<PAGE>

================================================================================
                   U. S. SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
                               -----------------
                                   FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF
    1934

                  For the fiscal year ended December 31, 2001

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

                For the transition period from        to

                        Commission file number 0-26016
                               -----------------
                           PALMETTO BANCSHARES, INC.
            (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                                    <C>
                    South Carolina                            74-2235055
   (State or other jurisdiction of incorporation or          (IRS Employer
                    organization)                         Identification No.)
</TABLE>

301 Hillcrest Drive, Laurens, South Carolina               29360
 (Address of principal executive offices)               (Zip Code)

Registrant's telephone number--(864)                 palmettobank.com
            984-4551                        (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 19, 2002, $147,924,846--based on the most recent
sales price of $27.00 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.  6,284,623 -
February 19, 2002.

                      DOCUMENTS INCORPORATED BY REFERENCE

   The Company's Proxy Statement dated March 16, 2002 with respect to an Annual
Meeting of Shareholders to be held April 16, 2002: Incorporated by reference in
Part III of this Form 10-K.

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

<PAGE>

                           PALMETTO BANCSHARES, INC.
                               AND SUBSIDIARIES

             FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

                               TABLE OF CONTENTS

                                    PART I

<TABLE>
<CAPTION>
                                                                         Page No.
                                                                         --------
<C>      <S>                                                             <C>
Item 1.  Business.......................................................    3
Item 2.  Properties.....................................................    8
Item 3.  Legal Proceedings..............................................    9

                                    PART II

Item 5.  Market for the Registrant's Common Stock and Related
         Shareholder Matters............................................    10
Item 6.  Selected Financial Data........................................    11
Item 7.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations..........................................    12
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.....    30
Item 8.  Financial Statements and Supplementary Data....................    30
Item 9.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure...........................................    30

                                    PART III

Item 10. Directors and Executive Officers of the Registrant.............    59
Item 11. Executive Compensation.........................................    59
Item 12. Security Ownership of Certain Beneficial Owners and Management.    59
Item 13. Certain Relationships and Related Transactions.................    59

                                    PART IV

Item 14. Exhibits and Financial Statement Schedules and Reports on Form
         8-K............................................................    59
</TABLE>

                                      2

<PAGE>

                                    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 "Upstate"). The Bank was organized and
chartered under South Carolina law in 1906.

   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 sales finance department establishes relationships with
Upstate automobile dealers to provide customer financing of automobile
purchases. The Bank's mortgage banking operation continues to meet a broader
range of its customers' financial service needs by originating, selling, and
servicing mortgage loans.

  Financial Information

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

  Competition

   The Upstate 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 competes effectively in its market.

   South Carolina legislation 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. As a result, a number of the Bank's
competitor banks continue to be 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 competes
effectively in this market segment by offering quality, personalized service.
It is management's intention to remain a locally based, independent, South
Carolina Bank.

  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.

                                      3

<PAGE>

  Growth

   Late in 2000, the South Carolina State Board of Financial Institutions
approved the Bank's application to open a branch in Travelers Rest in
Greenville County, South Carolina. The Company opened its new Travelers Rest
office on January 14, 2002.

   During 2001, the Company began making plans to enter Oconee County, a new
market area. The Bank has purchased a building in Seneca in Oconee County,
South Carolina with plans to open a de novo branch in the Spring of 2002.

   Management continually reviews opportunities to expand in the Upstate that
it believes to be in the best interest of the Bank, its customers and its
shareholders.

  Employees

   At December 31, 2001, the Bank had 366 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.

   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

                                      4

<PAGE>

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 South Carolina
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, 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," 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. Please see page 10 for the amount currently available for the payment
of dividends.

  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,

                                      5

<PAGE>

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, 2001, 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, 2001, 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 16 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").

   The FDIC uses a risk-based assessment schedule, having assessments ranging
from 0.00% to 0.27% of an institution's average assessment base as of December
31, 2001. 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. For the years
ended December 31, 2001, 2000 and 1999, the Bank maintained a status of "well
capitalized". Premiums paid for FDIC insurance during each of those years
amounted to $110,000, $111,000 and $132,000, respectively. This further
decrease in the Bank's premium is due to the Bank's FICO assessment as
described below.

   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). The Bank's actual assessment for 2001 was 1.82 basis
points.

                                      6

<PAGE>

  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 score 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, 2001, 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 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 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.

                                      7

<PAGE>

  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 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.

   The Bank owns all of its facilities except the following leased facilities,
which have annual rental expenses from $1 dollar to $173 thousand:

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

      Spartan Centre, Blackstock Road, Hillcrest offices--Spartanburg

      Gaffney office--Gaffney

      South Main Street and Ninety-Six offices--Greenwood

      North Anderson office--Anderson

                                      8

<PAGE>

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. All facilities are protected by alarm and security systems that 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

   On January 19, 2001, M. Snyder's, Inc., an automobile dealership that has
sold and assigned sales finance contracts to the Bank, filed suit against the
Bank and Richard O. Lollis, a former employee of the Bank who was the manager
of the sales finance department. The suit was filed in the Court of Common
Pleas for Greenville County, South Carolina. M. Snyder's claims arise from the
sales finance contracts and its business relationship with the Bank, including
causes of action for alleged breach of contract, breach of fiduciary duty,
fraud, negligent representation, breach of contract accompanied by fraudulent
acts, unfair trade practices, negligence and negligent supervision; M. Snyder's
seeks actual and consequential damages. The Bank has filed counterclaims
against M. Snyder's based on, among other things, alleged breach of contract
with fraudulent intent, fraud, misrepresentations, unfair trade practices, bad
faith, procurement of breach of contracts by customers and conversion of assets
properly belonging to the Bank. The Bank does not believe that M. Snyder's
claims are well-founded and is vigorously pursuing its counterclaims and its
defenses against the claims. In connection with the above lawsuit, the Bank has
also filed a third party complaint against an employee of M. Snyder's, Inc.
arising from his actions in dealing with sales finance contracts, including
causes of action for fraud, misrepresentation and conversion. The case is still
in the discovery stage. While the Bank does not anticipate a negative result
from this lawsuit, based on the apparent claims being asserted by the
plaintiff, there can be no assurance that a negative result might not have a
material adverse effect on the Company's financial condition.

   Bancshares is not currently engaged in legal proceedings. In addition to the
matter described above, from time to time the Bank is involved in legal
proceedings incidental to its normal course of business as a bank. Management
believes that 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

   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 $27.00 per share on February 19, 2002.
As of February 19, 2002, the Company had 1,034 shareholders with 6,284,623
shares outstanding.

   Bancshares, or its predecessor, the Bank, has paid regular dividends on
common stock since 1909. For the years ended December 31, 2001, 2000 and 1999,
Bancshares paid cash dividends of $2.6 million or $0.41 per share, $2.3 million
or $0.37 per share, and $2.0 million or $0.32 per share, respectively. These
dollars equate to dividend payout ratios (dividends declared divided by net
income) of 30.58%, 32.96% and 24.24% in 2001, 2000 and 1999, 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, 2001, there were 1,030
shareholders of record.

                            Sales Prices by Quarter

<TABLE>
<CAPTION>
      Fiscal Year 2001                                       High   Low
      ----------------                                      ------ ------
      <S>                                                   <C>    <C>
      First Quarter........................................ $25.50 $25.00
      Second Quarter....................................... $26.00 $26.00
      Third Quarter........................................ $26.00 $26.00
      Fourth Quarter....................................... $27.00 $26.00

      Fiscal Year 2000
      ----------------
      First Quarter........................................ $24.50 $22.50
      Second Quarter....................................... $24.50 $23.50
      Third Quarter........................................ $25.00 $24.50
      Fourth Quarter....................................... $25.00 $25.00
</TABLE>

                           Dividends Paid Per Share

<TABLE>
<CAPTION>
Fiscal Year 2001                        Fiscal Year 2000
----------------                        ----------------
<S>                                <C>  <C>                                <C>
March 31.......................... $.10 March 31.......................... $.09
June 29........................... $.10 June 30........................... $.09
September 28...................... $.10 September 29...................... $.09
December 28....................... $.11 December 27....................... $.10
</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 10.72%.
At December 31, 2001, the Bank had $11.7 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
                                                       ------------------------------------------------------
                                                          2001       2000       1999       1998       1997
                                                       ----------  ---------  ---------  ---------  ---------
<S>                                                    <C>         <C>        <C>        <C>        <C>
For the Year
Total interest income................................. $   49,271     46,873     43,142     40,829     36,969
Total interest expense................................     19,549     20,383     16,399     16,440     15,841
Net interest income...................................     29,722     26,490     26,743     24,389     21,128
Provision for loan losses.............................      4,038      3,880      2,431      1,877      1,331
Total non-interest income.............................     12,869      9,551      8,069      6,468      5,628
Total non-interest expense............................     26,553     22,549     21,274     19,130     17,085
Income before income taxes............................     12,000      9,612     11,107      9,850      8,340
Income tax provision..................................      3,600      2,637      3,038      3,000      2,415
Net income............................................      8,400      6,975      8,069      6,850      5,925

Per Common Share
Net income per share-basic, not subject to put/call... $     1.34       1.12       1.30       1.05       0.98
Net income per share-dilutive, not subject to put/call       1.31       1.09       1.26       1.02       0.97
Cash dividends declared...............................       0.41       0.37       0.32       0.25       0.19
Book value at year end (1)............................       9.40       8.41       7.33       6.79       5.93

Average common shares outstanding--basic (1)..........  6,263,031  6,241,775  6,208,750  6,178,318  6,109,754

At Year End
Total assets.......................................... $  735,279    663,390    625,835    578,196    514,170
Investment securities.................................     95,095     98,601    106,772    112,542     97,731
Total Loans...........................................    553,821    498,242    445,757    413,266    367,585
Total deposits........................................    645,300    572,666    538,324    500,469    450,353
Total shareholders' equity (2)........................     59,068     52,593     45,627     42,085     36,616
Total shareholders' equity............................     59,068     52,593     45,627     37,353     32,832

Common shares outstanding.............................  6,283,623  6,255,734  6,226,834  6,199,390  6,179,104

Full-time equivalent employees........................        366        341        327        306        281

Average Balances
Assets................................................ $  698,600    636,289    595,678    541,799    493,737
Investment securities.................................     94,796    108,591    110,546    102,635     97,136
Loans.................................................    542,024    470,381    430,960    390,776    350,493
Deposits..............................................    603,187    542,259    512,405    467,749    432,031
Total shareholders' equity (2)........................     56,696     48,906     45,094     39,552     33,858

Key Ratios (1)
Return on average assets..............................       1.20%      1.10%      1.35%      1.26%      1.20%
Return on average equity..............................      14.82%     14.26%     17.89%     17.32%     17.50%
Primary capital to assets at year end.................       8.74%      8.68%      8.22%      8.21%      8.06%
Net interest margin (fully tax-equivalent)............       4.75%      4.73%      5.09%      5.07%      4.80%
Allowance for loan losses to total loans..............       1.02%      1.09%      1.43%      1.40%      1.40%
Nonperforming assets to total assets..................       0.66%      0.64%      0.49%      0.33%      0.25%
Net charge-offs to average loans......................       0.71%      1.02%      0.43%      0.32%      0.26%
Average equity to average assets ratio................       8.12%      7.69%      7.57%      7.30%      6.86%
</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.

                                      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
Selected Consolidated Financial Data in Item 6 of this report and the
Consolidated Financial Statements and accompanying notes in Item 8 of this
report. 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. Significant accounting policies are disclosed throughout
management's discussion and analysis and may involve uncertainties.

  Forward-Looking Statements

   This document may contain certain "forward-looking statements," within the
meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. Such
forward-looking statements are about matters that are inherently subject to
certain risks, uncertainties, and assumptions. Factors that could influence the
matters discussed in certain forward-looking statements include the relative
levels of market interest rates, loan prepayments and deposit decline rates,
the timing and amount of revenues that may be recognized by the Company,
continuation of current revenue, expense and charge-off trends, legal and
regulatory changes, and general changes in the economy. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those expected or
projected. These forward-looking statements speak only as of the date of the
document. The Company assumes no obligation to update any forward-looking
statements. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them.

  Off-Balance Sheet Risk and Contractual Obligations

   The Company, through the operations of the Bank, makes contractual
commitments to extend credit in the ordinary course of its business activities.
These commitments are legally binding agreements to lend money to customers of
the Bank at predetermined interest rates for a specified period of time. At
December 31, 2001, the Bank had issued commitments to extend credit of $92.3
million through various types of lending arrangements, described further in the
table below.

<TABLE>
    <S>                                                             <C>
    Home equity loans.............................................. $12,162
    Credit cards...................................................  32,471
    Commercial real estate development.............................  19,086
    Other unused lines of credit...................................  28,601
                                                                    -------
                                                                    $92,320
                                                                    =======
</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.

   Most of the commercial loan commitments expire in one year or less. Other
commitments, including consumer loans and credit cards, typically have a
maturity of more than one year. Past experience indicates that many of these
commitments to extend credit will expire unused. However, as described in
"Liquidity and Asset and Liability Management", the Company believes that is
has adequate sources of liquidity to fund commitments that are drawn upon by
the borrower.

   In addition to commitments to extend credit, the Bank also issues standby
letters of credit which are assurances to a third party that they will not
suffer a loss if the Bank's customer fails to meet its contractual obligation
to the third party. Standby letters of credit totaled $2.1 million at December
31, 2001. Past experience

                                      12

<PAGE>

indicates that many of these standby letters of credit will expire unused.
However, through its various sources of liquidity, the Bank believes that it
will have the necessary resources to meet these obligations should the need
arise.

   Neither the Company nor its subsidiaries is involved in other off-balance
sheet contractual relationships, unconsolidated related entities that have
off-balance sheet arrangements, or transactions that could result in liquidity
needs or other commitments or significantly impact earnings. Obligations under
noncancelable operating lease agreements totaled $3.5 million at December 31,
2001. These obligations are payable over several years as shown in Note 13 to
the Company's consolidated financial statements.

  General

   Palmetto Bancshares achieved record earnings in 2001 of $8.4 million,
increasing 20% from $7.0 million in 2000. Basic and dilutive earnings per share
in 2001 improved to $1.34 and $1.31, respectively, compared with $1.12 and
$1.09, respectively in 2000. Net income was $8.1 million in 1999. Basic and
dilutive earnings per share totaled $1.30 and $1.26 in 1999, respectively. Net
earnings resulted in a return on average assets of 1.20% in 2001, 1.10% in
2000, and 1.35% in 1999. The return on average equity for the three years ended
December 31, 2001 was 14.82%, 14.26%, and 17.89%, respectively.

   The Company's earnings accelerated during 2001 principally as a result of
growth in net interest income. The Company's net interest margin improved from
4.53% in 2000 to 4.60% in 2001. Another important highlight in 2001 was the 35%
increase in non-interest income over 2000 principally due to the increase in
service charges on deposit accounts. During 2001, non-interest expense
increased by 18% due principally to the increase in salaries and other
personnel expenses. Provision for loan losses increased slightly from 2000 to
2001, as expected. There were significant charge-offs during 2001 that related
to the sales finance portfolio, as was also the case in 2000. (see further
discussion below) In 2001, a total of $4.0 million of loans was charged off,
56% of which were sales finance loans. Management has continued to reduce the
sales finance portfolio, which decreased 31% from $23.1 million in 2000 to
$15.9 million in 2001.

   During 2000, net income decreased to $7.0 million from $8.1 in 1999. The
decrease was principally due to the decrease in the net interest margin and the
increase in the provision for loan losses. The net interest margin decreased 34
basis points, from 4.87% in 1999 to 4.53% in 2000. The Bank recorded
charge-offs of $5.0 million during 2000, 21/2 times that of the previous year.
Approximately 76% of those charge-offs related to sales finance loans. The
sales finance portfolio naturally includes loans with more inherent risk than
the loans in the Bank's direct lending portfolio. During mid 1999, management
noted deterioration in the performance of the portfolio which resulted in the
Bank redirecting 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. Management reduced the sales finance
portfolio from $36.8 million to $23.1 million at December 31, 1999 and 2000,
respectively. Management also made certain organizational changes in the sales
finance department to improve the asset quality. As the lower quality loans
seasoned, the level of charge-offs arising from these loans increased in 2000,
as expected. In addition to the increased charge-offs on the sales finance
loans, the Bank also experienced increased losses on the sale of the
automobiles repossessed in conjunction with the defaulted loans due to the high
volume of cars to be sold at auction.

                                      13

<PAGE>

                              Financial Condition
                    As of December 31, 2001, 2000 and 1999

   At December 31, 2001, Bancshares had total assets of $735.3 million,
increasing by $71.9 million or 11% from December 31, 2000. Asset growth was
principally attributable to a $16.1 million increase in federal funds sold, a
$55.4 million increase in net loans and a $9.4 million increase in loans held
for sale. An $8.6 million decrease in cash and due from banks and a $3.5
million decrease in investment securities available for sale offset these
increases. Average assets increased by approximately 10% during the year while
average interest earning assets increased by almost 11%. During 2001, total
deposits increased $72.6 million principally in the transaction deposit
accounts and other time deposit accounts. Securities sold under repurchase
agreements and commercial paper decreased by $8.9 million as a result of lower
rates paid on these instruments.

   At December 31, 2000, Bancshares had assets that totaled $663.4 million,
increasing by $37.6 million or 6% from December 31, 1999. Asset growth was
principally attributed to growth in net loans, which increased by $53.4 million
during 2000, offset by a decrease in cash and due from banks of $6.1 million
and a decrease in investment securities available for sale of $8.2 million.

   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.

                                      14

<PAGE>

                                    TABLE 1
                    Distribution of Assets and Liabilities
                            (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                              Years Ended December 31,
                                       ----------------------------------------------------------------------
                                        2001     2001     2000     2000     1999     1999     1998     1998
                                       --------  ------  --------  ------  --------  ------  --------  ------
                                       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............... $ 24,974    3.57% $ 24,688    3.88% $ 25,416    4.27% $ 22,244    4.11%
Federal funds sold....................    7,192    1.03%    3,340    0.52%    5,287    0.89%    3,876    0.72%
Federal Home Loan Bank stock..........    1,733    0.25%    1,733    0.27%    1,691    0.28%    1,520    0.28%
Taxable investment securities.........   57,786    8.27%   44,770    7.04%   40,596    6.82%   53,756    9.92%
Non-taxable investment securities.....   37,010    5.30%   63,821   10.03%   69,950   11.74%   48,879    9.02%
Loans, net of unearned discount.......  542,024   77.59%  470,381   73.93%  430,960   72.35%  390,776   72.13%
   Less: allowance for loan losses....   (5,527)  -0.79%   (5,921)  -0.93%   (6,085)  -1.02%   (5,393)  -1.00%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Net loans......................  536,497   76.80%  464,460   73.00%  424,875   71.33%  385,383   71.13%
Premises and equipment, net...........   17,791    2.55%   16,641    2.62%   15,230    2.56%   14,255    2.63%
Accrued Interest......................    4,846    0.69%    4,657    0.73%    4,344    0.73%    4,065    0.75%
Other assets..........................   10,771    1.54%   12,179    1.91%    8,289    1.39%    7,821    1.44%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Total assets................... $698,600  100.00% $636,289  100.00% $595,678  100.00% $541,799  100.00%
                                       ========  ======  ========  ======  ========  ======  ========  ======
LIABILITIES AND
  SHAREHOLDERS' EQUITY
Liabilities
Deposits:
   Non-interest-bearing deposits......   92,792   13.28%   89,107   14.00%   82,921   13.92%   73,266   13.52%
   Interest-bearing demand............  204,983   29.34%  183,194   28.79%  165,370   27.76%  147,580   27.24%
   Savings............................   32,593    4.67%   32,578    5.12%   31,308    5.26%   28,718    5.30%
   Time...............................  272,818   39.05%  237,380   37.31%  232,806   39.08%  218,185   40.27%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Total deposits.................  603,186   86.34%  542,259   85.22%  512,405   86.02%  467,749   86.33%
Federal funds purchased and
  securities sold under agreements
  to repurchase.......................   18,520    2.65%   26,396    4.15%   19,295    3.24%   18,747    3.46%
Commercial paper......................   13,310    1.91%   15,945    2.51%   15,273    2.56%   12,668    2.34%
Other liabilities.....................    6,888    0.99%    2,783    0.44%    3,611    0.61%    3,083    0.57%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Total liabilities..............  641,904   91.88%  587,383   92.31%  550,584   92.43%  502,247   92.70%
Shareholders equity:
   Common stock--$5.00 par
     value............................   31,315    4.48%   31,123    4.89%   31,042    5.21%   30,890    5.70%
   Capital surplus....................       40      --        19      --        --      --        19      --
   Retained earnings..................   24,705    3.54%   19,898    3.13%   14,277    2.40%    8,385    1.55%
   Less: Treasury stock...............       --      --        --      --        --      --        --      --
   Accumulated other
     comprehensive income (loss)......      636    0.09%   (2,134)  -0.34%     (225)  -0.04%      258    0.05%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Total shareholders' equity.....   56,696    8.12%   48,906    7.69%   45,094    7.57%   39,552    7.30%
                                       --------  ------  --------  ------  --------  ------  --------  ------
       Total liabilities and
         shareholders' equity......... $698,600  100.00% $636,289  100.00% $595,678  100.00% $541,799  100.00%
                                       ========  ======  ========  ======  ========  ======  ========  ======
</TABLE>

                                      15

<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, 2001, total
loans, net of unearned discounts, were 82% of total earning assets. Loans
secured by real estate accounted for 60% of total loans as of December 31,
2001. Most of the loans classified as real estate-mortgage are commercial loans
where real estate provides additional collateral.

   At December 31, 2001, the sales finance portfolio was $15.9 million compared
to $23.1 million at December 31, 2000. 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 deterioration in the performance
of the portfolio that resulted in increased charge-offs during 2000 and 2001.
In estimating the allowance for loan losses at December 31, 2001 and in
allocating portions of the allowance to specific portions of the loan
portfolio, management has taken these factors into consideration and has
allocated what it believes to be an adequate portion of the allowance to the
sales finance portfolio.

   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 on 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 2001, 2000 and 1999 were
approximately $4.0 million or 0.73% (of total loans), $3.2 million or 0.65% and
$1.6 million or 0.37%, respectively. For information on impaired loans, please
see footnote number 4.

   Table 2 on page 17 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, 1997 through
December 31, 2001.

                                      16

<PAGE>

                                    TABLE 2
                              Nonperforming Loans
                            (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                   90 Days or                          Foregone
                                                    More Past              Percentage  Interest
                                                   Due and not             90 Days or   Income
                                            Non-       on      Total Loans More Past     From
                                           Accrual Non-Accrual Outstanding    Due     Non-Accrual
                                           ------- ----------- ----------- ---------- -----------
<S>                                        <C>     <C>         <C>         <C>        <C>
December 31, 2001:
   Commercial, financial and agricultural. $  811      139       154,069      0.62%      $ 48
   Real estate - construction.............     --       --        22,836      0.00         --
   Real estate - mortgage.................  2,074       --       310,981      0.67        171
   Installment loans to individuals.......    514      491        65,935      1.52        106
                                           ------      ---       -------      ----       ----
       Total.............................. $3,399      630       553,821      0.73%      $325
                                           ======      ===       =======      ====       ====
December 31, 2000:
   Commercial, financial and agricultural. $  873       --       123,727      0.71%      $ 68
   Real estate - construction.............     --       --        14,321      0.00         --
   Real estate - mortgage.................  1,103       --       283,541      0.39        140
   Installment loans to individuals.......  1,055      193        76,653      1.63        176
                                           ------      ---       -------      ----       ----
       Total.............................. $3,031      193       498,242      0.65%      $384
                                           ======      ===       =======      ====       ====
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
                                           ======      ===       =======      ====       ====
</TABLE>

                                      17

<PAGE>

  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 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. The allowance for loan losses is all allocated.

   The following table sets forth the breakdown of the Company's allowance for
loan losses by loan category at the dates indicated. Management believes that
the allowance for loan losses can be allocated by category only on an
approximate basis. The allocation of the allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.

<TABLE>
<CAPTION>
                              2001          2000          1999          1998          1997
                         -------------  ------------  ------------  ------------  ------------
                                % 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... $1,266  22.38% 1,741  31.97% 2,022  31.78% 1,309  22.59% 1,145  22.22%
   Real estate-
     construction.......    130   2.30     32   0.59     31    .49    145   2.50    123   2.39
   Real estate-
     mortgage...........  2,507  44.30  1,123  20.62    778  12.23  3,025  52.20  2,739  53.17
   Installment loans to
     individuals........  1,755  31.02  2,550  46.82  3,531  55.50  1,316  22.71  1,145  22.22
                         ------ ------  ----- ------  ----- ------  ----- ------  ----- ------
       Total............ $5,658 100.00% 5,446 100.00% 6,362 100.00% 5,795 100.00% 5,152 100.00%
                         ====== ======  ===== ======  ===== ======  ===== ======  ===== ======
</TABLE>

   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.


                                      18

<PAGE>

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

                                    TABLE 3
                 Summary of Loan Loss and Recovery Experience
                            (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                         2001     2000     1999     1998     1997
                                                       --------  -------  -------  -------  -------
<S>                                                    <C>       <C>      <C>      <C>      <C>
Average loans, net of unearned discount............... $542,024  470,381  430,960  390,776  350,493
                                                       ========  =======  =======  =======  =======
Allowance for loan losses:
   Beginning balance.................................. $  5,446    6,362    5,795    5,152    4,729
   Add provision for loan losses......................    4,038    3,880    2,431    1,877    1,331
Loan charge-offs:
   Commercial, financial and agricultural.............      809      390      532      344      158
   Real estate-construction...........................       50       --       --       --       --
   Real estate-mortgage...............................       28       --       --       --       --
   Installment loans to individuals...................    3,146    4,597    1,441    1,018      891
                                                       --------  -------  -------  -------  -------
Total loan charge-offs................................    4,033    4,987    1,973    1,362    1,049
Recoveries of loans previously charged-off:
   Commercial, financial and agricultural.............        8       15       22        5       56
   Real estate-construction...........................        9       --       --       --       --
   Real estate-mortgage...............................       --       --       --       --       --
   Installment loans to individuals...................      190      176       87      123       85
                                                       --------  -------  -------  -------  -------
Total recoveries of loans previously charged-off......      207      191      109      128      141
                                                       --------  -------  -------  -------  -------
       Net charge-offs................................    3,826    4,796    1,864    1,234      908
                                                       --------  -------  -------  -------  -------
Ending balance........................................ $  5,658    5,446    6,362    5,795    5,152
                                                       ========  =======  =======  =======  =======
Net charge-offs to average loans, net.................      .71%    1.02%    0.43%    0.32%    0.26%
Allowance for loan losses to average loans, net.......     1.04     1.16     1.48     1.48     1.47
Allowance for loan losses to total loans at period-end     1.02     1.09     1.43     1.40     1.40
</TABLE>

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

  Deposits

   At December 31, 2001, the Company's total deposits increased $72.6 million
or 13% from $572.7 million to $645.3 million. Management believes that market
conditions in 2001 were more favorable for deposit growth. Factors such as the
lower returns on investments and mutual funds and the fluctuations in the stock
market may have contributed to the increase in deposits during 2001.

   Retail deposits have traditionally been the primary source of funds for the
Company and also provide a customer base for the sale of additional financial
products and services. At December 31, 2001, transaction accounts made up 39%
of total deposits, while time deposits made up 45% of total deposits. Savings
and other money market accounts made up the remainder of total deposits. The
following table sets forth, by time remaining to maturity, domestic
certificates of deposit over $100, as of December 31, 2001, 2000 and 1999.

                                      19

<PAGE>

                                    TABLE 4
                     Maturities of Time Deposits Over $100

<TABLE>
<CAPTION>
                                                        2001    2000    1999
                                                       ------- ------- -------
 <S>                                                   <C>     <C>     <C>
 Maturities:
    3 months or less.................................. $32,006 $26,187 $21,451
    3 through 6 months................................  16,755   8,553  17,901
    6 through 12 months...............................  20,375  17,859  10,717
    Over 12 months....................................   7,900  11,245   3,768
                                                       ------- ------- -------
                                                       $77,036 $63,844 $53,837
                                                       ======= ======= =======
</TABLE>

  Capital Resources

   Average shareholder's equity was $56.7 million during 2001, or 8.12% of
average assets, increasing from 7.69% during 2000. The Consolidated Statements
of Shareholders' Equity and Comprehensive Income contained in Item 8 herein
provide details of the changes in stockholders' equity during the year. At
December 31, 2001 and 2000 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 16 for the Company's and the Bank's
various capital ratios at December 31, 2001.

Liquidity and Asset and Liability Management

  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 10%-25%. At December 31, 2001 and 2000, the Company's liquidity
ratio was 17% and 13%, respectively. The Company's liquidity position is
dependent upon its debt servicing needs and dividends declared. The Company had
no outstanding debt at December 31, 2001 and 2000, respectively.

   The Parent Company offers 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, 2001, the Company had $11.1
million in commercial paper with a weighted average rate paid during the year
of 2.70%, as compared to $15.4 million in 2000 with a weighted average paid
during the year of 4.95% and $12.6 million in 1999 with a weighted average rate
paid during the year of 3.44%.

   The Company's liquidity needs are met through the payment of dividends from
the Bank. At December 31, 2001, the Bank had available retained earnings of
$11.7 million 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,
alternative sources of funds, 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. Loan demand has been constant and loan

                                      20

<PAGE>

originations can be controlled through pricing decisions. 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 72% of the securities portfolio was pledged to secure liabilities
as of December 31, 2001, as compared to 84% at December 31, 2000. If needed,
alternative funding sources have been arranged through federal funds lines at
correspondent banks, the FHLB, and the Federal Reserve Discount Window. At
December 31, 2001, the Bank has unused short-term lines of credit totaling
approximately $42 million (which are withdrawable at the lender's option). At
December 31, 2001, unused borrowing capacity from the FHLB totaled $71 million.
Management believes that its sources of liquidity are adequate to meet
operational needs and to maintain the liquidity ratio within policy guidelines.

   The FHLB requires that securities, qualifying single family mortgage loans
and stock of the FHLB owned by the Bank be pledged to secure any advances from
the FHLB. The unused borrowing capacity currently available from the FHLB ($71
million as discussed above) assumes that the Bank's $1.7 million investment in
FHLB stock as well as certain securities and qualifying mortgages would be
pledged to secure any future borrowings. The Bank believes that it could obtain
additional borrowing capacity from the FHLB by identifying additional
qualifying collateral that could be pledged.

  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 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, 2001, approximately 28% of
the Company's earning assets could be repriced within one year compared to

                                      21

<PAGE>

approximately 96% of its interest-bearing liabilities. This compares to 24% and
92%, respectively, in 2000 and 25% and 95%, respectively, in 1999.

   The Company's current GAP analysis reflects that in periods of increasing
interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities and at the interest repricing of one year, the Company's net
interest margin would be adversely impacted. On the flip side, 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. 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 or
decreases by 100 basis points, all assets and liabilities that are due to
reprice will increase or decrease by 100 basis points at the next opportunity.
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 better manage the deposit side.

   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, 2001, 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 16%. 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 5% and 11%, respectively.
The model also shows that if interest rates dropped 300 basis points, the net
interest margin would benefit by approximately 2%. Similarly, if interest rates
dropped by only 100 or 200 basis points over the next twelve months, net
interest margin would benefit by approximately 4% under both scenarios. 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 losses in the investment securities portfolio
($823,000 at December 31, 2001). Unrealized losses exist because current market
rates are higher than the weighted average rate on particular investment
instruments within the investment portfolio. Management does not intend to
liquidate the entire investment security portfolio, and therefore the
unrealized losses are not expected be realized. The Company has sufficient
liquidity without selling the investment security portfolio. The Company sees
the investment security portfolio as mainly an income source, not a liquidity
source.

   On page 24, Table 5 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, 2001. Market risk sensitive
instruments are generally defined as on- and off-balance sheet derivatives and
other financial instruments.

  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.

                                      22

<PAGE>

  .  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 5
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 as of December 31, 2001 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.

                                      23

<PAGE>

                                    TABLE 5
                            Market Risk Sensitivity
     Expected Maturity/Repricing/Principal Repayments at December 31, 2001

<TABLE>
<CAPTION>
                                                       2002
                                 -----------------------------------------------
                                 Average            2 Days to  3 to 6   6 to 12
                                  Rate     1 Day    3 Months   Months   Months      2003      2004      2005      2006
                                 ------- ---------  --------- --------  --------  --------  --------  --------  --------
<S>                              <C>     <C>        <C>       <C>       <C>       <C>       <C>       <C>       <C>
Interest-sensitive assets:
  Federal funds sold............  4.48%  $  17,949        --        --        --        --        --        --        --
  Federal Home Loan Bank
   stock........................  6.87%         --        --        --        --     1,733        --                  --
  Mortgage-backed
   securities...................  6.27%         --       799     1,126               1,925     2,164        --     2,425
  Other investment securities...  5.73%         --       805     1,838    23,185     7,238     3,639     2,632     1,676
  Loans receivable..............  8.15%     98,265    10,038    25,169     6,811    51,668    44,239   126,126    27,179
                                  ----   ---------  --------  --------  --------  --------  --------  --------  --------
   Total interest-earning
    assets......................  7.63%  $ 116,214    11,642    28,133    29,996    62,564    50,042   128,758    31,280
                                  ====   =========  ========  ========  ========  ========  ========  ========  ========
Interest-sensitive liabilities:
  Interest-bearing demand.......  1.32%    151,211        --        --        --        --        --        --        --
  Insured money markets.........  2.69%     69,149        --        --        --        --        --        --        --
  Savings deposits..............  1.41%     33,294        --        --        --        --        --        --        --
  Time deposits over $100.......               437    31,419    16,755    20,524     4,803       838     1,841       419
  Other time deposits...........               306    85,469    53,115    55,661     9,938     2,850     3,519       974
                                  ----   ---------  --------  --------  --------  --------  --------  --------  --------
   Total time deposits..........  5.29%        743   116,888    69,870    76,185    14,741     3,688     5,360     1,393
                                  ====   =========  ========  ========  ========  ========  ========  ========  ========
  Short-term borrowings.........  3.44%     26,389        --        --        --        --        --        --        --
                                  ----   ---------  --------  --------  --------  --------  --------  --------  --------
   Total interest-bearing
    liabilities.................  3.61%  $ 280,786   116,888    69,870    76,185    14,741     3,688     5,360     1,393
                                  ====   =========  ========  ========  ========  ========  ========  ========  ========
  Interest rate sensitivity gap.         $(164,572) (105,246)  (41,737)  (46,189)   47,823    46,354   123,398    29,887
                                         =========  ========  ========  ========  ========  ========  ========  ========
  Cumulative interest rate
   sensitivity gap..............         $(164,572) (269,818) (311,555) (357,744) (309,921) (263,567) (140,169) (110,282)
                                         =========  ========  ========  ========  ========  ========  ========  ========
  Cumulative interest rate
   sensitive gap as a % of
   total interest-earning
   assets.......................            -24.61%   -40.36%   -46.60%   -53.51%   -46.35%   -39.42%   -20.96%   -16.49%
                                         =========  ========  ========  ========  ========  ========  ========  ========
Off-balance sheet items:
  Commitments to extend
   credit.......................     *          --        --        --        --        --        --        --        --
  Unused lines of credit........  5.07%         --        --        --        --        --        --        --        --
</TABLE>
<TABLE>
<CAPTION>


                                 There-   Carrying  Fair
                                 after     Value    Value
                                 -------  -------- -------
<S>                              <C>      <C>      <C>
Interest-sensitive assets:
  Federal funds sold............      --   17,949   17,949
  Federal Home Loan Bank
   stock........................      --    1,733    1,733
  Mortgage-backed
   securities...................   1,375    9,814    9,814
  Other investment securities...  44,268   85,281   85,281
  Loans receivable.............. 164,326  553,821  552,630
                                 -------  -------  -------
   Total interest-earning
    assets...................... 209,969  668,598  667,407
                                 =======  =======  =======
Interest-sensitive liabilities:
  Interest-bearing demand.......      --  151,211  151,211
  Insured money markets.........      --   69,149   69,149
  Savings deposits..............      --   33,294   33,294
  Time deposits over $100.......      --   77,036
  Other time deposits...........      99  211,931
                                 -------  -------  -------
   Total time deposits..........      99  288,967  295,986
                                 =======  =======  =======
  Short-term borrowings.........      --   26,389   26,389
                                 -------  -------  -------
   Total interest-bearing
    liabilities.................      99  569,010  576,029
                                 =======  =======  =======
  Interest rate sensitivity gap. 209,870   99,588
                                 =======  =======
  Cumulative interest rate
   sensitivity gap..............  99,588       --
                                 =======  =======
  Cumulative interest rate
   sensitive gap as a % of
   total interest-earning
   assets.......................   14.90%    0.00%
                                 =======  =======
Off-balance sheet items:
  Commitments to extend
   credit.......................  92,320   92,320   92,320
  Unused lines of credit........  18,449   18,449   18,449
</TABLE>
--------
*  These rates will vary according to prime.

Please see Notes to Market Risk Sensitivity table on page 23.

NOTE: For information regarding how fair values were determined, please see
notes to consolidated financial statements, number 14.

                                      24

<PAGE>

   The following table shows the amounts of loans included in Table 5,
excluding real estate-mortgage and installment loans to individuals, due to
mature and available for repricing within the time period stated.

                                    TABLE 6
   Maturities and Sensitivity of Selected Loans to Changes in Interest Rates

<TABLE>
<CAPTION>
                                                     After 1 Year
                                          ----------------------------------
                                          1 Year   Through   After 5
                                          or Less Five Years  Years   Total
                                          ------- ---------- ------- -------
   <S>                                    <C>     <C>        <C>     <C>
   Commercial, financial and agricultural $56,233   80,871   16,965  154,069
   Real estate-construction..............  15,667    5,640    1,529   22,836
                                          -------   ------   ------  -------
      Total.............................. $71,900   86,511   18,494  176,905
                                          =======   ======   ======  =======
</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, 2001
                                                          -----------------
    <S>                                                   <C>
    Predetermined interest rate..........................     $105,005
    Floating or adjustable interest rate.................           --
                                                              --------
       Total.............................................     $105,005
                                                              ========
</TABLE>

   Twenty-five percent of total loans are repricable within one year.

                             Results of Operations
              Three Years Ended December 31, 2001, 2000 and 1999

  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 totaled $29.7 million in 2001
compared with $26.5 million in 2000 and $26.7 million in 1999. Changes in
interest earned on assets and interest paid on liabilities, the rate of growth
of the asset and liability base, the ratio of interest-earning assets to
interest-bearing liabilities and management of the balance sheet's interest
rate sensitivity all factor in to changes in net interest income. The Company
manages its net interest margin through strategic asset-liability management as
discussed in "Asset-Liability Management and Market Risk Sensitivity" above.

   Net interest income increased by 12% to $29.7 million in 2001. During 2001,
the Company saw the yield on average interest earning assets decrease slower
than the cost of average interest-bearing liabilities. The net interest margin
was favorably impacted as a result of these market dynamics. At December 31,
2000, the tax equivalent yield on average earning assets was 8.21% and the cost
of average interest bearing liabilities was 4.11%. During 2001, the tax
equivalent yield on average earning assets decreased by 44 basis points to
7.77%, while the cost of average interest bearing liabilities decreased by 50
basis points to 3.61%.

   Net interest income was relatively flat during 2000, decreasing a slight 1%
from $26.7 in 1999 to $26.5 in 2000. The tax equivalent yield on interest
earning assets increased from 8.08% in 1999 to 8.21% in 2000, while the average
effective rate paid on all interest bearing liabilities increased from 3.53% in
1999 to 4.11% in 2000.

   As illustrated on Table 7 on page 26, for the year ended December 31, 2001,
the tax equivalent net interest margin was 4.75%, compared to 4.73% in 2000 and
5.09% in 1999.

   During 2001, interest and fees on loans increased 9% from $40.4 million in
2000 to $44.1 million in 2001 primarily as a result of volume changes. Interest
on investment securities decreased 23% from $6.1 million to $4.7 million in
2001 due to both a decrease in volume and a decrease in the tax equivalent
weighted average rate on the security portfolio from 6.86% in 2000 to 5.81% in
2001. Interest and fees on loans increased 10% or $3.6 million from 1999 to
2000 primarily because of volume changes. Interest on investment securities
increased 2%, or $111,000 from 1999 to 2000 due to an increase in the tax
equivalent weighted average rate on the securities portfolio from 6.49% to
6.86%.

                                      25

<PAGE>

  Rate/Volume Analysis

   Table 7 includes, for the years ended December 31, 2001, 2000 and 1999
interest income 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.

                                    TABLE 7
                             Rate Volume Analysis

<TABLE>
<CAPTION>
                                                            2001                                      2000
                                         ------------------------------------------  --------------------------------------
                                         Average            Yield/ Volume    Rate    Average   Income/       Volume   Rate
                                         Balances  Interest  Rate  Change   Change   Balances  Expense Yield Change  Change
                                         --------  -------- ------ -------  -------  --------  ------- ----- ------  ------
<S>                                      <C>       <C>      <C>    <C>      <C>      <C>       <C>     <C>   <C>     <C>
Assets:
Interest-earning deposits............... $    220  $     8   3.64% $     7  $    (4) $     82  $     5 6.10% $   (7) $    1
Federal funds sold......................    7,192      322   4.48%     225     (143)    3,340      240 7.19%   (119)     90
Federal Home Loan Bank stock............    1,733      120   6.92%      --      (15)    1,733      135 7.79%      3       4
Taxable investment securities...........   57,786    2,005   3.47%     650   (1,565)   44,770    2,920 6.52%    268      79
Non-taxable investment securities (1)...   37,010    3,615   9.77%  (2,201)   1,574    63,821    4,242 6.65%   (404)     87
Non-taxable loans (2)...................    1,734      133   7.65%     (17)       2     1,952      147 7.53%    (37)     (1)
Taxable Loans, net of unearned
  discount (3)..........................  540,290   44,019   8.15%   6,018   (2,296)  468,429   40,297 8.60%  3,422     254
                                         --------  -------   ----  -------  -------  --------  ------- ----  ------  ------
      Total earning assets..............  645,965   50,222   7.77%   4,683   (2,447)  584,127   47,986 8.21%  3,128     514
                                                                   -------  -------
Cash and due from banks.................   24,754                                      24,606
Allowance for loan losses...............   (5,527)                                     (5,921)
Premises and equipment, net.............   17,791                                      16,641
Accrued Interest........................    4,846                                       4,657
Other assets............................   10,771                                      12,179
                                         --------                                    --------
      Total assets...................... $698,600                                    $636,289
                                         ========                                    ========
Liabilities and Shareholders' Equity:
Interest-bearing demand deposits........  204,983    3,584   1.75%     434     (953)  183,194    4,103 2.24%    366     658
Savings deposits........................   32,593      458   1.41%       0     (180)   32,578      638 1.96%     25      (2)
Time deposits...........................  272,818   14,536   5.33%   1,936     (693)  237,380   13,293 5.60%    241   1,595
Federal funds purchased and securities
 sold under agreements to repurchase....   18,520      612   3.30%    (363)    (585)   26,396    1,560 5.91%    343     495
Commercial paper (Master notes).........   13,310      359   2.70%    (101)    (329)   15,945      789 4.95%     28     235
   Total interest-bearing liabilities...  542,224   19,549   3.61%   1,907   (2,741)  495,493   20,383 4.11%  1,003   2,981
Non-interest bearing demand deposits....   92,792                                      89,107
Other liabilities.......................    6,888                                       2,783
Shareholders' equity....................   56,696                                      48,906
                                         --------                                    --------
   Total liabilities and shareholders'
    equity.............................. $698,600                                    $636,289
                                         ========                                    ========
Net interest income on a fully taxable
 equivalent basis (1)/Net yield on
 interest-earning assets (FTE)..........            30,673   4.75%                              27,603 4.73%
</TABLE>
<TABLE>
<CAPTION>
                                                           1999
                                         ---------------------------------------
                                         Average   Income/       Volume   Rate
                                         Balances  Expense Yield Change  Change
                                         --------  ------- ----- ------  -------
<S>                                      <C>       <C>     <C>   <C>     <C>
Assets:
Interest-earning deposits............... $    211  $    11 5.21% $    6  $    --
Federal funds sold......................    5,287      269 5.09%     74      (16)
Federal Home Loan Bank stock............    1,691      128 7.57%     13        2
Taxable investment securities...........   40,596    2,573 6.34%   (828)      44
Non-taxable investment securities (1)...   69,950    4,559 6.52%  1,421     (270)
Non-taxable loans (2)...................    2,442      185 7.57%     12       (2)
Taxable Loans, net of unearned
  discount (3)..........................  428,518   36,621 8.55%  3,486   (1,334)
                                         --------  ------- ----  ------  -------
      Total earning assets..............  548,695   44,346 8.08%  4,184   (1,577)

Cash and due from banks.................   25,205
Allowance for loan losses...............   (6,085)
Premises and equipment, net.............   15,230
Accrued Interest........................    4,344
Other assets............................    8,289
                                         --------
      Total assets...................... $595,678
                                         ========
Liabilities and Shareholders' Equity:
Interest-bearing demand deposits........  165,370    3,079 1.86%    334      (43)
Savings deposits........................   31,308      615 1.96%     55     (103)
Time deposits...........................  232,806   11,457 4.92%    752   (1,001)
Federal funds purchased and securities
 sold under agreements to repurchase....   19,295      722 3.74%     21      (61)
Commercial paper (Master notes).........   15,273      526 3.44%     98      (93)
   Total interest-bearing liabilities...  464,052   16,399 3.53%  1,260   (1,301)
Non-interest bearing demand deposits....   82,921
Other liabilities.......................    3,611
Shareholders' equity....................   45,094
                                         --------
   Total liabilities and shareholders'
    equity.............................. $595,678
                                         ========
Net interest income on a fully taxable
 equivalent basis (1)/Net yield on
 interest-earning assets (FTE)..........            27,947 5.09%
</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 $917, $1,076 and $1,157 for 2001, 2000 and 1999, respectively.
(2) Yields on non-taxable loans 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 $34,
    $37, and $47 for 2001, 2000 and 1999, respectively.
(3) 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.

                                      26

<PAGE>

   Total interest expense decreased 4% during 2001 from $20.4 million to $19.5
million primarily as a result of rate changes, as the cost of interest bearing
liabilities adjusted downward 50 basis points during 2001. Although deposits
grew substantially during 2001, the decrease in the average interest rate paid
outpaced the interest expense increase due to volume. In 2000, the opposite was
true, as interest expense increased 24% from $16.4 million in 1999 to $20.4
million in 2000. The cost of interest bearing liabilities increased 58 basis
points during 2000, from 3.53% in 1999 to 4.11% in 2000.

  Provision For Loan Losses

   The provision for loan losses is a charge to earnings in a given period to
maintain the allowance at an adequate level. The provision for loan losses was
$4.0 million, $3.9 million and $2.4 million, respectively, for the years ended
December 31, 2001, 2000 and 1999. The progressive increase in the provision
over the last three years has been the result of higher charge-offs,
particularly in the sales finance area. Net charge-offs to average loans are
..71% or $3.9 million for 2001 as compared to 1.02% or $4.8 million for 2000 and
0.43% or $1.9 million for 1999. Charge offs in the sales finance portfolio
accounted for $2.3 million, or 58% of net charge-offs in 2001, and $3.8
million, or 79% of net charge-offs in 2000. Sales finance losses during 1999
were minimal. 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. The allowance for
loan losses totaled $5.6 million, $5.4 million and $6.4 million at December 31,
2001, 2000 and 1999, respectively. The level of the allowance for loan losses
to total loans outstanding is 1.02% at December 31, 2001. This compares to
1.09% as of December 31, 2000 and 1.43% as of December 31, 1999. Management
feels the 1.02% allowance for loan losses to total loans at December 31, 2001
is adequate because the allowance model described in the discussion on
allowance for loan losses takes into account the risk grades of loans,
delinquency trends, charge-off ratios and loan growth.

  Non-Interest Income

   Non-interest income increased by $3.3 million, or 35%, in 2001 to $12.9
million from $9.6 million in 2000. During 2000, non-interest income increased
by $1.5 million, or 18%, over 1999. The largest component of non-interest
income is service charges and fees on deposit accounts. Comprising 58% of total
non-interest income in 2001 and 49% in 2000, service charges on deposit
accounts improved to $7.4 million in 2001, from $4.6 million in 2000. The 59%
increase in 2001 was directly attributable to the introduction of an automatic
overdraft privilege offered to certain deposit customers. A $25.00 fee is
automatically charges to the customer's account each time an overdrawn check is
written, up to maximum overdraft amount of $500.00. Although management has
seen an increase in charge-offs of overdrawn accounts, the fee income generated
from this product more than offsets those increases. The increase in
charge-offs on overdrawn accounts was expected, as it is the Company's policy
to automatically charge off the account after it is 60 days past due.
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. Another principal increase during 2001 was the net
gains on sales of loans, increasing from $70,000 in 2000 to $684,000 in 2001.
Lower interest rates throughout the year improved fixed rate residential
mortgage production. The Bank typically sells a large majority of these loans
in the secondary market. Because interest rates are not expected to remain at
such low levels in subsequent quarters, the Company anticipates the possibility
of lower residential mortgage production and therefore smaller gains on the
sales of these loans.

   During 2000, non-interest income increased by $1.5 million, or 18% over 1999
from $8.1 million to $9.6 million in 2000. Service charges on deposit accounts
increased 20% during 2000, from $3.9 million to $4.6 million in 2000. This
increase was a result of the increased collection of insufficient funds
associated with debit card transactions and the increase in the volume of
deposit relationships. Other income increased $774,000 or 39% due to increases
in several miscellaneous fees including ATM fees, mortgage service fees,
brokerage commissions and credit card fees.

                                      27

<PAGE>

  Non-Interest Expense

   Total non-interest expense increased $4.0 million, or 18%, in 2001 from
$22.5 million to $26.5 million. During 2000, these costs increased $1.3 million
or 6%. The largest component of non-interest expense, salaries and other
personnel, increased $2.9 million, or 27%, during 2001. The biggest portion of
salaries and other personnel expense is salary, which accounted for the biggest
increase during 2001 as a result of the increase in staff in various operation
and retail areas as well as normal raises throughout the year. Higher health
insurance costs were incurred as a result of the repricing of health insurance
plans effective January 2001. The Company experienced a 19.75% increase in the
monthly premiums for group medical/dental coverage. Also during 2001, incentive
compensation was higher as a direct result of the financial performance of the
Company during 2001. In 2000, salaries and other personnel expense did not have
significant increases over 1999 primarily as a result of lower incentive
compensation.

   Combined net occupancy and furniture and equipment expense increased
$289,000 or 7% from 2000 to 2001 as compared to an increase of $181,000 or 5%
from 1999 to 2000. These increases are primarily related to remodeling and
expansion of current facilities, as well as improved technology during 2000 and
2001.

   Sales finance losses on repossessed were significantly higher in 2000 than
2001. The losses were only $29,000 in 2001 compared to $557,000 in 2000. Losses
related to the sales finance portfolio prior to 2000 were immaterial due to the
low volume of repossessed automobiles. These losses included in the income
statement were a result of the sale of the repossessed autos. During 2001, the
Company valued repossessed automobiles more quickly and accurately through the
allowance for loan losses at the time of repossession. As a result, losses on
sales of the vehicles were lower.

  Income Taxes

   Income tax expense totaled $3.6 million in 2001, compared to $2.6 million in
2000 and $3.0 million in 1999. The Company's effective tax rate was 30.0% in
2001 and 27.4% in 2000 and 1999. The effective tax rate in future periods is
expected to range from 27% to 30%. 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 recognize only actual loan losses. The Company
works actively with outside tax consultants to minimize tax expense.

  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 Matters

   Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an Amendment of FASB 133" establish accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and hedging activities. They require that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position, and measure those instruments at fair value. Changes in the fair
value of those derivatives will be reported in earnings or other comprehensive
income depending on the use of the derivative and whether the derivative

                                      28

<PAGE>

qualifies for hedge accounting. The Company adopted SFAS No. 133, as amended by
SFAS No. 138, on January 1, 1999. The adoption was not material to the
Company's consolidated financial statements except for in 1999 when the Company
transferred 100% of its held-to-maturity investment securities to the
available-for-sale category as allowed by the Statement.

   SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities--a replacement of FASB No. 125, " was issued
in September 2000. It revises the standards for accounting for securitizations
and other transfers of financial assets and collateral and requires certain
disclosures but carries over most of SFAS No. 125's provisions without
reconsideration. SFAS 140 is effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after March 31, 2001. This
statement is effective for recognition and reclassification of collateral and
for disclosures related to securitization transactions and collateral for
fiscal years ending after December 15, 2000. The adoption of the provisions of
SFAS No. 140 on April 1, 2001 did not have a material effect on the Company.

   In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001.
SFAS 141 also specifies criteria intangible assets acquired in a purchase
method business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled workforce
may not be accounted for separately. The Company adopted SFAS No. 141 on July
1, 2001 and does not expect the Statement to have a material impact on the
financial statements in the future as the Company has always accounted for
business combinations through the purchase method.

   SFAS No. 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."

   Currently, it is the Company's understanding that SFAS No. 142 does not
apply to the acquisition of a commercial bank, a savings and loan association,
a mutual savings bank, a credit union, other depository institutions having
assets and liabilities of the same type as those instituions, and branches of
such enterprises. Intangible assets arising from these types of business
combinations must conform to the guidance in SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions", and are thus exlcuded
from the scope of SFAS No. 142. At December 31, 2001, the Company had
unamortized goodwill relating to core deposit premiums purchased of $408,000 as
well as unamortized goodwill defined in SFAS 72 as an unidentifiable intangible
asset ("Statement 72" goodwill) of $4.0 million. The Company plans to continue
amortizing these assets as directed in SFAS No. 72. It is the Company's
understanding that the FASB has undertaken a limited scope project to
reconsider part of the guidance in SFAS No. 72, particularly the provision that
requires recognition and amortization of an unidentifiable intangible asset.
However, the Company plans to continue amortizing the "Statement 72" goodwill
until further guidance from the FASB.

   In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets". This SFAS supercedes prior pronouncements
associated with impairment or disposal of long-lived assets. SFAS No. 144
establishes methodologies for assessing impairment of long-lived assets,
including assets to be disposed of by sale or by other means. This statement is
effective for all fiscal years beginning after December 15, 2001. This SFAS is
not expected to have a material impact on the Company's financial position.

   On July 2, 2001, The Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 102 "Selected Loan Loss Allowance Methodology
and Documentation Issues". SAB 102 expresses the SEC's views on the
development, documentation and application of a systematic methodology for

                                      29

<PAGE>

determining the allowance for loan and lease losses in accordance with
Generally Accepted Accounting Principles. The Company believes that it is
currently in compliance with the requirements of SAB 102.

  Industry Developments

   On November 12, 1999, the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this
legislation is to modernize the financial services industry by establishing a
comprehensive framework to permit affiliations among commercial banks,
insurance companies, securities firms and other financial service providers.
Generally, the GLBA:

    a. repeals the historical restrictions and eliminates many federal and
       state law barriers to affiliations among banks, securities firms,
       insurance companies and other financial service providers;

    b. provides a uniform framework for the functional regulation of the
       activities of banks, savings institutions and their holding companies;

    c. broadens the activities that may be conducted by national banks, banking
       subsidiaries of bank holding companies and their financial subsidiaries;

    d. provides an enhanced framework for protecting the privacy of consumer
       information;

    e. adopts a number of provisions related to the capitalization, membership,
       corporate governance and other measures designed to modernize the FHLB
       system;

    f. modifies the laws governing the implementation of the Community
       Reinvestment Act; and

    g. addresses a variety of other legal and regulatory issues affecting
       day-to-day operations and long-term activities of financial institutions.

   The GLBA also imposes certain obligations on financial institutions to
develop privacy policies, restrict the sharing of nonpublic customer data with
nonaffiliated parties at the customer's request, and establish procedures and
practices to protect and secure customer data. These privacy provisions were
implemented by regulations that were effective on November 12, 2000. Compliance
with the privacy provisions was required by July 1, 2001. The Company believes
it is in compliance with these provisions.

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk

   See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Asset-Liability Management and Market Risk Sensitivity."

Item 8.  Financial Statements and Supplementary Data

   The information that is required by this item is set forth on the following
pages, 33 through 58.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure

   The information required in Item 9 is incorporated herein by reference to
the Current Report on Form 8-K filed by the Company with the Commission on
April 23, 2001.

                                      30

<PAGE>

                         Independent Auditors' Report

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

   We have audited the accompanying consolidated balance sheet of Palmetto
Bancshares, Inc. and subsidiary (the "Company") as of December 31, 2001 and the
related consolidated statement of operations, changes in shareholders' equity
and comprehensive income, and cash flows for the year then ended. 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 audit.

   We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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
audit provides a reasonable basis for our opinion.

   In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of Palmetto Bancshares, Inc. and
subsidiary as of December 31, 2001 and the results of their operations and
their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.


                                             /s/ Elliott Davis LLP
Greenville, South Carolina
February 8, 2002

                                      31

<PAGE>

                         Independent Auditors' Report

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

   We have audited the accompanying consolidated balance sheet of Palmetto
Bancshares, Inc. and subsidiary (the "Company") as of December 31, 2000, and
the related consolidated statements of operations, changes in shareholders'
equity and comprehensive income, and cash flows for each of the years in the
two-year period ended December 31, 2000. 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 auditing standards generally
accepted in the United States of America. 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, 2000, and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America.

   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."

                                          [LOGO] KPMG LLP

Greenville, South Carolina
February 9, 2001

                                      32

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                          Consolidated Balance Sheets
                          December 31, 2001 and 2000
            (Dollars in thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                                                           2001     2000
                                                                                         --------  -------
<S>                                                                                      <C>       <C>
Assets
Cash and due from banks................................................................. $ 27,742   36,305
Federal funds sold......................................................................   17,949    1,879
Federal Home Loan Bank stock, at cost...................................................    1,733    1,733
Investment securities available for sale (amortized costs of $94,708 and $99,030 in 2001
  and 2000, respectively)...............................................................   95,095   98,601
Loans held for sale.....................................................................   10,054      611
Loans...................................................................................  553,821  498,242
   Less allowance for loan losses.......................................................   (5,658)  (5,446)
                                                                                         --------  -------
       Loans, net.......................................................................  548,163  492,796
                                                                                         --------  -------
Premises and equipment, net.............................................................   19,175   16,481
Accrued interest........................................................................    4,947    5,229
Other assets............................................................................   10,421    9,755
                                                                                         --------  -------
       Total assets..................................................................... $735,279  663,390
                                                                                         ========  =======
Liabilities and Shareholders' Equity
Liabilities:
   Deposits:
     Non-interest-bearing............................................................... $102,679   96,097
     Interest-bearing...................................................................  542,621  476,569
                                                                                         --------  -------
       Total deposits...................................................................  645,300  572,666
   Securities sold under agreements to repurchase.......................................   15,313   19,923
   Commercial paper (Master note).......................................................   11,076   15,359
   Other liabilities....................................................................    4,522    2,849
                                                                                         --------  -------
       Total liabilities................................................................  676,211  610,797
                                                                                         --------  -------
Shareholders' equity:
   Common stock--$5.00 par value. Authorized 10,000,000 shares; issued and
     outstanding 6,283,623 in 2001; issued and outstanding 6,255,734 in 2000............   31,418   31,279
   Capital surplus......................................................................       26       23
   Retained earnings....................................................................   27,386   21,555
   Accumulated other comprehensive income/ (loss).......................................      238     (264)
                                                                                         --------  -------
       Total shareholders' equity.......................................................   59,068   52,593
                                                                                         --------  -------
       Total liabilities and shareholders' equity....................................... $735,279  663,390
                                                                                         ========  =======
</TABLE>

         See accompanying notes to consolidated financial statements.

                                      33

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                     Consolidated Statements of Operations
                 Years ended December 31, 2001, 2000 and 1999
            (Dollars in thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                                                 2001      2000      1999
                                                                              ---------- --------- ---------
<S>                                                                           <C>        <C>       <C>
Interest income:
   Interest and fees on loans................................................ $   44,118    40,407    36,759
   Interest and dividends on investment securities available for sale:
       U.S. Treasury and U.S. Government agencies............................        828     1,292       953
       State and municipal...................................................      2,698     3,166     3,402
       Mortgage-backed securities............................................      1,177     1,628     1,620
   Interest on federal funds sold............................................        322       240       269
   Dividends on FHLB stock...................................................        128       140       139
                                                                              ---------- --------- ---------
          Total interest income..............................................     49,271    46,873    43,142
                                                                              ---------- --------- ---------
Interest expense:
   Interest on deposits......................................................     18,578    18,034    15,151
   Interest on securities sold under agreements to repurchase................        549     1,111       564
   Interest on federal funds purchased.......................................         63       449       158
   Interest on commercial paper (Master note)................................        359       789       526
                                                                              ---------- --------- ---------
          Total interest expense.............................................     19,549    20,383    16,399
                                                                              ---------- --------- ---------
              Net interest income............................................     29,722    26,490    26,743
Provision for loan losses....................................................      4,038     3,880     2,431
                                                                              ---------- --------- ---------
              Net interest income after provision for loan losses............     25,684    22,610    24,312
                                                                              ---------- --------- ---------
Non-interest income:
   Service charges on deposit accounts.......................................      7,402     4,647     3,878
   Fees for trust services...................................................      1,869     1,968     1,968
   Gains on sales of loans...................................................        684        70       230
   Investment securities gains...............................................        161       131        32
   Other income..............................................................      2,753     2,735     1,961
                                                                              ---------- --------- ---------
              Total non-interest income......................................     12,869     9,551     8,069
                                                                              ---------- --------- ---------
Non-interest expense:
   Salaries and other personnel..............................................     13,590    10,682    10,255
   Net occupancy.............................................................      2,085     1,970     1,922
   Furniture and equipment...................................................      2,388     2,214     2,081
   FDIC assessment...........................................................        110       111       132
   Postage and supplies......................................................      1,312     1,144     1,155
   Marketing and advertising.................................................        919       719       776
   Telephone.................................................................        766       754       792
   Cardholder processing expense.............................................        548       563       521
   Sales finance repossession losses.........................................         29       557        --
   Other expense.............................................................      4,806     3,835     3,640
                                                                              ---------- --------- ---------
              Total non-interest expense.....................................     26,553    22,549    21,274
                                                                              ---------- --------- ---------
              Income before income taxes.....................................     12,000     9,612    11,107
Income tax provision.........................................................      3,600     2,637     3,038
                                                                              ---------- --------- ---------
              NET INCOME..................................................... $    8,400     6,975     8,069
                                                                              ========== ========= =========
Per share data:
   Net income per common share-basic......................................... $     1.34      1.12      1.30
                                                                              ========== ========= =========
   Net income per common share-dilutive...................................... $     1.31      1.09      1.26
                                                                              ========== ========= =========
   Cash dividends declared per common share.................................. $     0.41      0.37      0.32
                                                                              ========== ========= =========
   Weighted average common shares outstanding-basic..........................  6,263,031 6,241,775 6,208,750
                                                                              ========== ========= =========
   Weighted average common shares outstanding-dilutive.......................  6,431,983 6,422,457 6,386,912
                                                                              ========== ========= =========
</TABLE>

         See accompanying notes to consolidated financial statements.

                                      34

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

 Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
                                    Income
                 Years ended December 31, 2001, 2000 and 1999
                   (Dollars in thousands, except share data)

<TABLE>
<CAPTION>
                                                                            Accumulated    Common
                                                                               Other       Stock
                                                         Capital           Comprehensive Subject to
                                                Common   Surplus  Retained    Income      Put/call
                                                Stock   (Deficit) Earnings    (Loss)       Option   Total
                                                ------- --------- -------- ------------- ---------- ------
<S>                                             <C>     <C>       <C>      <C>           <C>        <C>
Balance at December 31, 1998................... $30,997    (19)    10,777        330       (4,732)  37,353
Net income.....................................      --     --      8,069         --           --    8,069
Other comprehensive income, 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 gains on investment
     securities................................      --     --         --     (2,727)          --       --
                                                                                                    ------
Comprehensive income...........................      --     --         --         --           --    5,342
                                                                                                    ------
Cash dividends declared........................      --     --     (1,956)        --           --   (1,956)
Issuance of 27,444 shares in connection with
  exercise of stock options....................     137     19         --         --           --      156
Expiration of put/call option on common stock
  subject to put/call option...................      --     --         --         --        4,732    4,732
                                                -------    ---     ------     ------       ------   ------
Balance at December 31, 1999...................  31,134     --     16,890     (2,397)          --   45,627
                                                -------    ---     ------     ------       ------   ------
Net income.....................................      --     --      6,975         --           --    6,975
Other comprehensive income, net of tax:
   Unrealized holding gains arising during
     period, net of tax effect of $1,386.......      --     --         --         --           --    2,214
   Less: reclassification adjustment for gains
     included in net income, net of tax
     effect of $50.............................      --     --         --         --           --      (81)
   Net unrealized gains on investment
     securities................................      --     --         --      2,133           --       --
                                                                                                    ------
Comprehensive income...........................      --     --         --         --           --    9,108
                                                                                                    ------
Cash dividends declared........................      --     --     (2,310)        --           --   (2,310)
Issuance of 28,900 shares in connection with
  exercise of stock options....................     145     23         --         --           --      168
                                                -------    ---     ------     ------       ------   ------
Balance at December 31, 2000...................  31,279     23     21,555       (264)          --   52,593
                                                -------    ---     ------     ------       ------   ------
Net income.....................................      --     --      8,400         --           --    8,400
Other comprehensive income, net of tax:
   Unrealized holding gains arising during
     period, net of tax effect of $376.........      --     --         --         --           --      601
   Less: reclassification adjustment for gains
     included in net income, net of tax
     effect of $62.............................      --     --         --         --           --      (99)
   Net unrealized gains on investment
     securities................................      --     --         --        502           --       --
                                                                                                    ------
Comprehensive income...........................      --     --         --         --           --    8,902
                                                                                                    ------
Cash dividends declared........................      --     --     (2,569)        --           --   (2,569)
Issuance of 27,899 shares in connection with
  exercise of stock options....................     139      3         --         --           --      142
                                                -------    ---     ------     ------       ------   ------
Balance at December 31, 2001................... $31,418     26     27,386        238           --   59,068
                                                =======    ===     ======     ======       ======   ======
</TABLE>

         See accompanying notes to consolidated financial statements.

                                      35

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                     Consolidated Statements of Cash Flows
                 Years ended December 31, 2001, 2000 and 1999
                            (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                   2001      2000     1999
                                                                                 ---------  -------  -------
<S>                                                                              <C>        <C>      <C>
Cash flows from operating activities:
   Net income................................................................... $   8,400    6,975    8,069
   Adjustments to reconcile net income to net cash provided by operating
     activities:
       Depreciation and amortization............................................     2,877    2,284    2,580
       Gain on sale of investment securities....................................      (161)    (131)     (32)
       Gain on sale of loans....................................................      (684)     (70)    (230)
       Provision for loan losses................................................     4,038    3,880    2,431
       Origination/acquisition of loans held for sale...........................  (101,943)  (9,303) (28,520)
       Sale of loans held for sale..............................................    93,184    9,931   29,703
       Provision (credit) for deferred taxes....................................       412      392      (57)
       Change in accrued interest receivable....................................       282     (581)    (149)
       Change in other assets...................................................    (1,508)     267   (3,174)
       Change in other liabilities..............................................       947      (33)   1,101
                                                                                 ---------  -------  -------
          Net cash provided by operating activities.............................     5,844   13,611   11,722
                                                                                 ---------  -------  -------
Cash flows from investing activities:
   Purchase of investment securities available for sale.........................   (29,486) (10,000) (41,032)
   Proceeds from maturities of investment securities available for sale.........    17,299    7,320   12,865
   Proceeds from sale of investment securities available for sale...............     8,783    8,954   21,359
   Principal paydowns on mortgage-backed securities available for sale..........     7,652    5,448    8,116
   Purchase of Federal Home Loan Bank stock.....................................        --       --     (192)
   Net increase in loans outstanding............................................   (59,616) (57,287) (34,690)
   Increase in premises and equipment, net......................................    (4,283)  (1,767)  (3,574)
                                                                                 ---------  -------  -------
          Net cash used in investing activities.................................   (59,651) (47,332) (37,148)
                                                                                 ---------  -------  -------
Cash flows from financing activities:
   Net increase in deposits.....................................................    72,634   34,342   23,463
   Acquisition of deposits, net.................................................        --       --   12,636
   Net increase (decrease) in securities sold under agreements to repurchase....    (4,610)     902   (2,609)
   Net increase (decrease) in commercial paper (Master note)....................    (4,283)   2,786    1,714
   Increase (decrease) in federal funds purchased...............................        --   (7,800)   7,800
   Proceeds from issuance of common stock.......................................       142      168      156
   Dividends paid...............................................................    (2,569)  (2,310)  (1,956)
                                                                                 ---------  -------  -------
          Net cash provided by financing activities.............................    61,314   28,088   41,204
                                                                                 ---------  -------  -------
Net increase (decrease) in cash and cash equivalents............................     7,507   (5,633)  15,778
Cash and cash equivalents at beginning of year..................................    38,184   43,817   28,039
                                                                                 ---------  -------  -------
Cash and cash equivalents at end of year........................................ $  45,691   38,184   43,817
                                                                                 =========  =======  =======
Supplemental information:
Cash paid during the year for:
   Interest..................................................................... $  19,965   20,093   16,300
                                                                                 =========  =======  =======
   Income taxes................................................................. $   3,028    1,714    3,423
                                                                                 =========  =======  =======
Supplemental schedule of non-cash investing and financing transactions:
     Change in unrealized gain (loss) on investment securities available for
       sale, before tax......................................................... $     816    3,469   (4,434)
                                                                                 =========  =======  =======
     Transfer of investment securities held to maturity to available for sale... $      --       --   66,455
                                                                                 =========  =======  =======
     Loans transferred to other real estate owned............................... $     211        6      335
                                                                                 =========  =======  =======
     Loans charged-off.......................................................... $   4,033    4,987    1,973
                                                                                 =========  =======  =======
</TABLE>

         See accompanying notes to consolidated financial statements.

                                      36

<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") in the United States of
America 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 deposits and making
loans. Palmetto Capital, Inc. ("Palmetto Capital"), a wholly owned subsidiary
of the 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.

  Cash and Cash Equivalents

   Cash and cash equivalents include cash and 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, 2001 or 2000.

  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 at December 31, 2001 and 2000. 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. The Bank has available $71,000 in lines of
credit from the FHLB. There were no advances on these lines at December 31,
2001 or 2000.

  Investment Securities

   The Bank accounts for its investment securities in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. SFAS No. 115

                                      37

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)

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 held to maturity or trading securities.

   In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The statement was 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 had no embedded derivative
instruments requiring separate accounting treatment. The Company has
freestanding derivative instruments consisting of fixed rate conforming loan
commitments. The Company does not currently engage in hedging activities. The
commitments to originate fixed rate conforming loans were not material at
December 31, 2001.

   Premiums and discounts are included in the basis of investment securities
and are recognized in income using the effective interest method.

  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, 2001 and 2000, the Company had loans held for sale of
$10,054 and $611, respectively. Loans serviced for the benefit of others
amounted to $190,252, $133,282 and $141,385 at December 31, 2001, 2000 and
1999, respectively. Most of these loans are serviced for Federal Home Loan
Mortgage Corporation (FHLMC).

  Mortgage Servicing Rights

   SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities,"--a replacement of SFAS 125, was issued in
September 2000. It revised the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures but carried over most of SFAS 125's provisions without
reconsideration. The Company adopted the provisions of SFAS 140 effective April
1, 2001 with no material impact.


                                      38

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)

   SFAS No. 140 requires the recognition of originated mortgage servicing
rights ("MSR's") as assets by allocating total costs incurred between the
originated loan and the servicing rights retained based on their relative fair
values. SFAS 140 also requires the recognition of purchased mortgage servicing
rights at fair value, which is presumed to be the price paid for the rights.

   Amortization of MSRs is based on the ratio of net servicing income received
in the current period to total net servicing income projected to be realized
from the MSRs. Projected net servicing income is in turn determined on the
basis of the estimated future balance of the underlying mortgage loan
portfolio, which declines over time from prepayments and scheduled loan
amortization. The Company estimates future prepayment rates based on current
interest rate levels, other economic conditions and market forecasts, as well
as relevant characteristics of the servicing portfolio, such as loan types,
interest rate stratification and recent prepayment experience.

   SFAS No. 140 also requires that all MSRs be evaluated for impairment based
on the excess of the carrying amount of the MSRs over their fair value. Fair
values of servicing rights are determined by estimating the present value of
future net servicing income considering the average interest rate and the
average remaining lives of the related loans being serviced. The Company
evaluates these servicing rights quarterly for possible impairment. 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.

   Included in other assets on the consolidated balance sheet, the Company had
net MSR's of $1,640 and $1,086 at December 31, 2001 and 2000, respectively. The
Company amortized $683, $167 and $488 of these MSR's during the years ended
December 31, 2001, 2000 and 1999, respectively.

  Loans and Interest Income

   Loans are carried at principal amounts outstanding including unamortized
costs net of 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.

                                      39

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


   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. 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 the allowance for loan losses.

  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 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 $217 and $6, at December 31, 2001 and 2000, 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.

                                      40

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


  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

   Included in other assets are certain intangibles related to various
acquisitions. At December 31, 2001 and 2000, premium on deposits acquired
amounted to $408 and $510, respectively, net of amortization. The premiums are
being amortized principally over 10 years using the double-declining balance
method. At December 31, 2001 and 2000, goodwill of approximately $4,010 and
$4,346, respectively, net of amortization, related to separate 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.

  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. Since 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 included in
shareholders' equity.

  Net Income Per Common Share

   Net income per common share-basic and net income per common share-dilutive
are calculated based on SFAS No. 128, as discussed in Note 11.

  Stock Options

   The Company accounts for its stock options in accordance with 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 10).

                                      41

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


  Comprehensive Income

   The Company discloses its comprehensive income in accordance with 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, 2001 and 2000, the Bank had $17,949 and $1,879,
respectively, outstanding in federal funds sold. The daily averages of these
outstanding agreements during 2001 and 2000 were $7,192 and $3,340,
respectively. The maximum amount of these outstanding agreements at any
month-end during 2001 and 2000 were $17,949 and $6,879, respectively.

(3)  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>
                                                            2001
                                           ---------------------------------------
                                           Amortized Unrealized Unrealized  Fair
                                             Cost      Gains      Losses    Value
                                           --------- ---------- ---------- -------
<S>                                        <C>       <C>        <C>        <C>
U.S. Treasury and U.S. Government agencies $ 29,269      284          (8)   29,545
State and Municipal.......................   55,798      753        (815)   55,736
Mortgage-backed securities................    9,641      173          --     9,814
                                           --------    -----      ------   -------
                                           $ 94,708    1,210        (823)   95,095
                                           ========    =====      ======   =======

                                                            2000
                                           ---------------------------------------
                                           Amortized Unrealized Unrealized  Fair
                                             Cost      Gains      Losses    Value
                                           --------- ---------- ---------- -------
U.S. Treasury............................. $ 17,491       49         (44)   17,496
State and Municipal.......................   58,622      554        (883)   58,293
Mortgage-backed securities................   22,917       33        (138)   22,812
                                           --------    -----      ------   -------
                                           $ 99,030      636      (1,065)   98,601
                                           ========    =====      ======   =======

                                                            1999
                                           ---------------------------------------
                                           Amortized Unrealized Unrealized  Fair
                                             Cost      Gains      Losses    Value
                                           --------- ---------- ---------- -------
U.S. Treasury............................. $ 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>

                                      42

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


   During the year ended December 31, 2001, the Company had realized gains of
$161 and no realized losses on sales of investment securities available for
sale; compared to realized gains of $133 and realized losses of $2 in 2000 on
sales of investment securities available for sale. During 1999, the realized
gains amounted to $32, with no realized losses 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, 2001:

<TABLE>
<CAPTION>
                                                           Due After
                                          Due After          Five
                             Due           One Year          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..... $24,357  2.62%    5,188   5.57%      --    -- %      --    -- %
State and municipals......   1,647  8.71     9,821   8.15   21,578   6.84   22,689   6.74
Mortgage-backed securities   1,850  6.07     7,965   6.32       --     --       --     --
                           -------  ----    ------   ----   ------   ----   ------   ----
Fair value total.......... $27,854  3.19%   22,974   6.93%  21,578   6.84%  22,689   6.74%
                           =======  ====    ======   ====   ======   ====   ======   ====
Amortized cost............ $27,715          22,292          21,501          23,200
                           =======          ======          ======          ======
</TABLE>

   Investment securities available for sale with an aggregate carrying value of
approximately $68,266 and $82,622 at December 31, 2001 and 2000, respectively,
are pledged to secure public deposits, securities sold under agreements to
repurchase, and for other purposes as required or permitted by law.

(4)  Loans

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

<TABLE>
<CAPTION>
                                         2001    2000    1999    1998    1997
                                       -------- ------- ------- ------- -------
<S>                                    <C>      <C>     <C>     <C>     <C>
Commercial, financial and agricultural $154,069 123,727 107,934  93,343  81,678
Real estate-construction..............   22,836  14,321  13,373  10,341   8,799
Real estate-mortgage..................  310,981 283,541 231,637 215,709 195,462
Installment loans to individuals......   65,935  76,653  92,813  93,873  81,646
                                       -------- ------- ------- ------- -------
Total................................. $553,821 498,242 445,757 413,266 367,585
                                       ======== ======= ======= ======= =======
Non-accrual loans included above...... $  3,399   3,031   1,521   1,485     718
                                       ======== ======= ======= ======= =======
</TABLE>

   The foregone interest income related to loans on non-accrual amounted to
$325, $384 and $240 for the years ended December 31, 2001, 2000 and 1999,
respectively. Interest income recognized on loans on non-accrual amounted to
$11, $14 and $7 for the years ended December 31, 2001, 2000 and 1999,
respectively.

                                      43

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


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

<TABLE>
<CAPTION>
                                              2001     2000    1999
                                             -------  ------  ------
           <S>                               <C>      <C>     <C>
           Balance at beginning of year..... $ 5,446   6,362   5,795
           Provision for loan losses........   4,038   3,880   2,431
           Loan recoveries..................     207     191     109
           Loans charged-off................  (4,033) (4,987) (1,973)
                                             -------  ------  ------
           Balance at end of year........... $ 5,658   5,446   6,362
                                             =======  ======  ======
</TABLE>

   At December 31, 2001, impaired loans amounted to approximately $307. During
2001, the average recorded investment in impaired loans was approximately $396,
and there is $155 included in the allowance for loan losses related to impaired
loans at December 31, 2001. Impaired loans are included in the non-accrual
numbers above.

   At December 31, 2000, impaired loans amounted to approximately $481. During
2000, the average recorded investment in impaired loans was approximately $428,
and there is $243 included in the allowance for loan losses related to impaired
loans at December 31, 2000.

   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.

   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, 2001, 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, 2001 as
follows:

<TABLE>
              <S>                                         <C>
              Home equity loans.......................... $12,162
              Credit cards...............................  32,471
              Commercial real estate development.........  19,086
              Other unused lines of credit...............  28,601
                                                          -------
                                                          $92,320
                                                          =======
              Standby letters of credit.................. $ 2,074
                                                          =======
</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.

                                      44

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(5)  Premises and Equipment, Net

   A summary of premises and equipment, net, as of December 31 follows:

<TABLE>
<CAPTION>
                                                  2001     2000
                                                --------  -------
              <S>                               <C>       <C>
              Land............................. $  3,874    3,025
              Buildings and leasehold
                improvements...................   15,051   13,336
              Furniture and equipment..........   15,320   13,750
                                                --------  -------
                                                  34,245   30,111
              Less accumulated depreciation and
                amortization...................  (15,070) (13,630)
                                                --------  -------
              Premises and equipment, net...... $ 19,175   16,481
                                                ========  =======
</TABLE>

(6)  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>
                                                             2001 2000  1999
                                                             ---- ----  ----
    <S>                                                      <C>  <C>   <C>
    Balance at beginning of year............................ $ 1   234  229
    Aggregate additions charged and reductions credited to
      operations............................................  68  (233)   5
    Aggregate direct writedowns charged against allowance...  --    --   --
                                                             ---  ----  ---
    Balance at end of year.................................. $69     1  234
                                                             ===  ====  ===
</TABLE>

(7)   Deposits

   A summary of deposits, by type, as of December 31 follows:

<TABLE>
<CAPTION>
                                                   2001    2000
                                                 -------- -------
               <S>                               <C>      <C>
               Transaction accounts............. $253,890 218,066
               Savings deposits.................   33,294  30,468
               Insured money market accounts....   69,149  66,052
               Time deposits over $100..........   77,036  63,844
               Other time deposits..............  211,931 194,236
                                                 -------- -------
                  Total deposits................ $645,300 572,666
                                                 ======== =======
</TABLE>

   Interest paid on time deposits of $100 or more amounted to $4,163, $2,870,
and $2,273 for the years ended December 31, 2001, 2000 and 1999, respectively.

   The following table displays the aggregate amounts of time deposits with
maturities for the years following December 31, 2001:

<TABLE>
         <S>                                                   <C>
         Maturing within one year............................. $263,559
         Maturing after one year through two years............   14,875
         Maturing after two years through three years.........    3,688
         Maturing after three years through four years........    5,353
         Maturing after four years through five years.........    1,393
         Maturing after five years............................       99
                                                               --------
            Total............................................. $288,967
                                                               ========
</TABLE>

                                      45

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(8)  Short-Term Borrowings

<TABLE>
<CAPTION>
                                                      2001     2000    1999
                                                     -------  ------  ------
   <S>                                               <C>      <C>     <C>
   SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
     WITH CUSTOMERS
      Amount outstanding at year-end................ $15,313  12,733   7,769
      Average amount outstanding during year........  15,269  13,842  15,291
      Maximum amount outstanding at any month-end...  16,055  16,759  20,762
      Weighted average rate paid at year-end........    1.00%   4.15%   1.81%
      Weighted average rate paid during the year....    2.63%   4.96%   3.40%
</TABLE>

   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>
                                                      2001    2000    1999
                                                     ------  ------  ------
   <S>                                               <C>     <C>     <C>
   SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
     WITH A BANK
      Amount outstanding at year-end................ $   --   7,190  11,252
      Average amount outstanding during year........  1,736   6,193   1,277
      Maximum amount outstanding at any month-end...  7,220  12,625  11,252
      Weighted average rate paid at year-end........     --    6.65%   5.96%
      Weighted average rate paid during the year....   5.98%   6.88%   5.96%
</TABLE>

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

<TABLE>
<CAPTION>
                                                      2001     2000    1999
                                                     -------  ------  ------
   <S>                                               <C>      <C>     <C>
   FEDERAL FUNDS PURCHASED
      Amount outstanding at year-end................ $    --      --   7,800
      Average amount outstanding during year........   1,515   6,361   2,727
      Maximum amount outstanding at any month-end...   6,800  28,000  15,000
      Weighted average rate paid at year-end........      --      --    5.13%
      Weighted average rate paid during the year....    3.92%   7.06%   5.79%

                                                      2001     2000    1999
                                                     -------  ------  ------
   COMMERCIAL PAPER (MASTER NOTE)
      Amount outstanding at year-end................ $11,076  15,359  12,573
      Average amount outstanding during year........  13,310  15,945  15,273
      Maximum amount outstanding at any month-end...  14,990  17,850  17,035
      Weighted average rate paid at year-end........    1.00%   4.40%   2.06%
      Weighted average rate paid during the year....    2.70%   4.95%   3.44%
</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.

                                      46

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(9)  Income Taxes

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

<TABLE>
<CAPTION>
                                                         2001  2000  1999
                                                        ------ ----- -----
    <S>                                                 <C>    <C>   <C>
    Current:
       Federal......................................... $2,795 1,909 2,724
       State...........................................    393   336   371
                                                        ------ ----- -----
                                                         3,188 2,245 3,095
                                                        ------ ----- -----
    Deferred:
       Federal.........................................    362   392   (57)
       State...........................................     50    --    --
                                                        ------ ----- -----
                                                           412   392   (57)
                                                        ------ ----- -----
           Total....................................... $3,600 2,637 3,038
                                                        ====== ===== =====
</TABLE>

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

<TABLE>
<CAPTION>
                                                          2001  2000   1999
                                                          ----  -----  ----
    <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........................ (6.7) (10.1) (9.7)
       Expenses not deductible for tax purposes..........   .7     .8    .6
       State taxes, net of Federal income tax benefit....  2.5    2.3   2.2
       Other.............................................  (.5)     4     3
                                                          ----  -----  ----
    Effective tax rates.................................. 30.0%  27.4% 27.4%
                                                          ====  =====  ====
</TABLE>

   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>
                                                                 2001     2000
                                                                -------  ------
<S>                                                             <C>      <C>
Deferred tax assets:
   Loan loss reserves.......................................... $ 2,030   1,677
   Basis of intangible assets for tax purposes in excess of
     basis for financial reporting.............................     184     169
   Unrealized loss on securities available for sale............      --     164
   Other.......................................................     155     151
                                                                -------  ------
       Total gross deferred tax assets.........................   2,369   2,161
       Less valuation allowance................................      --      --
                                                                -------  ------
       Net deferred tax assets.................................   2,369   2,161
                                                                -------  ------
Deferred tax liabilities:
   Fixed assets, due to depreciation differences...............    (925)   (698)
   Deferred loan costs deducted for tax purposes as incurred...    (524)   (578)
   Deferred loan fees recognized under the principal reduction
     method for tax purposes...................................    (672)   (545)
   Prepaid pension expense.....................................    (673)   (497)
   Other.......................................................    (297)    (10)
                                                                -------  ------
       Total gross deferred tax liabilities....................  (3,091) (2,328)
                                                                -------  ------
       Net deferred tax asset (liability)...................... $  (722)   (167)
                                                                =======  ======
</TABLE>

                                      47

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


   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 expense related to the change in unrealized gains and losses on
securities available for sale of $314 has been recorded directly to
shareholders equity. The rest of the change in the deferred tax liability
results from the current period deferred tax expense of $412.

   No valuation allowance for deferred tax assets has been established at
either December 31, 2001 or 2000. 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 1998 and subsequent years are subject to examination by the
taxing authorities.

   The Internal Revenue Service is currently examining the Company's federal
income tax returns for the years 1997 and 1998. Although the amount of any
ultimate liability with respect to such examination cannot be determined, it is
the opinion of management, any such liability will not have a material impact
on the Company's financial position or results of operations.

(10)  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>
                                                           2001   2000
                                                          ------  -----
       <S>                                                <C>     <C>
       Change in benefit obligation
          Benefit obligation at beginning of year........ $5,871  5,159
          Service cost...................................    486    356
          Interest cost..................................    462    400
          Actuarial loss (gain)..........................  1,440    144
          Benefits paid..................................   (257)  (188)
                                                          ------  -----
          Benefit obligation at end of year.............. $8,002  5,871

       Change in plan assets
          Fair value of plan assets at beginning of year.  6,592  6,422
          Actual return on plan assets...................     54     24
          Employer contribution..........................    625    334
          Benefits paid..................................   (257)  (188)
                                                          ------  -----
          Fair value of plan assets at end of year....... $7,014  6,592
                                                          ======  =====

       Funded status.....................................   (988)   721
       Unrecognized prior service cost...................     43     51
       Unrecognized net actuarial loss...................  2,590    747
       Unrecognized transition...........................    (26)   (52)
                                                          ------  -----
       Prepaid benefit cost included in other assets..... $1,619  1,467
                                                          ======  =====
</TABLE>

                                      48

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


<TABLE>
<CAPTION>
                                                         2001   2000  1999
                                                         -----  ----  ----
    <S>                                                  <C>    <C>   <C>
    Components of net periodic benefit cost:
       Service cost..................................... $ 356   343   335
       Interest cost....................................   400   348   310
       Expected return on plan assets...................  (522) (463) (404)
       Amortization of transition asset.................   (26)  (26)  (26)
       Amortization of prior service cost...............     9     9     9
       Amortization of loss.............................    --    --     7
                                                         -----  ----  ----
       Net periodic benefit cost........................ $ 217   211   231
                                                         =====  ====  ====

    Weighted-average assumptions at December 31:
       Discount rate....................................  6.50% 7.75% 7.75%
       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>

   (b) 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, 2001 and
       2000, 589,000 and 534,000 shares, respectively, had been granted under
       these plans.

       At December 31, 2001 and 2000, there were 74,800 and 120,000 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>
                                                       Weighted-Average
                                         Stock Options  Exercise Price
                                         ------------- ----------------
        <S>                              <C>           <C>
        Outstanding at December 31, 1998    286,800         $ 7.55
           Granted......................     18,000          13.00
           Exercised....................    (27,444)          5.76

        Outstanding at December 31, 1999    277,356           7.96
           Granted......................     40,000          13.00
           Forfeited....................    (28,000)         13.00
           Exercised....................    (28,900)          5.81

        Outstanding at December 31, 2000    260,456           8.55
           Granted......................     55,000          13.50
           Forfeited....................     (9,800)          8.75
           Exercised....................    (28,926)          5.87

        Outstanding at December 31, 2001    276,730         $ 9.81
</TABLE>

                                      49

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


   The following table summarizes information about stock options outstanding
at December 31, 2001:

<TABLE>
<CAPTION>
                                      Options Outstanding                  Options Exercisable
                         --------------------------------------------- ----------------------------
                           Number    Weighted-Average                    Number
                         Outstanding    Remaining     Weighted-Average Exercisable Weighted-Average
Range of Exercise Prices at 12/31/01 Contractual Life  Exercise Price  at 12/31/01  Exercise Price
------------------------ ----------- ---------------- ---------------- ----------- ----------------
<S>                      <C>         <C>              <C>              <C>         <C>
$3.92 - 4.13............     5,730      1.00 years         $ 4.13          5,730        $ 4.13
$4.52 - 4.85............    11,500      2.00 years           4.52         11,500          4.52
$6.88 - 8.75............   174,500      7.13 years           8.63        121,300          8.64
$13.00 - 13.50..........    85,000      9.65 years          13.32         23,000         13.24
                           -------      ----------         ------        -------        ------
Total...................   276,730      7.56 years         $ 9.81        161,530        $ 8.84
                           =======      ==========         ======        =======        ======
</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 2001, 2000 and 1999.

   The Company accounts for its stock options in accordance with 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
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 2001,
2000 and 1999 were $4.27, $5.15 and $4.30, 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 4.70%, 6.41% and 5.65%,
respectively; expected dividend yields of 1.50%, 1.40% and 1.30%, respectively;
and expected volatility factors of 19.10%, 20.50% and 21.30%, 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 2001, 2000 and 1999 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>
                                                        2001   2000   1999
                                                       ------ ------ ------
     <S>                                               <C>    <C>    <C>
     Net income--as reported.......................... $8,400 $6,975 $8,069
     Net income--pro forma............................  8,259  6,863  7,984
     Net income per common share-basic--as reported...   1.34   1.12   1.30
     Net income per common share-basic--pro forma.....   1.32   1.10   1.29
     Net income per common share-dilutive--as reported   1.31   1.09   1.26
     Net income per common share-dilutive--pro forma..   1.28   1.07   1.25
</TABLE>

   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.

                                      50

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(11)  Net Income per Common 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, 2001, 2000 and 1999:

<TABLE>
<CAPTION>
                                                                    Income       Shares     Per-Share
                                                                  (Numerator) (Denominator)  Amount
                                                                  ----------- ------------- ---------
<S>                                                               <C>         <C>           <C>
2001
Basic EPS:
Income available to common stockholders..........................   $8,400      6,263,031     $1.34
Effect of dilutive securities: stock options.....................       --        168,952        --
                                                                    ------      ---------     -----
Diluted EPS:
Income available to common stockholders plus assumed exercises of
  stock options..................................................   $8,400      6,431,983     $1.31
                                                                    ======      =========     =====
</TABLE>

<TABLE>
<CAPTION>
                                                                    Income       Shares     Per-Share
                                                                  (Numerator) (Denominator)  Amount
                                                                  ----------- ------------- ---------
<S>                                                               <C>         <C>           <C>
2000
Basic EPS:
Income available to common stockholders..........................   $6,975      6,241,775     $1.12
Effect of dilutive securities: stock options.....................       --        180,682        --
                                                                    ------      ---------     -----
Diluted EPS:
Income available to common stockholders plus assumed exercises of
  stock options..................................................   $6,975      6,422,457     $1.09
                                                                    ======      =========     =====
</TABLE>

<TABLE>
<CAPTION>
                                                                    Income       Shares     Per-Share
                                                                  (Numerator) (Denominator)  Amount
                                                                  ----------- ------------- ---------
<S>                                                               <C>         <C>           <C>
1999
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>

(12)  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 $5,600 and $2,524 at December 31, 2001 and 2000,
respectively. From January 1 through December 31, 2001, these directors and
executive officers and their related interests borrowed $7,536 and repaid
$4,347. In the opinion of management, these loans do not involve more than the
normal risk of collectibility and do not present other unfavorable features.

                                      51

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(13)  Commitments and Contingencies

   On December 31, 2001, 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>
                        2002.................... $  714
                        2003....................    635
                        2004....................    518
                        2005....................    200
                        2006....................    179
                        Subsequent years........  1,227
                                                 ------
                                                 $3,473
                                                 ======
</TABLE>

   Rental expense was $786, $768 and $469 for the years ended December 31,
2001, 2000 and 1999, respectively.

   In 2001, the Bank became involved in a lawsuit related to the Sales Finance
Department. The Bank does not believe that the claims are well founded and is
vigorously pursuing its counterclaims. However, due to the current status of
the case, it is difficult to predict the outcome of this litigation and its
potential impact on the consolidated financial statements.

   In the normal course of business the Company and subsidiary are periodically
involved in other 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.

(14)  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.

                                      52

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


   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 Available For Sale

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

   (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, 2001 and
       2000, 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 4 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 (Master
       note), Federal Funds Sold and Federal Funds Purchased

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

                                      53

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(14)  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>
                                                          2001                2000
                                                   ------------------- -------------------
                                                   Carrying Estimated  Carrying Estimated
                                                    Amount  Fair Value  Amount  Fair Value
                                                   -------- ---------- -------- ----------
<S>                                                <C>      <C>        <C>      <C>
Cash and due from banks........................... $ 27,742   27,742    36,305    36,305
                                                   ========  =======   =======   =======
Federal funds sold................................ $ 17,949   17,949     1,879     1,879
                                                   ========  =======   =======   =======
Federal Home Loan Bank stock...................... $  1,733    1,733     1,733     1,733
                                                   ========  =======   =======   =======
Investment securities available for sale.......... $ 95,095   95,095    98,601    98,601
                                                   ========  =======   =======   =======
Loans held for sale............................... $ 10,054   10,054       611       611
                                                   ========  =======   =======   =======
Loans:
   Commercial mortgage............................ $222,303  222,133   172,693   172,693
   Commercial other...............................  152,460  151,761   133,245   133,120
   Real estate--mortgage..........................   49,147   49,073    48,450    48,678
   Installment mortgage...........................   84,011   84,560    84,123    84,100
   Installment other..............................   45,900   45,103    59,731    58,668
                                                   --------  -------   -------   -------
       Total loans, gross......................... $553,821  552,630   498,242   497,158
                                                   ========  =======   =======   =======
Deposits.......................................... $645,300  652,318   572,666   572,771
                                                   ========  =======   =======   =======
Borrowings:
   Securities sold under agreements to repurchase. $ 15,313   15,313    19,923    19,923
   Commercial paper (Master note).................   11,076   11,076    15,359    15,359
                                                   --------  -------   -------   -------
                                                   $ 26,389   26,389    35,282    35,282
                                                   ========  =======   =======   =======
</TABLE>

                                      54

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


(15)  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, 2001, the Bank had available
retained earnings of approximately $11,698 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 as
of December 31, 2001 and 2000, and the related condensed statements of
operations and cash flows for the three-year period ended December 31, 2001 are
as follows:

                       Statements of Financial Condition

<TABLE>
<CAPTION>
                                                             2001    2000
                                                            ------- ------
      <S>                                                   <C>     <C>
      Assets
      Cash................................................. $   508    366
      Due from subsidiary..................................  11,076 15,359
      Investment in wholly-owned bank subsidiary...........  57,856 51,462
      Goodwill, net........................................     704    765
                                                            ------- ------
         Total assets...................................... $70,144 67,952
                                                            ======= ======
      Liabilities and Shareholders' Equity
      Commercial paper (Master note)....................... $11,076 15,359
                                                            ------- ------
         Total liabilities.................................  11,076 15,359
                                                            ------- ------
      Shareholders' equity.................................  59,068 52,593
                                                            ------- ------
         Total liabilities and shareholders' equity........ $70,144 67,952
                                                            ======= ======
</TABLE>

                           Statements of Operations

<TABLE>
<CAPTION>
                                                         2001   2000   1999
                                                        ------  -----  -----
  <S>                                                   <C>     <C>    <C>
  Interest income from commercial paper (Master note).. $  359    789    526
  Dividends received from Bank.........................  2,569  2,310  1,956
  Equity in undistributed earnings of subsidiary.......  5,892  4,725  6,174
  Interest expense on commercial paper (Master note)...   (359)  (789)  (526)
  Other operating expenses.............................    (61)   (60)   (61)
                                                        ------  -----  -----
  Net income........................................... $8,400  6,975  8,069
                                                        ======  =====  =====
</TABLE>

                                      55

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


                           Statements of Cash Flows

<TABLE>
<CAPTION>
                                                              2001     2000    1999
                                                             -------  ------  ------
<S>                                                          <C>      <C>     <C>
Cash flows from operating activities:
   Net income............................................... $ 8,400   6,975   8,069
   Decrease (increase) in due from subsidiary...............   4,283  (2,786) (1,714)
   Earnings retained by wholly owned subsidiary.............  (5,892) (4,725) (6,174)
   Amortization of goodwill.................................      61      61      62
                                                             -------  ------  ------
       Net cash provided (used) by operating activities.....   6,852    (475)    243
                                                             -------  ------  ------
Cash flows from financing activities:
   Net change in commercial paper (Master note).............  (4,283)  2,786   1,714
   Proceeds from issuance of common stock...................     142     168     156
   Dividends paid...........................................  (2,569) (2,310) (1,956)
                                                             -------  ------  ------
       Net cash (used) provided by financing activities.....  (6,710)    644     (86)
                                                             -------  ------  ------
Net increase in cash........................................     142     169     157
Cash at beginning of year...................................     366     197      40
                                                             -------  ------  ------
Cash at end of year......................................... $   508     366     197
                                                             =======  ======  ======
</TABLE>

(16)  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, 2001, that the Company and the Bank
meet all capital adequacy requirements to which they are subject.

   At December 31, 2001 and 2000 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.

                                      56

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


<TABLE>
<CAPTION>
                                                                            To Be Well
                                                                         Capitalized Under
                                                          For Capital    Prompt Corrective
                                            Actual     Adequacy Purposes Action Provisions
                                        -------------  ----------------- -----------------
As of December 31, 2001:                Amount  Ratio   Amount    Ratio   Amount    Ratio
------------------------                ------- -----  -------    -----  -------   -------
<S>                                     <C>     <C>    <C>        <C>    <C>        <C>
Total capital to risk-weighted assets:
   Company............................. $60,068 10.81% $44,454    8.00%      N/A      N/A
   Bank................................ $59,561 10.72% $44,454    8.00%  $55,568    10.00%
Tier 1 capital to risk-weighted assets:
   Company............................. $54,411  9.79% $22,227    4.00%      N/A      N/A
   Bank................................ $53,904  9.70% $22,227    4.00%  $33,341     6.00%
Tier 1 capital to average assets:
   Company............................. $54,411  7.45% $29,204    4.00%      N/A      N/A
   Bank................................ $53,904  7.38% $29,209    4.00%  $36,512     5.00%
</TABLE>

<TABLE>
<CAPTION>
As of December 31, 2000:
------------------------
<S>                                     <C>     <C>    <C>     <C>   <C>     <C>
Total capital to risk-weighted assets:
   Company............................. $53,447 10.76% $39,719 8.00%     N/A   N/A
   Bank................................ $53,081 10.69% $39,719 8.00% $49,649 10.00%
Tier 1 capital to risk-weighted assets:
   Company............................. $48,001  9.67% $19,860 4.00%     N/A   N/A
   Bank................................ $47,635  9.59% $19,860 4.00% $29,789  6.00%
Tier 1 capital to average assets:
   Company............................. $48,001  7.40% $25,934 4.00%     N/A   N/A
   Bank................................ $47,635  7.35% $25,936 4.00% $32,420  5.00%
</TABLE>

(17)  Quarterly Financial Data (Unaudited)

   Quarterly operating data for the years ended December 31 is summarized as
follows:

<TABLE>
<CAPTION>
                                                                   2001
                                                  --------------------------------------
                                                   First  Second   Third  Fourth
                                                  Quarter Quarter Quarter Quarter Total
                                                  ------- ------- ------- ------- ------
<S>                                               <C>     <C>     <C>     <C>     <C>
Net interest income.............................. $6,785   7,322   7,574   8,041  29,722
Provision for loan losses........................    850   1,388     900     900   4,038
Non-interest income..............................  2,602   3,477   3,232   3,558  12,869
Non-interest expense.............................  6,197   6,405   6,832   7,119  26,553
Income tax provision.............................    670     916     882   1,132   3,600
                                                  ------   -----   -----   -----  ------
Net income....................................... $1,670   2,090   2,192   2,448   8,400
                                                  ======   =====   =====   =====  ======
Net income per share-basic....................... $ 0.27    0.33    0.35    0.39    1.34
                                                  ======   =====   =====   =====  ======
Net income per share-dilutive.................... $ 0.26    0.32    0.35    0.38    1.31
                                                  ======   =====   =====   =====  ======
</TABLE>

                                      57

<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY

            Notes to Consolidated Financial Statements--(Continued)


<TABLE>
<CAPTION>
                                                       2000
                                      --------------------------------------
                                       First  Second   Third  Fourth
                                      Quarter Quarter Quarter Quarter Total
                                      ------- ------- ------- ------- ------
   <S>                                <C>     <C>     <C>     <C>     <C>
   Net interest income............... $6,480   6,786   6,616   6,608  26,490
   Provision for loan losses.........    525   1,610     800     945   3,880
   Non-interest income...............  2,177   2,407   2,314   2,653   9,551
   Non-interest expense..............  5,494   5,437   5,719   5,899  22,549
   Income tax provision..............    743     605     608     681   2,637
                                      ------   -----   -----   -----  ------
   Net income........................ $1,895   1,541   1,803   1,736   6,975
                                      ======   =====   =====   =====  ======
   Net income per share-basic........ $ 0.30    0.25    0.29    0.28    1.12
                                      ======   =====   =====   =====  ======
   Net income per share-dilutive..... $ 0.30    0.24    0.28    0.27    1.09
                                      ======   =====   =====   =====  ======
</TABLE>

                                      58

<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" in the definitive Proxy
Statement of the Company filed in connection with its 2002 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" in the definitive Proxy
Statement of the Company filed in connection with its 2002 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" in the
definitive Proxy Statement of the Company filed in connection with its 2002
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" in the definitive Proxy
Statement of the Company filed in connection with its 2002 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.

   (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
</TABLE>

                                      59

<PAGE>

<TABLE>
<CAPTION>
Exhibit No.                                            Description
-----------                                            -----------
<S>         <C>

   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.

  10.1*       Palmetto Bancshares, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10 (a) to the
              Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the
              Securities and Exchange Commission on May 2, 1988.

  10.2*       The Palmetto Bank Pension Plan and Trust Agreement: Incorporated by reference to Exhibit 10 (c)
              to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with
              the Securities and Exchange Commission on May 2, 1988.

  10.3*       The Palmetto Bank Officer Incentive Compensation Plan

  10.4*       Palmetto Bancshares, Inc. 1997 Stock Compensation Plan, as amended to date: incorporated by
              reference to Exhibit 10.1 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
</TABLE>
--------
*  Management contract or compensatory plan or arrangement.

^  Filed herewith.

   (b) Reports on Form 8-K

       The Registrant did not file any reports on Form 8-K during the three
       months ended December 31, 2001.

   (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.

                                      60

<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 19, 2002

   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:

          Signature                       Title                   Date
          ---------                       -----                   ----

   /s/  L. LEON PATTERSON               Director            February 19, 2002
-----------------------------
      L. Leon Patterson

    /s/  PAUL W. STRINGER               Director            February 19, 2002
-----------------------------
      Paul W. Stringer

   /s/  W. FRED DAVIS, JR.              Director            February 19, 2002
-----------------------------
     W. Fred Davis, Jr.

  /s/  DAVID P. GEORGE, JR.             Director            February 19, 2002
-----------------------------
    David P. George, Jr.

    /s/  MICHAEL D. GLENN               Director            February 19, 2002
-----------------------------
      Michael D. Glenn

  /s/  JOHN T. GRAMLING, II             Director            February 19, 2002
-----------------------------
    John T. Gramling, II

    /s/  WILLIAM S. MOORE               Director            February 19, 2002
-----------------------------
      William S. Moore

  /s/  SAM B. PHILLIPS, JR.             Director            February 19, 2002
-----------------------------
    Sam B. Phillips, Jr.

/s/  JAMES M. SHOEMAKER, JR.            Director            February 19, 2002
-----------------------------
   James M. Shoemaker, Jr.

      /s/  ANN B. SMITH                 Director            February 19, 2002
-----------------------------
        Ann B. Smith

/s/  EDWARD KEITH SNEAD, III            Director            February 19, 2002
-----------------------------
   Edward Keith Snead, III

  /s/  J. DAVID WASSON, JR.             Director            February 19, 2002
-----------------------------
    J. David Wasson, Jr.

                                      61

<PAGE>

                                 EXHIBIT INDEX

<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.

  10.1*     Palmetto Bancshares, Inc. Stock Option Plan: Incorporated by reference to Exhibit 10 (a) to the
              Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed with the
              Securities and Exchange Commission on May 2, 1988.
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
Exhibit No.                                           Description
-----------                                           -----------
<C>         <S>

   10.2*    The Palmetto Bank Pension Plan and Trust Agreement: Incorporated by reference to Exhibit 10 (c)
              to the Company's Registration Statement on Form S-4, Commission File No. 33-19367, filed
              with the Securities and Exchange Commission on May 2, 1988.

   10.3*    The Palmetto Bank Officer Incentive Compensation Plan

   10.4*    Palmetto Bancshares, Inc. 1997 Stock Compensation Plan, as amended to date: incorporated by
              reference to Exhibit 10.1 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
</TABLE>
--------
*  Management contract or compensatory plan or arrangement.

^  Filed herewith.