($68,737) as allowed by SFAS No. 133. The unrealized gain at the time of
transfer was $2,282 before tax. Such transfers from the held-to-maturity
category at the date of initial adoption shall not call into question the
Company's intent to hold other debt securities to maturity in the future. The
Company has no investments that are considered derivatives under SFAS No. 133
and does not engage in any hedging activities.

Loans Held for Sale

   Loans held for sale are reported at the lower of cost or market value on an
aggregate loan basis. Deferred net fees or costs are included as part of the
Company's net investment in loans held for sale until such loans are sold.
Gains or losses realized on the sales of loans are recognized at the time of
sale and are determined by the difference between the net sales proceeds and
the carrying value of loans sold.

   At December 31, 1999 and 1998, the Company has loans held for sale of
$1,169 and $2,122, respectively. Loans serviced for the benefit of others
amounted to $141,385, $141,086 and $147,988 at December 31, 1999, 1998 and
1997, respectively. Most of these loans are serviced for Federal Home Loan
Mortgage Corporation (FHLMC).

   The Bank recognizes mortgage servicing rights (MSR's) in accordance with
SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities, an Amendment of SFAS No. 122. The statement
requires the recognition of a separate asset for the right to service mortgage
loans for others, regardless of how those rights were acquired. Further, it
requires assessment of impairment based on fair value. The Company evaluates
these rights quarterly for possible impairment.

                                      32
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(1) Summary of Significant Accounting Policies, Continued

   Included in other assets on the consolidated balance sheet, the Company had
net MSR's of $1,111 and $1,232 at December 31, 1999 and 1998, respectively.
The Company amortized $488, $795 and $421 of these MSR's during the years
ended December 31, 1999, 1998 and 1997, respectively. The fair value of the
mortgage servicing rights are determined considering market prices for similar
MSR's and on the discounted anticipated future net cash flows considering
market consensus loan prepayment predictions, historical prepayment rates,
interest rates, and other economic factors. For purposes of measuring the
impairment, the Company stratifies the MSR's based on the predominant risk
characteristics of the underlying loans, including interest rate, loan type,
and amortization type (fixed rate or adjustable rate). To the extent that the
carrying value of MSR's exceeds this fair value by individual stratum, a
valuation allowance is established. The allowance may be adjusted in the
future as the values of the MSR's increase or decrease. The cost of MSR's is
amortized over the estimated period of net servicing revenues, considering
historical industry-average prepayment rates.

Loans and Interest Income

   Loans are carried at principal amounts outstanding reduced by unearned
discounts. Interest income on all loans is recorded on an accrual basis. The
accrual of interest is generally discontinued on loans that become 90 days
past due as to principal or interest. The accrual of interest on some loans,
however, may continue even though they are 90 days past due if the loans are
well secured, in the process of collection, and management deems it
appropriate. If non-accrual loans decrease their past due status to 60 days or
less, they are reviewed individually by management to determine if they should
be returned to accrual status.

Impaired Loans

   The Bank accounts for its impaired loans in accordance with SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, which requires that all
creditors value all specifically reviewed nonhomogenous loans for which it is
probable that the creditor will be unable to collect all amounts due according
to the terms of the loan agreement at the loan's fair value. Fair value may be
determined based upon the present value of expected cash flows, market price
of the loan, if available, or value of the underlying collateral. Expected
cash flows are required to be discounted at the loan's effective interest
rate. SFAS No. 114 was amended by SFAS No. 118 to allow a creditor to use
existing methods for recognizing interest income on impaired loans and by
requiring additional disclosures about how a creditor recognizes interest
income related to impaired loans.

   The Bank determines which loans are impaired through a loan review process.
When the ultimate collectibility of an impaired loan's principal is in doubt,
wholly or partially, all cash receipts are applied to principal. When this
doubt no longer exists, cash receipts are applied under the contractual terms
of the loan agreement first to principal and then to interest income. Once the
recorded principal balance has been reduced to zero, future cash receipts are
applied to interest income, to the extent that any interest has been foregone.
Further cash receipts are recorded as recoveries of any amounts previously
charged off.

   SFAS No. 114 specifically states that it need not be applied to "large
groups of smaller-balance homogeneous loans that are collectively evaluated
for impairment." Thus, the Company determined that the statement does not
apply to its consumer loan, credit card or residential mortgage loan
portfolios, except that it may choose to apply it to certain specific larger
loans determined by management. In effect, these portfolios are covered
adequately in the Company's normal formula for determining loan loss reserves.

Loan Fees and Costs

   Non-refundable fees and certain direct costs associated with originating or
acquiring loans are recognized as a yield adjustment over the contractual life
of the related loans, or if the related loan is held for resale, until

                                      33
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(1) Summary of Significant Accounting Policies, Continued

the loan is sold. Recognition of deferred fees and costs is discontinued on
non-accrual loans until they return to accrual status or are charged-off.
Commitment fees associated with lending are deferred and if the commitment is
exercised, the fee is recognized over the life of the related loan as a yield
adjustment. If the commitment expires unexercised the amount is recognized
upon expiration of the commitment.

Allowance for Loan Losses

   Additions to the allowance for loan losses are based on management's
evaluation of the loan portfolio under current economic conditions, past loan
loss experience, and such other factors which, in management's judgment,
deserve recognition in estimating loan losses. Loans are charged-off when, in
the opinion of management, they are deemed to be uncollectible. Recognized
losses are charged against the allowance, and subsequent recoveries are added
to the allowance. While management uses the best information available to make
evaluations, future adjustments to the allowance may be necessary if economic
conditions differ substantially from the assumptions used in making the
evaluation. The allowance for loan losses is subject to periodic evaluation by
various regulatory authorities and may be subject to adjustment, based upon
information that is available to them at the time of their examination.

Premises and Equipment

   Premises and equipment are reported at cost less accumulated depreciation
and amortization. Depreciation is recorded using the straight-line method over
the estimated useful life of the related asset as follows: buildings, 12 to 39
years; and furniture and equipment, 5 to 12 years. Amortization of leasehold
improvements is recorded using the straight-line method over the lesser of the
estimated useful life of the asset or the term of the lease. Maintenance and
repairs are charged to operating expense as incurred.

Foreclosed Properties

   Property acquired through foreclosure is included in other assets and
amounted to $267 and $0, at December 31, 1999 and 1998, respectively. Such
property is recorded at the lower of cost or fair value minus estimated
selling costs. Gains and losses on the sale of foreclosed properties and
write-downs resulting from periodic reevaluation are charged to other
operating expenses.

Income Taxes

   Under the asset and liability method of SFAS No. 109, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using the enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. Under SFAS No. 109, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

Intangibles

   At December 31, 1999, deposits are shown net of premium on deposits
acquired of approximately $637, net of amortization, which is being amortized
principally over 10 years using the double-declining balance method. At
December 31, 1999, goodwill of approximately $4,682, net of amortization,
related to different acquisitions is being amortized on a straight-line basis
over varying periods from 15-20 years. The Company periodically assesses the
recoverability of these intangibles by evaluating whether the amortization of
the remaining balance can be recovered through projected undiscounted future
cash flows, which are based on historical trends.

                                      34
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(1) Summary of Significant Accounting Policies, Continued

Common Stock Subject to Put/Call Option

   The stock in the Company's Employee Stock Ownership Plan ("ESOP") had a put
and a call feature because the Company's stock is not listed on a national
securities exchange. Accordingly, the shares that had been distributed from
the ESOP were recorded outside of shareholders' equity at their fair value,
which is determined annually by an independent valuation. The Company's Board
of Directors had voted to terminate the ESOP effective February 28, 1997. Per
the Plan document, the shares distributed in 1998 due to the termination of
the ESOP were subject to the put/call until June 29, 1999. Now that the
put/call has expired, the current year balance sheet and income statements are
absent the put/call effect of the ESOP. The distributed shares are now
included in shareholders' equity.

Net Income Per Share

   Net income per share-basic, not subject to put/call is based on the
weighted average number of shares outstanding not subject to put/call. Net
income per common share-dilutive, not subject to put/call is calculated based
on SFAS No. 128, as discussed in note 12.

Stock Options

   In 1996, the Company adopted SFAS No. 123, Accounting for Stock-based
Compensation. SFAS No. 123 introduces a preferable fair-value based method of
accounting for stock-based compensation. It encourages, but does not require,
companies to recognize compensation expense for grants of stock, stock
options, and other equity instruments to employees based on fair value.
Companies that choose not to adopt the fair value method will continue to
apply the existing accounting rules contained in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
chosen the latter option. SFAS No. 123 requires companies that choose not to
adopt the fair value method of accounting to disclose pro forma net income and
earnings per share under the fair value method. In addition, all companies
with stock-based plans are required to make detailed disclosures about plan
terms, exercise prices, and assumptions used in measuring the fair value of
stock-based grants (see note 11).

Comprehensive Income

   In 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires that changes in the amounts of comprehensive income
items be shown in a primary financial statement. The statement defines
comprehensive income as "the change in equity (net assets) of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity during
a period except those resulting from investments by owners and distributions
to owners." In accordance with SFAS No. 130, the Company elected to disclose
changes in comprehensive income in its Consolidated Statements of Changes in
Shareholders' Equity and Comprehensive Income.

(2) Federal Funds Sold

   At December 31, 1999 and 1998, the Bank had $1,371 and $110, respectively,
outstanding in federal funds sold. The daily averages of these outstanding
agreements during 1999 and 1998 were $5,287 and $3,876, respectively. The
maximum amount of these outstanding agreements at any month-end during 1999
and 1998 were $13,061 and $5,615, respectively.

                                      35
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(3) Investment Securities Held to Maturity

   The amortized cost and fair values of investment securities held to maturity
as of December 31 are summarized as follows:

<TABLE>
<CAPTION>
                                                           1998
                                          --------------------------------------
                                          Amortized Unrealized Unrealized  Fair
                                            Cost      Gains      Losses   Value
                                          --------- ---------- ---------- ------
<S>                                       <C>       <C>        <C>        <C>
U.S. Government agencies.................  $10,985       44       --      11,029
State and municipal......................   36,685    2,101       --      38,786
Mortgage-backed securities...............   18,785      151       (14)    18,922
                                           -------    -----       ---     ------
                                           $66,455    2,296       (14)    68,737
                                           =======    =====       ===     ======
</TABLE>

<TABLE>
<CAPTION>
                                                           1997
                                          --------------------------------------
                                          Amortized Unrealized Unrealized  Fair
                                            Cost      Gains      Losses   Value
                                          --------- ---------- ---------- ------
<S>                                       <C>       <C>        <C>        <C>
U.S. Government agencies.................  $16,984       65        (13)   17,036
State and municipal......................   36,861    1,572         (5)   38,428
Mortgage-backed securities...............   26,161      101       (148)   26,114
                                           -------    -----       ----    ------
                                           $80,006    1,738       (166)   81,578
                                           =======    =====       ====    ======
</TABLE>

(4) Investment Securities Available for Sale

   The amortized cost and fair values of investment securities available for
sale as of December 31 are summarized as follows:

<TABLE>
<CAPTION>
                                                        1999
                                       ---------------------------------------
                                       Amortized Unrealized Unrealized  Fair
                                         Cost      Gains      Losses    Value
                                       --------- ---------- ---------- -------
<S>                                    <C>       <C>        <C>        <C>
U.S. Treasury and U.S. Government
 agencies............................. $ 14,481       7         (399)   14,089
State and Municipal...................   67,738     340       (3,057)   65,021
Mortgage-backed securities............   28,451     --          (789)   27,662
                                       --------     ---       ------   -------
                                       $110,670     347       (4,245)  106,772
                                       ========     ===       ======   =======
</TABLE>

<TABLE>
<CAPTION>
                                                           1998
                                          --------------------------------------
                                          Amortized Unrealized Unrealized  Fair
                                            Cost      Gains      Losses   Value
                                          --------- ---------- ---------- ------
<S>                                       <C>       <C>        <C>        <C>
U.S. Treasury............................  $ 6,500     205         --      6,705
State and Municipal......................   27,436     366         (94)   27,708
Mortgage-backed securities...............   11,615      70         (11)   11,674
                                           -------     ---        ----    ------
                                           $45,551     641        (105)   46,087
                                           =======     ===        ====    ======
</TABLE>

<TABLE>
<CAPTION>
                                                           1997
                                          --------------------------------------
                                          Amortized Unrealized Unrealized  Fair
                                            Cost      Gains      Losses   Value
                                          --------- ---------- ---------- ------
<S>                                       <C>       <C>        <C>        <C>
U.S. Treasury............................  $12,492     201        (12)    12,681
State and Municipal......................    4,918     126        --       5,044
                                           -------     ---        ---     ------
                                           $17,410     327        (12)    17,725
                                           =======     ===        ===     ======
</TABLE>

                                       36
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(4) Investment Securities Available for Sale, Continued

   During the year ended December 31, 1999 the Company had realized gains of
$32 and no realized losses on sales of investment securities available for
sale; compared to realized gains of $150 and no realized losses in 1998 on
sales of investment securities available for sale. During 1997, the realized
gains amounted to $49, and the realized losses were $9 on sales of investment
securities available for sale. Specific identification is the basis on which
cost was determined in computing realized gains and losses.

   The following is a maturity distribution of investment securities available
for sale at December 31, 1999:

<TABLE>
<CAPTION>
                                         Due After         Due After
                           Due            One Year         Five Years
                          Within          Through           Through          Due After
                         One Year Yield  Five Years Yield  Ten Years  Yield  Ten Years Yield
                         -------- -----  ---------- -----  ---------- -----  --------- -----
<S>                      <C>      <C>    <C>        <C>    <C>        <C>    <C>       <C>
U.S. Treasury and U. S.
 Government Agencies....  $  --    -- %     9,387   6.18%     4,702   6.22       --     --
State and municipals....   3,053  9.23      9,527   8.41     17,160   7.22    35,281   6.88
Mortgage-backed
 securities.............     708  5.34     23,472   6.31      3,482   6.25       --     --
                          ------  ----     ------   ----     ------   ----    ------   ----
Fair value total........  $3,761  8.48%    42,386   6.74%    25,344   6.89%   35,281   6.88%
                          ======  ====     ======   ====     ======   ====    ======   ====
Amortized cost..........  $3,757           42,873            26,233           37,807
                          ======           ======            ======           ======
</TABLE>

   Investment securities held to maturity and available for sale with an
aggregate carrying value of approximately $80,092 and $69,757 at December 31,
1999 and 1998, respectively, are pledged to secure public deposits, securities
sold under agreements to repurchase, and for other purposes as required or
permitted by law.

(5) Loans

   A summary of loans, by classification, as of December 31 follows:

<TABLE>
<CAPTION>
                                                    December 31,
                                      ----------------------------------------
                                        1999    1998    1997    1996    1995
                                      -------- ------- ------- ------- -------
<S>                                   <C>      <C>     <C>     <C>     <C>
Commercial, financial and
 agricultural........................ $107,934  93,343  81,678  68,616  45,377
Real estate--construction............   13,373  10,341   8,799   9,598   5,453
Real estate--mortgage................  231,637 215,709 195,462 181,775 149,017
Installment loans to individuals.....   92,813  93,873  81,646  72,997  55,340
                                      -------- ------- ------- ------- -------
Total................................ $445,757 413,266 367,585 332,986 255,187
                                      ======== ======= ======= ======= =======
Non-accrual loans included above..... $  1,521   1,485     718   1,113     796
                                      ======== ======= ======= ======= =======
</TABLE>

   The foregone interest income related to loans on non-accrual amounted to
$240, $130 and $66 for the years ended December 31, 1999, 1998 and 1997,
respectively. Interest income recognized on loans on non-accrual amounted to
$7, $5 and $6 for the years ended December 31, 1999, 1998 and 1997,
respectively.

   The following is a summary of activity affecting the allowance for loan
losses for the years ended December 31:

<TABLE>
<CAPTION>
                                                         1999     1998    1997
                                                        -------  ------  ------
<S>                                                     <C>      <C>     <C>
Balance at beginning of year........................... $ 5,795   5,152   4,729
Provision for loan losses..............................   2,431   1,877   1,331
Loan recoveries........................................     109     128     141
Loans charged-off......................................  (1,973) (1,362) (1,049)
                                                        -------  ------  ------
Balance at end of year................................. $ 6,362   5,795   5,152
                                                        =======  ======  ======
</TABLE>


                                      37
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(5) Loans, Continued

   At December 31, 1999, impaired loans amounted to approximately $467. During
1999, the average recorded investment in impaired loans was approximately
$240, and there is $234 included in the allowance for loan losses related to
impaired loans at December 31, 1999. Impaired loans are included in the non-
accrual numbers above.

   At December 31, 1998, impaired loans amounted to approximately $62. During
1998, the average recorded investment in impaired loans was approximately
$115, and there is $62 included in the allowance for loan losses related to
impaired loans at December 31, 1998.

   At December 31, 1997, impaired loans amounted to approximately $70. During
1997, the average recorded investment in impaired loans was approximately $44,
and there is $70 included in the allowance for loan losses related to impaired
loans at December 31, 1997.

   The Bank makes contractual commitments to extend credit, which are legally
binding agreements to lend money to customers at predetermined interest rates
for a specific period of time. The Bank also provides standby letters of
credit which are issued on behalf of customers in connection with contracts
between the customers and third parties. Under a standby letter of credit the
Bank assures that the third party will not suffer a loss if the customer fails
to meet the contractual obligation. The Bank applies the same credit standards
used in the lending process when extending these commitments, and periodically
reassesses the customers' creditworthiness through ongoing credit reviews.

   At December 31, 1999, except for the fact that the majority of the loan
portfolio is located in the Bank's immediate market area, there were no
concentrations of loans in any type of industry, type of property, or to one
borrower.

   The Bank had outstanding, unused loan commitments as of December 31, 1999
as follows:

<TABLE>
<S>                                                                     <C>
Home equity loans...................................................... $10,305
Credit cards...........................................................  26,347
Commercial real estate development.....................................  12,474
Other unused lines of credit...........................................  22,466
                                                                        -------
                                                                        $71,592
                                                                        =======
Standby letters of credit.............................................. $ 1,409
                                                                        =======
</TABLE>

   All unused loan commitments are at adjustable rates that fluctuate with
prime rate, or are at fixed rates that approximate market rates. The current
amounts of these commitments approximate their fair value.

(6) Premises and Equipment, Net

   A summary of premises and equipment, net, as of December 31 follows:
<TABLE>
<CAPTION>
                                                                1999     1998
                                                              --------  -------
<S>                                                           <C>       <C>
Land......................................................... $  2,775    2,125
Buildings and leasehold improvements.........................   12,939   11,894
Furniture and equipment......................................   12,937   11,096
                                                              --------  -------
                                                                28,651   25,115
Less accumulated depreciation and amortization...............  (12,332) (10,768)
                                                              --------  -------
Premises and equipment, net.................................. $ 16,319   14,347
                                                              ========  =======
</TABLE>

                                      38
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(7) Mortgage Servicing Rights

   The following is a summary of activity affecting the valuation allowance
for impairment of mortgage servicing rights for the years ended December 31:
<TABLE>
<CAPTION>
                                                                1999 1998 1997
                                                                ---- ---- ----
<S>                                                             <C>  <C>  <C>
Balance at beginning of year................................... $229  62  --
Aggregate additions charged and reductions credited to
 operations....................................................    5 167   62
Aggregate direct writedowns charged against allowance..........  --  --   --
                                                                ---- ---  ---
Balance at end of year......................................... $234 229   62
                                                                ==== ===  ===
</TABLE>

(8) Deposits

   A summary of deposits, by type, as of December 31 follows:
<TABLE>
<CAPTION>
                                                                1999     1998
                                                              --------  -------
<S>                                                           <C>       <C>
Transaction accounts......................................... $206,606  184,346
Savings deposits.............................................   30,975   27,939
Insured money market accounts................................   59,768   56,258
Time deposits over $100......................................   53,837   46,712
Other time deposits..........................................  187,138  185,214
Premium on deposits acquired.................................     (637)    (796)
                                                              --------  -------
  Total deposits............................................. $537,687  499,673
                                                              ========  =======
</TABLE>

   Interest paid on time deposits of $100 or more amounted to $2,273, $2,636,
and $2,784 for the years ended December 31, 1999, 1998 and 1997, respectively.

   The following table displays the aggregate amounts of time deposits with
maturities for the years following December 31, 1999:

<TABLE>
<S>                                                                    <C>
Maturing within one year.............................................. $215,610
Maturing after one year through two years.............................   12,923
Maturing after two years through three years..........................    6,616
Maturing after three years through five years.........................    5,747
Maturing after five years.............................................       79
                                                                       --------
  Total............................................................... $240,975
                                                                       ========
</TABLE>

(9) Short-Term Borrowings

<TABLE>
<CAPTION>
SECURITIES SOLD UNDER AGREEMENTS                         1999     1998    1997
 TO REPURCHASE WITH CUSTOMERS                           -------  ------  ------
<S>                                                     <C>      <C>     <C>
Amount outstanding at year-end......................... $ 7,769  11,630  12,224
Average amount outstanding during year.................  15,291  16,112  13,926
Maximum amount outstanding at any month-end............  20,762  18,127  15,112
Weighted average rate paid at year-end.................    1.81%   2.81%   3.44%
Weighted average rate paid during the year.............    3.40%   3.97%   4.01%
</TABLE>

                                      39
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(9) Short-Term Borrowings, Continued

   Bank of America holds the securities underlying these agreements in the
Bank's name in safekeeping for the benefit of the Bank's customers.

<TABLE>
<CAPTION>
SECURITIES SOLD UNDER AGREEMENTS
 TO REPURCHASE WITH A BANK
<S>                                                      <C>      <C>     <C>
Amount outstanding at year-end.......................... $11,252  10,000    --
Average amount outstanding during year..................   1,277     438    --
Maximum amount outstanding at any month-end.............  11,252  10,000    --
Weighted average rate paid at year-end..................    5.96%   5.32%   -- %
Weighted average rate paid during the year..............    5.96%   5.32%   -- %

   The securities underlying these agreements are held in the Bank's name in
safekeeping by Sun Trust for the benefit of the Bank.

<CAPTION>
FEDERAL FUNDS PURCHASED
<S>                                                      <C>      <C>     <C>
Amount outstanding at year-end.......................... $ 7,800     --   1,500
Average amount outstanding during year..................   2,727   2,197  1,353
Maximum amount outstanding at any month-end.............  15,000   9,200  8,125
Weighted average rate paid at year-end..................    5.13%    -- %  6.13%
Weighted average rate paid during the year..............    5.79%   5.60%  6.36%
</TABLE>


<TABLE>
<CAPTION>
                                                         1999     1998    1997
COMMERCIAL PAPER (MASTER NOTE)                          -------  ------  ------
<S>                                                     <C>      <C>     <C>
Amount outstanding at year-end......................... $12,573  10,859  11,289
Average amount outstanding during year.................  15,273  12,668   9,382
Maximum amount outstanding at any month-end............  17,035  14,084  12,292
Weighted average rate paid at year-end.................    2.06%   3.06%   3.69%
Weighted average rate paid during the year.............    3.44%   4.11%   4.06%
</TABLE>

   During 1991 the Company began selling commercial paper as an alternative
investment tool for its commercial customers. Through a master note
arrangement between the Company and the Bank, Palmetto Master Notes are issued
as an alternative investment for commercial sweep accounts. These master notes
are unsecured but are backed by the full faith and credit of the Company. The
commercial paper of the Company is issued only in conjunction with the
automated sweep account customer agreement on deposits at the Bank level.

(10) Income Taxes

   Components of income tax provision expense/(benefit) for the years ended
December 31 are as follows:

<TABLE>
<CAPTION>
                                                             1999   1998   1997
                                                            ------  -----  -----
<S>                                                         <C>     <C>    <C>
Current:
  Federal.................................................. $2,724  2,704  1,888
  State....................................................    371    338    268
                                                            ------  -----  -----
                                                             3,095  3,042  2,156
                                                            ------  -----  -----
Deferred:
  Federal..................................................    (57)   (42)   259
  State....................................................    --     --     --
                                                            ------  -----  -----
                                                               (57)   (42)   259
                                                            ------  -----  -----
    Total.................................................. $3,038  3,000  2,415
                                                            ======  =====  =====
</TABLE>


                                      40
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(10) Income Taxes, Continued

   The effective tax rates for the years ended December 31 vary from the
Federal statutory rates as follows:

<TABLE>
<CAPTION>
                                                            1999   1998   1997
                                                            ----   ----   ----
<S>                                                         <C>    <C>    <C>
U.S. Federal income tax rates.............................. 34.0 % 34.0 % 34.0 %
Changes from statutory rates resulting from:
  Tax-exempt interest income............................... (9.7)  (8.2)  (7.5)
  Expenses not deductible for tax purposes.................   .6     .7     .7
  State taxes, net of Federal income tax benefit...........  2.2    2.3    2.1
  Other....................................................   .3    1.7    (.3)
                                                            ----   ----   ----
Effective tax rates........................................ 27.4 % 30.5 % 29.0 %
                                                            ====   ====   ====
</TABLE>

   Different accounting methods have been used for reporting income for income
tax and for financial reporting purposes. The tax provisions shown in the
financial statements relate to items of income or expense in those statements
and as a result may not be the amount paid for the period. Deferred income
taxes have been provided on such differences.

   The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, are presented below.

<TABLE>
<CAPTION>
                                                                1999     1998
                                                               -------  ------
<S>                                                            <C>      <C>
Deferred tax assets:
  Loan loss reserves.......................................... $ 1,904   1,616
  Basis of intangible assets for tax purposes in excess of
   basis for financial reporting..............................     232     140
  Unrealized loss on securities available for sale............   1,500     --
  Other.......................................................     108      43
                                                               -------  ------
    Total gross deferred tax assets...........................   3,744   1,799
    Less valuation allowance..................................     --      --
                                                               -------  ------
    Net deferred tax assets...................................   3,744   1,799
                                                               -------  ------
Deferred tax liabilities:
  Fixed assets, due to depreciation differences...............    (667)   (571)
  Deferred loan costs deducted for tax purposes as incurred...    (573)   (468)
  Deferred loan fees recognized under the principal reduction
   method for tax purposes....................................    (497)   (388)
  Unrealized gain on securities available for sale............     --     (207)
  Prepaid pension expense.....................................    (436)   (360)
  Other.......................................................     (10)     (8)
                                                               -------  ------
    Total gross deferred tax liabilities......................  (2,183) (2,002)
                                                               -------  ------
    Net deferred tax asset (liability)........................ $ 1,561    (203)
                                                               =======  ======
</TABLE>

   A portion of the change in the net deferred tax liability relates to the
unrealized gains and losses on securities available for sale. A current period
deferred tax benefit related to the change in unrealized gain on securities
available for sale of $1,707 has been recorded directly to shareholders
equity. The rest of the change in the deferred tax liability results from the
current period deferred tax benefit of $57.

   No valuation allowance for deferred tax assets has been established at
either December 31, 1999 or 1998. Because of taxes paid in carry back periods,
as well as estimates of future taxable income, it is management's belief that
realization of the net deferred tax asset is more likely than not.

   Tax returns for 1997 and subsequent years are subject to examination by the
taxing authorities.

                                      41
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(11) Employee Benefit Plans

  (a) The Bank has a noncontributory defined benefit pension plan which
      covers all full-time employees who have at least twelve months
      continuous service and have attained age 21. The plan is designed to
      produce a designated retirement benefit, and benefits are fully vested
      at five years or more of service. No vesting occurs with less than five
      years of service. The Bank's Trust Department administers the plan.
      Contributions to the plan are made as required by the Employee
      Retirement Income Security Act of 1974.

     The following table details the funded status of the plan, the amounts
     recognized in the Company's consolidated financial statements, the
     components of net periodic benefit cost, and the weighted-average
     assumptions used in determining these amounts for the years ended
     December 31:

<TABLE>
<CAPTION>
                                                                   1999   1998
                                                                  ------  -----
     <S>                                                          <C>     <C>
     Change in benefit obligation
       Benefit obligation at beginning of year................... $5,056  3,590
       Service cost..............................................    343    335
       Interest cost.............................................    348    310
       Actuarial loss (gain).....................................   (486)   934
       Benefits paid.............................................   (102)  (113)
                                                                  ------  -----
       Benefit obligation at end of year......................... $5,159  5,056

     Change in plan assets
       Fair value of plan assets at beginning of year............  5,539  4,846
       Actual return on plan assets..............................    491    397
       Employer contribution.....................................    494    409
       Benefits paid.............................................   (102)  (113)
                                                                  ------  -----
       Fair value of plan assets at end of year.................. $6,422  5,539
                                                                  ------  -----

     Funded status...............................................  1,263    483
     Unrecognized prior service cost.............................     60     69
     Unrecognized net actuarial loss.............................    104    617
     Unrecognized transition.....................................    (78)  (103)
                                                                  ------  -----
     Prepaid benefit cost included in other assets............... $1,349  1,066
                                                                  ======  =====
</TABLE>

<TABLE>
<CAPTION>
                                                              1999   1998  1997
                                                              -----  ----  ----
     <S>                                                      <C>    <C>   <C>
     Components of net periodic benefit cost:
       Service cost.......................................... $ 335   237   205
       Interest cost.........................................   310   249   221
       Expected return on plan assets........................  (404) (328) (286)
       Amortization of transition asset......................   (26)  (26)  (26)
       Amortization of prior service cost....................     9     9     9
       Amortization of loss..................................     7    --    --
                                                              -----  ----  ----
       Net periodic benefit cost............................. $ 231   141   123
                                                              =====  ====  ====

     Weighted-average assumptions at December 31:
       Discount rate.........................................  7.75% 7.00% 8.00%
       Rate of increase in compensation levels...............  5.00% 5.00% 5.00%
       Expected long-term rate of return on plan assets......  8.00% 8.00% 8.00%
</TABLE>


                                      42
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(11) Employee Benefit Plans, Continued

  (b) Until February 28, 1997, the Company had an Employee Stock Ownership
      Plan (ESOP) established by its Board of Directors. The ESOP covered the
      same employees and had the same vesting schedule as the pension plan.
      Based on profits, the Company contributed annually to a trust created
      to acquire shares of the Company's common stock for the exclusive
      benefit of the participants. During 1997, the Company contributed
      common stock to the ESOP, which had been previously repurchased as
      treasury stock, and accounted for these transactions in accordance with
      Statement of Position 93-6. The Company recorded compensation expense
      equal to the fair value of the shares contributed. The Company made no
      contributions in 1999 or 1998 due to the termination of the plan in
      1997. The charge to income for contributions to the ESOP for the year
      ended December 31, 1997 is as follows:

<TABLE>
<CAPTION>
                                                                           1997
                                                                           ----
     <S>                                                                   <C>
     Repurchase of treasury stock for ESOP................................ $125
     Investment income received by ESOP...................................  --
                                                                           ----
     Contributions to ESOP................................................ $125
                                                                           ====
</TABLE>

     At December 31, 1999, there were no allocated shares in the plan due to
     the termination of the ESOP as of February 28, 1997.

  (c) Since 1987, the Company has adopted several plans (Stock Option Plans)
      pursuant to which the Company's Board of Directors may grant incentive
      and non-incentive stock options to certain key employees and directors
      of the Company and its subsidiaries. The option price and term of the
      options shall be determined by the Board on grant date, but shall not
      be less than 100% of fair market value as of grant date and shall not
      be greater than 10 years, respectively. Because the Company's stock is
      not traded on an established market, the fair value may be determined
      by an annual independent actuarial valuation. As of December 31, 1999
      and 1998, 494,000 and 476,000 shares, respectively, had been granted
      under these plans.

     At December 31, 1999 and 1998, there were 132,000 and 150,000 remaining
     shares, respectively, available for grant under the Stock Option Plans.
     Stock option activity for these plans is summarized in the following
     table:

<TABLE>
<CAPTION>
                                                       Stock    Weighted-Average
                                                      Options    Exercise Price
                                                      --------  ----------------
     <S>                                              <C>       <C>
     Outstanding at December 31, 1996................  216,000       $ 3.19
                                                      --------       ------
     Granted.........................................   18,000         6.88
     Forfeited.......................................   (4,800)        5.84
     Exercised....................................... (113,200)        2.35
                                                      --------       ------
     Outstanding at December 31, 1997................  116,000         4.47
                                                      --------       ------
     Granted.........................................  200,000         8.75
     Exercised.......................................  (29,200)        3.58
                                                      --------       ------
     Outstanding at December 31, 1998................  286,800         7.55
                                                      --------       ------
     Granted.........................................   18,000        11.25
     Exercised.......................................  (27,444)        5.76
                                                      --------       ------
     Outstanding at December 31, 1999................  277,356       $ 7.96
                                                      --------       ------
</TABLE>


                                      43
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(11) Employee Benefit Plans, Continued

   The following table summarizes information about stock options outstanding
at December 31, 1999:

<TABLE>
<CAPTION>
                  Options Outstanding                Options Exercisable
      -------------------------------------------------------------------
                               Weighted-
                                Average   Weighted-             Weighted-
       Range of     Number     Remaining   Average    Number     Average
       Exercise   Outstanding Contractual Exercise  Exercisable Exercise
        Prices    at 12/31/99    Life       Price   at 12/31/99   Price
      ----------  ----------- ----------- --------- ----------- ---------
     <S>          <C>         <C>         <C>       <C>         <C>
      $3.92-4.13     28,456    3.54 years    4.03      28,456      4.03
      $4.52-4.85     26,500    5.34 years    4.63      26,500      4.63
      $6.88-8.75    204,400    9.95 years    8.65      61,440      8.75
      $11.25         18,000   10.00 years   11.25       3,600     11.25
                    -------   -----------  ------     -------     -----
      Total         277,356    8.85 years  $ 7.96     119,996     $6.80
                    =======   ===========  ======     =======     =====
</TABLE>

     The Company follows the provisions of Accounting Principles Board (APB)
     Opinion No. 25, Accounting for Stock Issued to Employees, and related
     interpretations, which requires compensation expense for options to be
     recognized only if the market price of the underlying stock exceeds the
     exercise price on the date of grant. Accordingly, the Company has not
     recognized compensation expense for its options granted in 1999, 1998
     and 1997.

     In 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based
     Compensation. SFAS No. 123 permits companies to recognize as expense
     over the vesting period the fair value of all stock-based awards on the
     date of grant. In management's opinion, the existing stock option
     valuation models do not necessarily provide a reliable single measure of
     stock option fair value. Therefore, as permitted, the Company will
     continue to apply the existing accounting rules under APB No. 25 and
     provide pro forma net income and pro forma earnings per share
     disclosures for employee stock option grants made in 1996 and subsequent
     years as if the fair-value-based method defined in SFAS No. 123 had been
     applied.

     The per-share weighted average fair values of stock options granted in
     1999, 1998 and 1997 were $4.30, $3.34 and $2.74, respectively. The fair
     values were estimated as of the respective grant dates using the Black-
     Scholes option-pricing model. Input variables used in the model included
     weighted-average risk free interest rates of 5.65%, 5.57% and 6.03%,
     respectively; expected dividend yields of 1.30%, 1.40% and 1.30%,
     respectively; and expected volatility factors of 21.30%, 22.20% and
     22.3%, respectively; and estimated option lives of 10 years. The pro
     forma impact on income assumes no options will be forfeited. Had
     compensation expense for the Company's Stock Option Plan been determined
     based on the fair value grant date for awards granted in 1999, 1998 and
     1997 consistent with the provisions of SFAS No. 123, the Company's net
     income and earnings per share would have been effected as shown in the
     following table:

<TABLE>
<CAPTION>
                                                             1999  1998  1997
                                                            ------ ----- -----
     <S>                                                    <C>    <C>   <C>
     Net income--as reported............................... $8,069 6,850 5,925
     Net income--pro forma.................................  7,984 6,771 5,912
     Net income per common share--basic, not subject to
      put/call--as reported................................   1.30  1.05  0.98
     Net income per common share--basic, not subject to
      put/call--pro forma..................................   1.29  1.03  0.98
     Net income per common share--dilutive, not subject to
      put/call--as reported................................   1.26  1.02  0.97
     Net income per common share--dilutive, not subject to
      put/call--pro forma..................................   1.25  1.01  0.96
</TABLE>

                                      44
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(11) Employee Benefit Plans, Continued

     The pro forma effects may not be representative of the effects on
     reported net income for future years as most of the Company's employee
     stock option grants vest in cumulative increments over a period of five
     years.

(12) Earnings per Share

   The table below illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net income
for the years ended December 31, 1999, 1998 and 1997:

<TABLE>
<CAPTION>
                                              Income       Shares     Per-Share
   1999                                     (Numerator) (Denominator)  Amount
   ----                                     ----------- ------------- ---------
   <S>                                      <C>         <C>           <C>
   Basic EPS:
   Income available to common
    stockholders..........................    $8,069      6,208,750     $1.30
                                              ------      ---------     -----
   Effect of dilutive securities: stock
    options...............................       --         178,162       --
   Diluted EPS:
   Income available to common stockholders
    plus assumed exercises of stock
    options...............................    $8,069      6,386,912     $1.26
                                              ======      =========     =====
</TABLE>

<TABLE>
<CAPTION>
                                              Income       Shares     Per-Share
   1998                                     (Numerator) (Denominator)  Amount
   ----                                     ----------- ------------- ---------
   <S>                                      <C>         <C>           <C>
   Basic EPS:
   Income available to common
    stockholders..........................    $5,902      5,631,040     $1.05
                                              ------      ---------     -----
   Effect of dilutive securities: stock
    options...............................       --         145,168       --
   Diluted EPS:
   Income available to common stockholders
    plus assumed exercises of stock
    options...............................    $5,902      5,776,208     $1.02
                                              ======      =========     =====
</TABLE>

<TABLE>
<CAPTION>
                                              Income       Shares     Per-Share
   1997                                     (Numerator) (Denominator)  Amount
   ----                                     ----------- ------------- ---------
   <S>                                      <C>         <C>           <C>
   Basic EPS:
   Income available to common
    stockholders..........................    $5,455      5,544,596     $0.98
                                              ------      ---------     -----
   Effect of dilutive securities: stock
    options...............................       --         104,742       --
   Diluted EPS:
   Income available to common stockholders
    plus assumed exercises of stock
    options...............................    $5,455      5,649,338     $0.97
                                              ======      =========     =====
</TABLE>

(13) Related Party Transactions

   Certain of the Company's directors and executive officers are also
customers of the Bank who, including their related interests, were indebted to
the Bank in the approximate amounts of $2,648 and $3,128 at December 31, 1999
and 1998, respectively. From January 1 through December 31, 1999, these
directors and executive officers and their related interests borrowed $1,055
and repaid $1,535. In the opinion of management, these loans do not involve
more than the normal risk of collectibility and do not present other
unfavorable features.

                                      45
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(14) Commitments and Contingencies

   On December 31, 1999, the Bank was obligated under a number of
noncancelable operating leases on certain property and equipment that have
initial terms of more than one year. The minimum scheduled payments under
these leases are as follows:

<TABLE>
      <S>                                                                 <C>
      2000..............................................................  $  481
      2001..............................................................     479
      2002..............................................................     476
      2003..............................................................     397
      2004..............................................................     281
      Subsequent years..................................................   1,583
                                                                          ------
                                                                          $3,697
                                                                          ======
</TABLE>

   Rental expense was $469, $417 and $392 for the years ended December 31,
1999, 1998 and 1997, respectively.

   In the normal course of business, the Company and subsidiary are
periodically involved in legal proceedings. In the opinion of the Company's
management, none of these proceedings is likely to have a materially adverse
effect on the accompanying consolidated financial statements.

(15) Disclosures Regarding Fair Value of Financial Instruments

   SFAS No. 107, Disclosure About Fair Value of Financial Instruments
(Statement 107), requires disclosure of fair value information about financial
instruments whether or not recognized in the balance sheet, for which it is
practicable to estimate fair value. Fair value estimates are made as of a
specific point in time based on the characteristics of the financial
instruments and the relevant market information. Where available, quoted
market prices are used. In other cases, fair values are based on estimates
using present value or other valuation techniques. These techniques involve
uncertainties and are significantly affected by the assumptions used and the
judgments made regarding risk characteristics of various financial
instruments, discount rates, prepayments, estimates of future cash flows,
future expected loss experience and other factors. Changes in assumptions
could significantly affect these estimates. Derived fair value estimates
cannot be substantiated by comparison to independent markets and, in many
cases, may or may not be realized in an immediate sale of the instrument.

   Under Statement 107, fair value estimates are based on existing financial
instruments without attempting to estimate the value of anticipated future
business and the value of the assets and liabilities that are not financial
instruments. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.

   The following describes the methods and assumptions used by the Company in
estimating the fair values of financial instruments:

 (a)Cash and Due From Banks

   The carrying value approximates fair value.

 (b) Investment Securities Held to Maturity and Available For Sale

   The fair values of investment securities are derived from quoted market
prices.


                                      46
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(15) Disclosures Regarding Fair Value of Financial Instruments, Continued

 (c)Federal Home Loan Bank Stock

   No ready market exists for this stock and it has no quoted market value.
However, redemption of this stock has historically been at par value.

 (d) Loans Held for Sale

   The fair value of loans held for sale is based on prices for outstanding
commitments to sell these loans.

 (e) Loans

   The current value of variable-rate consumer and commercial loans or
consumer and commercial loans with remaining maturities of three months or
less approximates fair value. The fair value of fixed-rate consumer and
commercial loans with maturities greater than three months are valued using a
discounted cash flow analysis and assumes the rate being offered on these
types of loans by the Company at December 31, 1999 and 1998, approximates
market.

   For credit cards and lines of credit the carrying value approximates fair
value. No value has been placed on the underlying credit card relationship
rights.

   Unused loan commitments are at adjustable rates, which fluctuate with the
prime rate or are funded within ninety days. The current amounts of these
commitments approximate their fair value. Please see note 5 for these amounts.

 (f) Deposits

   Under Statement 107, the estimated fair value of deposits with no stated
maturity is equal to the carrying amount. The fair value of time deposits is
estimated by discounting contractual cash flows, by applying interest rates
currently being offered at the dates indicated on the deposit products. Under
Statement 107, the fair value estimates for deposits do not include the
benefit that results from the low-cost funding provided by the deposits
liabilities as compared to the cost of alternative forms of funding.

 (g) Securities Sold Under Agreements to Repurchase, Commercial Paper, Federal
    Funds Sold and Federal Funds Purchased

   The carrying amount approximates fair value due to the short-term nature of
these instruments.

                                      47
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(15) Disclosures Regarding Fair Value of Financial Instruments, Continued

   The estimated fair values of the Company's financial instruments at December
31 are as follows:

<TABLE>
<CAPTION>
                                                 1999               1998
                                          ------------------ ------------------
                                                   Estimated          Estimated
                                          Carrying   Fair    Carrying   Fair
                                           Amount    Value    Amount    Value
                                          -------- --------- -------- ---------
<S>                                       <C>      <C>       <C>      <C>
Cash and due from banks.................. $ 42,446   42,446   27,929    27,929
                                          ========  =======  =======   =======
Federal funds sold....................... $  1,371    1,371      110       110
                                          ========  =======  =======   =======
Federal Home Loan Bank stock............. $  1,733    1,733    1,541     1,541
                                          ========  =======  =======   =======
Investment securities held to maturity... $     --       --   66,455    68,737
                                          ========  =======  =======   =======
Investment securities available for
 sale.................................... $106,772  106,772   46,087    46,087
                                          ========  =======  =======   =======
Loans held for sale...................... $  1,169    1,169    2,122     2,122
                                          ========  =======  =======   =======
Loans:
  Commercial mortgage.................... $139,003  138,717  125,753   125,490
  Commercial other.......................  116,727  116,324  101,314   101,043
  Real estate--mortgage..................   32,756   32,725   24,877    24,885
  Installment mortgage...................   77,844   77,801   79,030    78,851
  Installment other......................   79,427   78,253   82,292    81,339
                                          --------  -------  -------   -------
    Total loans, gross................... $445,757  443,820  413,266   411,608
                                          ========  =======  =======   =======
Deposits................................. $537,687  537,750  499,673   501,848
                                          ========  =======  =======   =======
Borrowings:
  Securities sold under agreements to
   repurchase............................ $ 19,021   19,021   21,630    21,630
  Commercial paper.......................   12,573   12,573   10,859    10,859
  Federal funds purchased................    7,800    7,800       --        --
                                          --------  -------  -------   -------
                                          $ 39,394   39,394   32,489    32,489
                                          ========  =======  =======   =======
</TABLE>

                                       48
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(16) Palmetto Bancshares, Inc. (Parent Company)

   The Parent Company's principal source of income is dividends from the Bank.
Certain regulatory requirements restrict the amount of dividends that the Bank
can pay to the Parent Company. At December 31, 1999, the Bank had available
retained earnings of approximately $6,814 for payment of dividends.

   The Parent Company's principal asset is its investment in its bank
subsidiary. The Parent Company's condensed statements of financial condition
data as of December 31, 1999 and 1998, and the related condensed statements of
operations data and cash flow data for the three-year period ended December 31,
1999 are as follows:

                            Financial Condition Data

<TABLE>
<CAPTION>
                                                                   1999    1998
                                                                  ------- ------
<S>                                                               <C>     <C>
Assets
Cash............................................................. $   197     40
Due from subsidiary..............................................  12,573 10,859
Investment in wholly-owned bank subsidiary.......................  44,604 41,157
Goodwill.........................................................     826    888
                                                                  ------- ------
    Total assets................................................. $58,200 52,944
                                                                  ======= ======
Liabilities and Shareholders' Equity
Commercial paper (Master notes).................................. $12,573 10,859
                                                                  ------- ------
    Total liabilities............................................  12,573 10,859
                                                                  ------- ------
Common stock subject to put/call.................................     --   4,732
Shareholders' equity.............................................  45,627 37,353
                                                                  ------- ------
    Total liabilities and shareholders' equity................... $58,200 52,944
                                                                  ======= ======
</TABLE>

                                Operations Data

<TABLE>
<CAPTION>
                                                           1999   1998   1997
                                                          ------  -----  -----
<S>                                                       <C>     <C>    <C>
Interest income from commercial paper (Master notes)..... $  526    521    381
Other interest income....................................    --     --       5
Dividends received from Bank.............................  1,956  1,544  1,165
Equity in undistributed earnings of subsidiary...........  6,174  5,376  4,840
Interest expense on commercial paper (Master notes)......   (526)  (521)  (381)
Other operating expenses.................................    (61)   (70)   (85)
                                                          ------  -----  -----
Net income............................................... $8,069  6,850  5,925
                                                          ======  =====  =====
</TABLE>

                                       49
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(16) Palmetto Bancshares, Inc. (Parent Company), Continued

                                 Cash Flow Data

<TABLE>
<CAPTION>
                                                        1999     1998    1997
                                                       -------  ------  ------
   <S>                                                 <C>      <C>     <C>
   Cash flows from operating activities:
    Net income.......................................  $ 8,069   6,850   5,925
    Decrease (increase) in due from subsidiary.......   (1,714)    430  (3,557)
    Earnings retained by wholly owned subsidiary.....   (6,174) (5,376) (4,840)
    Amortization of goodwill.........................       62      61      61
                                                       -------  ------  ------
      Net cash provided (used) by operating
       activities....................................      243   1,965  (2,411)
                                                       -------  ------  ------
   Cash flows from financing activities:
    Net change in commercial paper...................    1,714    (430)  3,854
    Proceeds from issuance of common stock...........      156     104     266
    Retirement of common stock.......................      --      (78)    --
    Sale of treasury stock...........................      --      --      125
    Cash transfer to Bank capital....................      --      --     (885)
    Dividends paid...................................   (1,956) (1,544) (1,165)
                                                       -------  ------  ------
      Net cash (used) provided by financing
       activities....................................      (86) (1,948)  2,195
                                                       -------  ------  ------
   Net increase (decrease) in cash...................      157      17    (216)
   Cash at beginning of year.........................       40      23     239
                                                       -------  ------  ------
   Cash at end of year...............................  $   197      40      23
                                                       =======  ======  ======
</TABLE>

                                       50
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


(17) Regulatory Capital Requirements

   The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory--and possibly
additional discretionary--actions by regulators that, if undertaken, could
have a material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company's and the Bank's assets, liabilities and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company's and the Bank'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 Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulation) to risk-weighted assets (as defined) and to average assets.
Management believes, as of December 31, 1999, that the Company and the Bank
meet all capital adequacy requirements to which they are subject.

   At December 31, 1999 and 1998 the Company and the Bank were each
categorized as "well capitalized," under the regulatory framework for prompt
corrective action. To be categorized as "adequately capitalized," the Company
and the Bank must maintain minimum total risk-based, Tier 1 risk-based and
Tier 1 leverage ratios as set forth in the table below. There are no current
conditions or events that management believes would change the Company's or
the Bank's category.

<TABLE>
<CAPTION>
                                                                   To Be Well
                                                                   Capitalized
                                                                  Under Prompt
                                                    For Capital    Corrective
                                                     Adequacy        Action
                                       Actual        Purposes      Provisions
                                    -------------  -------------  -------------
                                    Amount  Ratio  Amount  Ratio  Amount  Ratio
                                    ------- -----  ------- -----  ------- -----
<S>                                 <C>     <C>    <C>     <C>    <C>     <C>
As of December 31, 1999:
 Total capital to risk-weighted
  assets:
  Company.......................... $48,376 10.68% $36,241 8.00%  $45,301   N/A
  Bank............................. $48,178 10.64% $36,241 8.00%  $45,301 10.00%
 Tier 1 capital to risk-weighted
  assets:
  Company.......................... $42,705  9.43% $18,120 4.00%  $27,181   N/A
  Bank............................. $42,507  9.38% $18,120 4.00%  $27,181  6.00%
 Tier 1 capital to average assets:
  Company.......................... $42,705  6.96% $24,530 4.00%  $30,663   N/A
  Bank............................. $42,507  6.93% $24,532 4.00%  $30,665  5.00%

As of December 31, 1998:
 Total capital to risk-weighted
  assets:
  Company.......................... $43,065 10.16% $33,908 8.00%  $42,385   N/A
  Bank............................. $43,025 10.15% $33,908 8.00%  $42,385 10.00%
 Tier 1 capital to risk-weighted
  assets:
  Company.......................... $37,761  8.91% $16,954 4.00%  $25,431   N/A
  Bank............................. $37,721  8.90% $16,954 4.00%  $25,431  6.00%
 Tier 1 capital to average assets:
  Company.......................... $37,761  6.79% $22,232 4.00%  $27,790   N/A
  Bank............................. $37,721  6.78% $22,270 4.00%  $27,838  5.00%
</TABLE>

                                      51
<PAGE>

                                   Part III

Item 10. Directors and Executive Officers of the Registrant

   The information required by this item is set forth under the headings
"Election of Directors" and "Executive Officers" on pages 2 through 4 in the
definitive Proxy Statement of the Company filed in connection with its 2000
Annual Meeting of the Shareholders, which is incorporated herein by reference.

Item 11. Executive Compensation

   The information required by this item is set forth under the headings
"Compensation of Directors and Executive Officers," "Aggregated Option
Exercises in Last Fiscal Year and Year-end Option Values" and "Security
Ownership of Certain Beneficial Owners and Management" on pages 5 through 8
and pages 11 through 12 in the definitive Proxy Statement of the Company filed
in connection with its 2000 Annual Meeting of Shareholders, which is
incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

   The information required by this item is set forth under the heading
"Security Ownership of Certain Beneficial Owners and Management" on pages 11
through 12 in the definitive Proxy Statement of the Company filed in
connection with its 2000 Annual Meeting of Shareholders, which is incorporated
herein by reference.

Item 13. Certain Relationships and Related Transactions

   The information required by this item is set forth under the heading
"Certain Relationships and Related Transactions" on page 12 in the definitive
Proxy Statement of the Company filed in connection with its 2000 Annual
Meeting of Shareholders, which is incorporated herein by reference.

                                    Part IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

  (a) (2) Additional financial statement schedules furnished pursuant to the
      requirements of Form 10-K

     All other schedules have been omitted as the required information is
     either inapplicable or included in the Notes to the Consolidated
     Financial Statements.

                                      52
<PAGE>

  (3) Exhibits:

<TABLE>
<CAPTION>
     Exhibit
       No.                               Description
     -------                             -----------
     <C>     <S>
     3.1.1   Articles of Incorporation filed on May 13, 1982 in the office of
             the Secretary of State of South Carolina: Incorporated by
             reference to Exhibit 3 to the Company's Registration Statement on
             Form S-4, Commission File No. 33-19367, filed with the Securities
             and Exchange Commission on December 30, 1987
     3.1.2   Articles of Amendment filed on May 5, 1988 in the office of the
             Secretary of State of South Carolina: Incorporated by reference to
             Exhibit 4.1.2 to the Company's Registration Statement on Form S-8,
             Commission File No. 33-51212 filed with the Securities and
             Exchange Commission on August 20, 1992
     3.1.3   Articles of Amendment filed on January 26, 1989 in the office of
             the Secretary of State of South Carolina: Incorporated by
             reference to Exhibit 4.1.3 to the Company's Registration Statement
             on Form S-8, Commission File No. 33-51212 filed with the
             Securities and Exchange Commission on August 20, 1992
     3.1.4   Articles of Amendment filed on April 23, 1990 in the office of the
             Secretary of State of South Carolina: Incorporated by reference to
             Exhibit 4.1.4 to the Company's Registration Statement on Form S-8,
             Commission File No. 33-51212 filed with the Securities and
             Exchange Commission on August 20, 1992
     3.1.5   Articles of Amendment filed on October 16, 1996 in the office of
             the Secretary of State of South Carolina: Incorporated by
             reference to Exhibit 3.1.5 to the Company's Quarterly Report on
             Form 10-Q for the fiscal quarter ended September 30, 1996.
     3.1.6   Articles of Amendment filed on May 17, 1999 in the office of the
             Secretary of State of South Carolina: incorporated by reference to
             Exhibit 3.1.6 of the Company's quarterly report on Form 10-Q for
             the fiscal quarter ended June 30, 1999.
     3.2.1   By-Laws adopted April 10, 1990. Incorporated by reference to
             Exhibit 3.2.1 to the Company's 1996 Annual Report on Form 10-K,
             filed with the Securities and Exchange Commission on March 30,
             1997.
     3.2.2   Amendment to By-Laws dated April 12, 1994. Incorporated by
             reference to Exhibit 3.2.2 to the Company's 1996 Annual Report on
             Form 10-K, filed with the Securities and Exchange Commission on
             March 30, 1997.
     3.2.3   Amendment to By-Laws dated January 19, 1999. Incorporated by
             reference to Exhibit 3.2.3 to the Company's 1998 Annual Report on
             Form 10-K, filed with the Securities and Exchange Commission on
             March 19, 1999.
     4.1.1   Articles of Incorporation of the Registrant: Included in Exhibits
             3.1.1-.5
     4.2     Bylaws of the Registrant: Included in Exhibit 3.2.1-.3
     4.3     Specimen Certificate for Common Stock: Incorporated by reference
             to Exhibit 4.3 to the Company's Registration Statement on Form S-
             8, Commission File No. 33-51212, filed with the Securities and
             Exchange Commission on August 20, 1992
     4.4     Palmetto Bancshares, Inc. 1997 Stock Compensation Plan, as amended
             to date. Incorporated by reference to the Company's 1997 Annual
             Report on Form 10-K, filed with the Securities and Exchange
             Commission on March 23, 1998.
     21.1+   List of Subsidiaries of the Registrant
     27.1+   Financial Data Schedule
</TABLE>
--------
* Management contract or compensatory plan or arrangement.
+ Filed herewith.

                                       53
<PAGE>

  (b) Reports on Form 8-K

     The Registrant did not file any reports on Form 8-K during the three
     months ended December 31, 1999.

  (c) Exhibits required to be filed with this Form 10-K by Item 601 of
      Regulation S-K are filed herewith or incorporated by reference herein.

  (d) Certain additional financial statements.
      Not Applicable.


                                       54
<PAGE>

                                  SIGNATURES

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

                                          PALMETTO BANCSHARES, INC.

                                          By: _________________________________
                                                 /s/ L. Leon Patterson
                                                    L. Leon Patterson
                                                   Chairman and Chief
                                                    Executive Officer

                                          By: _________________________________
                                                 /s/ Paul W. Stringer
                                                    Paul W. Stringer
                                              President and Chief Operating
                                                         Officer
                                               (Chief Accounting Officer)

Date: February 15, 2000

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below and on the dates by the following persons on
behalf of the registrant and in the capacities indicated:

<TABLE>
<CAPTION>
             Signature                        Title                     Date
             ---------                        -----                     ----

<S>                                  <C>                      <C>
      /s/ L. Leon Patterson                  Director            February 15, 2000
____________________________________
         L. Leon Patterson

       /s/ Paul W. Stringer                  Director            February 15, 2000
____________________________________
          Paul W. Stringer

       /s/ James A. Cannon                   Director            February 15, 2000
____________________________________
          James A. Cannon

      /s/ W. Fred Davis, Jr.                 Director            February 15, 2000
____________________________________
         W. Fred Davis, Jr.

       /s/ Michael D. Glenn                  Director            February 15, 2000
____________________________________
          Michael D. Glenn

                                             Director            February   , 2000
____________________________________
        David P. George, Jr.

     /s/ John T. Gramling, II                Director            February 15, 2000
____________________________________
        John T. Gramling, II

   /s/ James M. Shoemaker, Jr.               Director            February 15, 2000
____________________________________
      James M. Shoemaker, Jr.

    /s/ J. David Wasson, Jr.                 Director            February 15, 2000
____________________________________
        J. David Wasson, Jr.

         /s/ Ann B. Smith                    Director            February 15, 2000
____________________________________
            Ann B. Smith

    /s/ Edward Keith Snead III               Director            February 15, 2000
____________________________________
       Edward Keith Snead III

       /s/ William S. Moore                  Director            February 15, 2000
____________________________________
          William S. Moore
</TABLE>


                                      55
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
 Exhibit
   No.                              Description
 -------                            -----------
 <C>     <S>                                                                <C>
  3.1.1  Articles of Incorporation filed on May 13, 1982 in the office of
         the Secretary of State of South Carolina: Incorporated by
         reference to Exhibit 3 to the Company's Registration Statement
         on Form S-4, Commission File No. 33-19367, filed with the
         Securities and Exchange Commission on December 30, 1987
  3.1.2  Articles of Amendment filed on May 5, 1988 in the office of the
         Secretary of State of South Carolina: Incorporated by reference
         to Exhibit 4.1.2 to the Company's Registration Statement on Form
         S-8, Commission File No. 33-51212 filed with the Securities and
         Exchange Commission on August 20, 1992
  3.1.3  Articles of Amendment filed on January 26, 1989 in the office of
         the Secretary of State of South Carolina: Incorporated by
         reference to Exhibit 4.1.3 to the Company's Registration
         Statement on Form S-8, Commission File No. 33-51212 filed with
         the Securities and Exchange Commission on August 20, 1992
  3.1.4  Articles of Amendment filed on April 23, 1990 in the office of
         the Secretary of State of South Carolina: Incorporated by
         reference to Exhibit 4.1.4 to the Company's Registration
         Statement on Form S-8, Commission File No. 33-51212 filed with
         the Securities and Exchange Commission on August 20, 1992
  3.1.5  Articles of Amendment filed on October 16, 1996 in the office of
         the Secretary of State of South Carolina: incorporated by
         reference to Exhibit 3.1.5 to the Company's quarterly report on
         Form 10-Q for the fiscal quarter ended September 30, 1996.
  3.1.6  Articles of Amendment filed on May 17, 1999 in the office of the
         Secretary of State of South Carolina: incorporated by reference
         to Exhibit 3.1.6 of the Company's quarterly report on Form 10-Q
         for the fiscal quarter ended June 30, 1999.
  3.2.1  By-Laws adopted April 10, 1990. Incorporated by reference to
         Exhibit 3.2.1 to the Company's 1996 Annual Report on Form 10-K,
         filed with the Securities and Exchange Commission on March 30,
         1997.
  3.2.2  Amendment to By-Laws dated April 12, 1994. Incorporated by
         reference to Exhibit 3.2.2 to the Company's 1996 Annual Report
         on Form 10-K, filed with the Securities and Exchange Commission
         on March 30, 1997.
  3.2.3  Amendment to By-Laws dated January 19, 1999. Incorporated by
         reference to Exhibit 3.2.3 to the Company's 1998 Annual Report
         on Form 10-K, filed with the Securities and Exchange Commission
         on March 19, 1999.
  4.1.1  Articles of Incorporation of the Registrant: Included in
         Exhibits 3.1.1-.5
  4.2    Bylaws of the Registrant: Included in Exhibit 3.2.1-.3
  4.3    Specimen Certificate for Common Stock: Incorporated by reference
         to Exhibit 4.3 to the Company's Registration Statement on Form
         S-8, Commission File No. 33-51212, filed with the Securities and
         Exchange Commission on August 20, 1992
  4.4    Palmetto Bancshares, Inc. 1997 Stock Compensation Plan, as
         amended to date. Incorporated by reference to the Company's 1997
         Annual Report on Form 10-K, filed with the Securities and
         Exchange Commission on March 23, 1998.
  21.1+  List of Subsidiaries of the Registrant
  27.1+  Financial Data Schedule
</TABLE>
--------
+ Filed herewith.