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UNITED STATES

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, 2010

or

| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------

For the transition period from                  to

Commission file number 0-26016







PALMETTO BANCSHARES, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|South Carolina                                                 |  | 74-2235055                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)   
|                                                               | 
|306 East North Street, Greenville, South Carolina              |  | 29601                               
|(Address of principal executive offices)                       |  | (Zip Code)                          
|                                                               | 
|(800) 725-2265                                                 |  | palmettobank.com                    
|(Registrants telephone number)                                |  | (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 $0.01 per share

(Title of class)



Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ̈    No  x



Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ̈    No  x



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 whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).    Yes   ̈    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.   ̈



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of accelerated filer, large accelerated filer, and smaller reporting company in Rule 12b-2 of the Act.



|                             |  |                               
|---------------------------- |  | ------------------------------
|Large accelerated filer     ̈ |  | Accelerated filer     ̈        
|Non accelerated filer     ̈   |  | Smaller reporting company    x



Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the
Act).    Yes   ̈  No  x



The aggregate market value of the voting and nonvoting
common equity held by nonaffiliates of the registrant (computed by reference to the price at which the stock was most recently sold) was $14,105,595 as of the last business day of the registrants most recently completed second fiscal quarter.
See Part II, Item 5.



50,513,722 shares of the
registrants common stock were outstanding as of February 22, 2011.



DOCUMENTS INCORPORATED BY REFERENCE



The Companys Proxy Statement with respect to an Annual Meeting of Shareholders to be held May 19, 2011 is incorporated by reference in Part III of this Form 10-K.









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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



2010 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS



|                           |  |                                                                                                              |     |  |     | 
|-------------------------- |  | ------------------------------------------------------------------------------------------------------------ | --- |  | --- | 
|PART I                     |  |                                                                                                              |     | 
|                           | 
|FORWARD-LOOKING STATEMENTS |  |                                                                                                              | 1   | 
|ITEM 1.                    |  | BUSINESS                                                                                                     |     |  | 3   | 
|ITEM 1A.                   |  | RISK FACTORS                                                                                                 |     |  | 23  | 
|ITEM 1B.                   |  | UNRESOLVED STAFF COMMENTS                                                                                    |     |  | 35  | 
|ITEM 2.                    |  | PROPERTIES                                                                                                   |     |  | 35  | 
|ITEM 3.                    |  | LEGAL PROCEEDINGS                                                                                            |     |  | 36  | 
|ITEM 4.                    |  | (REMOVED AND RESERVED)                                                                                       |     |  | 36  | 
|                          
|PART II                    | 
|                           |  |                                                                                                             
|ITEM 5.                    |  | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |     |  | 37  | 
|ITEM 6.                    |  | SELECTED FINANCIAL DATA                                                                                      |     |  | 40  | 
|ITEM 7.                    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |     |  | 41  | 
|                           |  | CRITICAL ACCOUNTING POLICIES AND ESTIMATES                                                                   |     |  | 41  | 
|                           |  | EXECUTIVE SUMMARY OF 2010 FINANCIAL RESULTS                                                                  |     |  | 48  | 
|                           |  | FINANCIAL CONDITION                                                                                          |     |  | 59  | 
|                           |  | DERIVATIVE ACTIVITIES                                                                                        |     |  | 96  | 
|                           |  | LIQUIDITY                                                                                                    |     |  | 97  | 
|                           |  | EARNINGS REVIEW                                                                                              |     |  | 101 | 
|                           |  | RECENTLY ISSUED / ADOPTED AUTHORITATIVE PRONOUNCEMENTS                                                       |     |  | 113 | 
|                           |  | IMPACT OF INFLATION AND CHANGING PRICES                                                                      |     |  | 113 | 
|ITEM 7A.                   |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   |     |  | 114 | 
|ITEM 8.                    |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  |     |  | 116 | 
|ITEM 9.                    |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         |     |  | 183 | 
|ITEM 9A.                   |  | CONTROLS AND PROCEDURES                                                                                      |     |  | 183 | 
|ITEM 9B.                   |  | OTHER INFORMATION                                                                                            |     |  | 183 | 
|                          
|PART III                   | 
|                           |  |                                                                                                             
|ITEM 10.                   |  | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                       |     |  | 184 | 
|ITEM 11.                   |  | EXECUTIVE COMPENSATION                                                                                       |     |  | 184 | 
|ITEM 12.                   |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS               |     |  | 184 | 
|ITEM 13.                   |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                    |     |  | 184 | 
|ITEM 14.                   |  | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                       |     |  | 184 | 
|                          
|PART IV                    | 
|                           |  |                                                                                                             
|ITEM 15.                   |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                      |     |  | 185 | 
|                           | 
|SIGNATURES                 |  |                                                                                                              | 187 | 
|                           | 
|EXHIBIT INDEX              |  |                                                                                                              | 189 | 



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PART I



FORWARD-LOOKING STATEMENTS



This report, including information
included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of
future performance. Our actual results may differ materially from those anticipated in any forward-looking statements as they will depend on many factors about which we are unsure including many factors which are beyond our control. The words
may, would, could, should, will, expect, anticipate, predict, project, potential, continue, assume,
believe, intend, plan, forecast, goal, and estimate as well as similar expressions are meant to identify such forward-looking statements. Potential risks and uncertainties
that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, but are not limited to, the following:



| |  |  | Greater than expected losses could occur due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio
secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Greater than expected losses could occur due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower
type, or location of the borrower or collateral,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The rate of delinquencies and amounts of loans charged-off,
| | - |  | -----------------------------------------------------------



| |  |  | The adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | Our ability to complete the sale of our commercial loans held for sale, specifically at values equal or above the currently recorded loan balances
which would not result in additional writedowns,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our ability to maintain appropriate levels of capital, including the potential that the regulatory agencies may require higher levels of capital
above the standard regulatory-mandated minimums,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our ability to comply with our Consent Order and potential regulatory actions if we fail to comply,
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Our ability to attract and retain key personnel,
| | - |  | ------------------------------------------------



| |  |  | Our ability to retain our existing customers, including our deposit relationships,
| | - |  | ----------------------------------------------------------------------------------



| |  |  | The rates of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio,
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | The amount of our loan portfolio collateralized by real estate, and weakness in the real estate market,
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Increased funding costs due to market illiquidity, increased competition for funding, and / or increased regulatory requirements with regard to
funding,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in availability of wholesale funding sources, including increases in collateral margin requirements,
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Significant increases in competitive pressure in the banking and financial services industries,
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Changes in the interest rate environment which could reduce anticipated or actual margins,
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | Changes in political conditions and the legislative or regulatory environment, including the effect of the recent financial reform legislation on
the banking and financial services industries,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



1



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| |  |  | General economic conditions, either nationally or regionally and especially in our primary service areas, becoming less favorable than expected,
resulting in, among other things, a further deterioration in credit quality,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes occurring in business conditions and inflation,
| | - |  | -------------------------------------------------------



| |  |  | Changes in technology,
| | - |  | ----------------------



| |  |  | Changes in deposit flows,
| | - |  | -------------------------



| |  |  | Changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board
and the Financial Accounting Standards Board,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Potential limitations on our ability to utilize net operating loss carryforwards and net unrealized built in losses for income tax purposes due to
the change in control resulting from the Private Placement transaction,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Risks associated with income taxes, including the potential for adverse adjustments and the inability to reverse valuation allowances on deferred
tax assets,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in accounting principles, policies, or guidelines,
| | - |  | ----------------------------------------------------------



| |  |  | Our ability to maintain effective internal control over financial reporting,
| | - |  | ----------------------------------------------------------------------------



| |  |  | Our reliance on available secondary funding sources such as Federal Home Loan Bank (FHLB) advances, the Board of Governors of the
Federal Reserve (the Federal Reserve) Discount Window borrowings, sales of securities and loans, and lines of credit from correspondent banks to meet our liquidity needs,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adverse changes in asset quality and resulting credit risk-related losses and expenses,
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | The value of our stock price, including our ability to become listed on a national stock exchange and the resulting impact on our stock price as a
result of such listing,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions,
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in the securities markets, and / or
| | - |  | -------------------------------------------



| |  |  | Other risks and uncertainties detailed in Part I, Item 1A of this Annual Report on Form 10-K, and from time to time in our other filings with
the SEC.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



These risks are
exacerbated by the state of national and international financial markets, and we are unable to predict what impact these uncertain market conditions will have on us. During 2008 and 2009, the capital and credit markets experienced extended
volatility and disruption which continued to impact the Company in 2010. There can be no assurance that these unprecedented developments will not continue to materially and adversely impact our business, financial condition, and results of
operations, as well as our ability to maintain sufficient capital or other funding for liquidity and business purposes.



We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations
reflected in our forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements whether as a result of new
information, future events, or otherwise.



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|ITEM 1. | BUSINESS
|------- | --------



Development and Description of Business



Organization



Palmetto Bancshares, Inc. (the Company) is a
regional bank holding company organized in 1982 under the laws of South Carolina and is headquartered in Greenville, South Carolina. Through the Companys subsidiary, The Palmetto Bank (the Bank), and the Banks wholly-owned
subsidiary Palmetto Capital, Inc. (Palmetto Capital), we provide a broad array of commercial banking, consumer banking, trust and investment management, and brokerage services throughout our primary market area of northwest South
Carolina. Throughout this report, the Company, we, us, or our refers to Palmetto Bancshares, Inc. and our subsidiary, the Bank, which includes its brokerage subsidiary, Palmetto Capital, except where
the context indicates otherwise.



Since the
Company is a holding company and does not conduct stand alone operations, the Companys primary sources of liquidity are debt and equity offerings by the Company and dividends upstreamed from the Bank.



Subsidiary of Palmetto Bancshares,
Inc.    The Bank was organized under South Carolina law in 1906. The Company owns all of the Banks capital stock. The Bank primarily acts as a financial intermediary by attracting deposits from the general public and
using those funds, together with borrowed funds, to originate loans and invest in securities. In light of the capital received in the Private Placement and stagnant loan origination activity in 2010, the Bank also currently holds a substantial
portion of its assets as cash on deposit at the Federal Reserve.



Significant services offered by the Bank include:



| |  |  | Commercial Banking. The Bank provides commercial banking services to corporations and other business clients. Loans are made for a wide
variety of corporate purposes, including financing industrial and commercial properties, construction related to industrial and commercial properties, equipment, inventories and accounts receivable, and acquisition financing. The Bank also provides
cash management products and offers merchant services through a third party referral arrangement.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Consumer Banking. The Bank provides consumer banking services, including checking accounts, savings programs, automated teller machines, overdraft
facilities, installment and real estate loans, residential first mortgage loans, home equity loans and lines of credit, credit cards, drive-in and night deposit services, and safe deposit facilities.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Wealth Management. The Bank provides trust, investment, agency, insurance, and custodial services for individual and corporate clients.
These services include the administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit plans, and charitable foundations. At December 31, 2010, the estimated fair value of
customer assets managed and / or serviced by the Banks trust unit was approximately $241.9 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Subsidiaries of the Bank.    Palmetto Capital is a wholly-owned subsidiary of the Bank and provides brokerage
services relating to stocks, treasury, corporate and municipal bonds, mutual funds, and insurance annuities, as well as college and retirement planning through a third party arrangement with Raymond James Financial Services, Inc., an affiliate of
Raymond James & Associates, Inc. At December 31, 2010, the estimated fair value of customer assets in accounts serviced by the Banks brokerage unit was approximately $175.9 million.



In 2009, the Bank formed a wholly-owned subsidiary, Palmetto
Loan Subsidiary, Inc. To date, there have been no significant operations in this subsidiary.



Our corporate offices are located at 306 East North, Greenville, South Carolina 29601, and our main telephone number is (800) 725-2265. Our corporate headquarters was relocated to downtown
Greenville, South Carolina in 2009. Our operations center remains at the Laurens location.



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The following table summarizes our consolidated assets, revenues, and net income (loss) at
the dates and for the periods indicated (in thousands).



|                                     |  |                                         |           |   |      |   |           |      |  |   |           | 
|------------------------------------ |  | --------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | 
|                                     |  | At and for the years ended December 31, |          
|                                     |  | 2010                                    |           |   | 2009 |   |           | 2008 | 
|Total consolidated assets            |  | $                                       | 1,355,247 |   |      | $ | 1,435,763 |      |  | $ | 1,368,328 | 
|Total consolidated revenues          |  |                                         | 74,228    |   |      |   | 83,641    |      |  |   | 96,262    | 
|Total consolidated net income (loss) |  |                                         | (60,202   | ) |      |   | (40,085   | )    |  |   | 13,599    | 



Market



The Company is a locally oriented, community-based financial services institution. Our local market orientation is reflected in our
management and advisory boards, which are comprised of local business persons, professionals, and other community representatives, who assist us in identifying and responding to banking needs within our market. Despite this community-based market
focus, we believe we offer many of the products and services available from larger competitors.



Our primary market area is located within northwest South Carolina and includes the counties of Laurens, Greenville, Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, Pickens, Oconee, and York, the
majority of which are referred to as the Upstate of South Carolina. We currently originate most of our loans and deposits in our primary market area.



The Upstates ability to attract both small, local
companies and major internationally recognized corporations is the result of cooperation between city and state governments and the private sector. We believe that the Upstates entrepreneurial spirit and strong workforce creates a strong
magnet for business. Major industries of commerce in the Upstate include the automobile industry which is concentrated mainly along the corridor between Greenville and Spartanburg around the BMW manufacturing facility in Greer. Greenville Hospital
System and Bon Secours St. Francis Health System represent the healthcare and pharmaceuticals industry in the area. The Upstate is also home to a large amount of private sector and university-based research, including research and development
facilities for Michelin, Fuji and General Electric, and research centers to support the automotive, life sciences, plastics and photonics industries. Clemson University, BMW, IBM, Microsoft, and Michelin have combined their resources to create
International Center for Automotive Research (ICAR), a research park that specializes in the development of automotive technology. The Upstate also benefits from being an academic center and is home to collegiate and university education facilities
such as Clemson University, Furman University, Presbyterian College, Wofford College, and Converse College, among others.



Located adjacent to major transportation corridors such as Interstates 85 and 26 and centrally located between Charlotte, North Carolina,
and Atlanta, Georgia, the Upstate provides a diversified, broad economic base. We believe that our primary market area is not dependent on any one or a few types of commerce due to the areas diverse economic base. Our customer base is
similarly diverse, although as a community bank our loan portfolio includes concentrations in construction and commercial real estate.



Despite being in what we believe are some of the best growth markets in South Carolina, we face the risk of being particularly sensitive
to changes in the state and local economies. South Carolina has not been immune to the economic challenges of the past two years. Unemployment has been rising in our markets and property values have declined. According to the Department of Labor,
unemployment rates, not seasonally adjusted, at December 31, 2010 for counties in our market areas were as follows: Greenville, 9.0%; Spartanburg, 10.9%; Anderson, 10.8%; and Laurens, 11.0%. The average state unemployment rate, seasonally
adjusted, for South Carolina at December 31, 2010 was 10.7% compared to 9.4% for the United States (U.S.). We believe continued elevated levels of unemployment will continue to adversely impact credit quality. As a result, we
continue to spend significant time on credit solutions for our customers and the management and disposition of foreclosed real estate as effectively as possible.



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The weakening in the state and local economies has impacted our loan demand and, to a lesser
extent, available deposits.



See Item 1A.
Risk Factors for a discussion regarding the material risks and uncertainties that may impact our market.



Distribution Channels



The Company, through the Bank, is primarily engaged in the business of commercial and consumer banking through our 29 banking offices in
the counties of Laurens, Greenville, Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, Pickens, Oconee, and York. In addition to our banking offices, at December 31, 2010, the Bank had 37 automatic teller machine locations (including nine
at nonbanking office locations) and six limited service banking offices located in retirement centers in the Upstate. We provide our services primarily through our banking office network. Additionally, Palmetto Capital maintains a separate
investment office location in Greenville County.



We provide customers with access to their funds through extended weekday hours at banking offices, Saturday banking at select banking
offices, an automatic teller machine network that incorporates regional and national networks, a call center, and Internet banking. Our banking offices also serve as locations where customers can apply for and obtain various loan products. We also
offer loans to finance the purchase of new and used automobiles through a network of auto dealerships throughout our footprint (commonly referred to as indirect lending).



During 2010, we redefined our organization structure and began the process of more specifically delineating our
businesses based on product and service offerings. However, at this time we do not yet have in place a reporting structure to separately report and evaluate our various lines of businesses. Our efforts to do so will continue in 2011.



See Item 1A. Risk Factors for a discussion regarding the
material risks and uncertainties that may impact our distribution channels.



Competition



We face substantial competition. Competitors include national banks, regional banks, and other community banks. We also face competition from many other types of financial institutions, including savings
and loan associations, finance companies, credit unions, mortgage banks, and other financial intermediaries as well as full service brokerage firms and discount brokerage firms with regard to the services offered by Palmetto Capital. Out-of-state
financial intermediaries that have opened loan production offices or that solicit deposits in our market areas also provide competition. In addition to historical competitors, in recent years, money market, stock, and fixed income mutual funds have
attracted an increasing share of household savings. Consequently, we consider these funds to be competitors. We compete with major financial companies that have greater resources than we have, which afford them a marketplace advantage by enabling
them to maintain numerous locations and mount extensive promotional and advertising campaigns. Additionally, due to their size, many competitors may offer a broader range of products and services as well as better pricing for those products and
services than we offer. In addition, banks and other financial institutions with larger capitalization and financial intermediaries that are not subject to bank regulatory restrictions may have larger lending limits that allow them to serve the
lending needs of larger customers. Because larger competitors have advantages in attracting business from larger corporations, we do not generally compete for that business. Instead, we concentrate our efforts on attracting the business of
individuals and small and medium-size businesses. With regard to such accounts, we generally compete on the basis of customer service and responsiveness to customer needs, the convenience of banking offices and hours, and the availability and
pricing of our products and services.



5



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The following table summarizes the Banks deposit market share information, as of
June 30, 2010, the most recent date for which data is available from the Federal Deposit Insurance Corporation (the FDIC).



|                                                             |  |                   |      |   |          |  |      |             |  |  |          |   |  |  |      |  
|------------------------------------------------------------ |  | ----------------- | ---- | - | -------- |  | ---- | ----------- |  |  | -------- | - |  |  | ---- | -
|                                                             |  | Metropolitan area |     
|                                                             |  | Greenville        |      |   | Anderson |  |      | Spartanburg |  |  | Combined |  
|Ranking among all institutions                               |  |                   | 6    |   |          |  | 9    |             |  |  | 10       |   |  |  | 7    |  
|Total institutions                                           |  |                   | 35   |   |          |  | 21   |             |  |  | 19       |   |  |  | 42   |  
|Market share among all institutions                          |  |                   | 4.80 | % |          |  | 4.54 | %           |  |  | 3.53     | % |  |  | 4.46 | %
|                                                             |  |                   |      |  
|Ranking among South Carolina headquartered institutions      |  |                   | 2    |   |          |  | 6    |             |  |  | 6        |   |  |  | 3    |  
|Total South Carolina headquartered institutions              |  |                   | 25   |   |          |  | 14   |             |  |  | 12       |   |  |  | 32   |  
|Market share among South Carolina headquartered institutions |  |                   | 8.58 | % |          |  | 7.71 | %           |  |  | 8.96     | % |  |  | 8.53 | %



With regard to the entire state of South Carolina, according to the FDIC, as of June 30, 2010, the Banks market share ranks 10th out of 107 institutions and 6th out of 87 South Carolina
headquartered institutions.



Employees



At December 31, 2010, we had 394
full-time equivalent employees, none of whom were subject to collective bargaining agreements, compared with 406 full-time equivalent employees at December 31, 2009. Based on the current and expected future size and scope of business activities
of the Company, we are currently focused on the proper alignment of roles and responsibilities within the Company. Such focus may result in the need to hire additional employees with specific expertise and industry knowledge.



Supervision and Regulation



General



We are subject to extensive regulation under federal and
state laws. The regulatory framework is intended primarily for the protection of depositors, federal deposit insurance funds, and the banking system as a whole and not for the protection of security holders.



Set forth below is a summary of the significant laws and
regulations applicable to the Company and the Bank. The description is qualified in its entirety by reference to the full text of the statutes, regulations, and policies that are described. Those statutes, regulations, and policies are continually
under review by Congress, state legislatures, and federal and state regulatory agencies. A change in statutes, regulations, or regulatory policies applicable to the Company and the Bank could have a material adverse impact on our business, financial
condition, results of operations, and cash flows.



See Item 1A. Risk Factors for a discussion regarding the material risks and uncertainties that may impact our supervision and
regulation.



Recent Legislative and Regulatory
Initiatives to Address Financial and Economic Crises



Congress, the U.S. Department of the Treasury (the U.S. Treasury), and the federal banking regulators, including the FDIC, have taken broad action throughout 2008, 2009 and 2010 to address
volatility and risk in the U.S. banking system.



The Emergency Economic Stabilization Act of 2008 (EESA) authorized the Treasury Secretary to purchase from financial
institutions and their holding companies up to $700 billion in mortgage loans, mortgage-backed securities, and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in
a Troubled Asset Relief Program (TARP). The U.S. Treasury allocated $250 billion towards the TARP Capital Purchase Program (CPP), pursuant to which the U.S.



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Treasury purchased debt or equity securities from participating institutions. The TARP also included direct purchases or guarantees of troubled assets of financial institutions. Participants in
the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications. Our Board of Directors determined not to participate in the CPP.



Following a systemic risk determination, the FDIC established
its Temporary Liquidity Guarantee Program (TLGP) in October 2008. Under the interim rule for the TLGP, there are two parts to the program: the Debt Guarantee Program (DGP) and the Transaction Account Guarantee Program
(TAGP). Eligible entities generally are participants unless they exercised an opt-out right in timely fashion. Under the DGP, the FDIC guarantees certain senior unsecured debt issued by participating entities. Under the TAGP, the FDIC
guarantees all funds held in qualifying noninterest-bearing transaction accounts at participating insured depository institutions.



The DGP initially permitted participating entities to issue FDIC-guaranteed senior unsecured debt until June 30, 2009, with the
FDICs guarantee for such debt to expire on the earlier of the maturity of the debt (or the conversion date, for mandatory convertible debt) or June 30, 2012. To reduce the potential for market disruptions at the conclusion of the DGP and
to begin the orderly phase-out of the program, on May 29, 2009 the FDIC issued a final rule that extended for four months the period during which certain participating entities could issue FDIC-guaranteed debt. All insured depository
institutions and those other participating entities that had issued FDIC-guaranteed debt on or before April 1, 2009 were permitted to participate in the extended DGP without application to the FDIC. Other participating entities that received
approval from the FDIC also were permitted to participate in the extended DGP. The expiration of the guarantee period was also extended from June 30, 2012 to December 31, 2012. As a result, all such participating entities were permitted to
issue FDIC-guaranteed debt through and including October 31, 2009, with the FDICs guarantee expiring on the earliest of the debts mandatory conversion date (for mandatory convertible debt), the stated maturity date, or
December 31, 2012. The Company opted out of the DGP.



For the TAGP, eligible entities are all FDIC-insured institutions. Under the TAGP, the FDIC provides unlimited deposit insurance coverage for noninterest-bearing transaction accounts (typically business
checking accounts) and certain funds swept into noninterest-bearing savings accounts. We elected to voluntarily participate in the TAGP through December 31, 2010. Throughout 2010, participating institutions paid fees of 15 to 25 basis points
(annualized), depending on the Risk Category assigned to the institution, on the balance of each covered account in excess of $250 thousand. Coverage under the TAGP was in addition to and separate from the basic coverage available under the
FDICs general deposit insurance rules. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) that was signed into law on July 21, 2010, the voluntary TAGP program will end on
December 31, 2010, and all institutions will be required to provide full deposit insurance on noninterest-bearing transaction accounts until December 31, 2012. There will not be a separate assessment for this as there was for institutions
participating in the TAGP program.



EESA has been
followed by numerous actions by the Federal Reserve, Congress, U.S. Treasury, the SEC and others to address the liquidity and credit crisis that followed the recession that commenced in 2007. These measures include homeowner relief that encourages
loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and banks; the lowering of the federal funds rate; action against short-term selling practices, the temporary guaranty
program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking
sector.



On July 21, 2010, the U.S. President
signed into law the Dodd-Frank Act. The Dodd-Frank Act will likely result in dramatic changes across the financial regulatory system, some of which become effective immediately and some of which will not become effective until various future
dates. Implementation of the Dodd-Frank Act will require many new rules to be made by various federal regulatory agencies over the next several years. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act until final
rulemaking is complete,



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which could have a material adverse impact either on the financial services industry as a whole or on our business, financial condition, results of operations, and cash flows. Provisions in
the legislation that affect consumer financial protection regulations, deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase the costs associated with deposits and place limitations on certain
revenues those deposits may generate. The Dodd-Frank Act includes provisions that, among other things, will:



| |  |  | Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection, responsible for
implementing, examining, and enforcing compliance with federal consumer financial laws.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Create the Financial Stability Oversight Council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity,
risk management and other requirements as companies grow in size and complexity.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Provide mortgage reform provisions regarding a customers ability to repay, restricting variable-rate lending by requiring that the ability to
repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other
revisions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate
the ceiling on the size of the Deposit Insurance Fund (DIF), and increase the floor on the size of the DIF, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Make permanent the $250,000 limit for federal deposit insurance and provide unlimited federal deposit insurance until December 31, 2012 for
noninterest-bearing demand transaction accounts at all insured depository institutions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, which apply to all public
companies, not just financial institutions.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business
transactions and other accounts.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amend the Electronic Fund Transfer Act (EFTA) to, among other things, give the Federal Reserve the authority to establish rules regarding
interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the
issuer.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Eliminate the Office of Thrift Supervision (OTS) one year from the date of the new laws enactment. The Office of the Comptroller of
the Currency (OCC), which is currently the primary federal regulator for national banks, will become the primary federal regulator for federal thrifts. In addition, the Federal Reserve will supervise and regulate all savings and
loan holding companies that were formerly regulated by the OTS.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On September 27, 2010, the U.S. President signed into law the Small Business Jobs Act of 2010 (the Act). The Small Business Lending Fund (the SBLF), which was enacted as part
of the Act, is a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. On December 21, 2010, the U.S. Treasury published the application form,
term sheet and their guidance for participation in the SBLF. Under the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1
capital for regulatory purposes and rank senior to a participating institutions common stock. The application deadline for participating in the SBLF is March 31, 2011. Based on the program criteria, we do not plan to participate in the
SBLF.



In November 2010, the Federal
Reserves monetary policymaking committee, the Federal Open Market Committee (FOMC), decided that further support to the economy was needed. With short-term interest rates



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already nearing 0%, the FOMC agreed to deliver that support by committing to purchase additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600
billion of longer-term U.S. Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August 2010.



On December 16, 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires
the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with
less than $10 billion in assets, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates.



On December 29, 2010, the Dodd-Frank Act was amended to include full FDIC insurance on Interest on Lawyers
Trust Accounts (IOLTAs.) IOLTAs will receive unlimited insurance coverage as noninterest-bearing transaction accounts for two years ending December 31, 2012.



With respect to any other potential future government
assistance programs, we will evaluate the merits of the programs, including the terms of the financing, the Companys capital position, the cost to the Company of alternative capital, and the Companys strategy for the use of additional
capital, to determine whether it is prudent to participate.



Proposed Legislation and Regulatory Action



Internationally, both the Basel Committee on Banking Supervision (the Basel Committee) and the Financial Stability Board (established in April 2009 by the Group of Twenty (G-20)
Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and
liquidity buffers within the banking system (Basel III).



On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity
ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with full implementation by January 2019.



In December 2010, the Basel Committee released its final
framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as Basel III. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank
holding companies and their bank subsidiaries to maintain substantially more capital with a greater emphasis on common equity.



The Basel III final capital framework, among other things, (i) introduces as a new capital measure Common Equity Tier 1
(CET1), (ii) specifies that Tier 1 capital consists of CET1 and Additional Tier 1 capital instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory
capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.



When fully phased in on January 1, 2019, Basel III
requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer (which is added to the 4.5% CET1 ratio as that
buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added
to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted
assets of at



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least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon
full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for
each quarter of the month-end ratios for the quarter).



Basel III also provides for a countercyclical capital buffer, generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup
of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).



The aforementioned capital conservation buffer is designed to
absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital
buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.



The implementation of the Basel III final framework will commence January 1, 2013. On that date, banking institutions will be
required to meet the following minimum capital ratios:



| |  |  | 3.5% CET1 to risk-weighted assets;
| | - |  | ----------------------------------



| |  |  | 4.5% Tier 1 capital to risk-weighted assets; and
| | - |  | ------------------------------------------------



| |  |  | 8.0% Total capital to risk-weighted assets.
| | - |  | -------------------------------------------



The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the
requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of
CET1 or all such categories in the aggregate exceed 15% of CET1.



Implementation of the deductions and other adjustments to CET1 will begin on January 1, 2014 and will be phased-in over a five-year period (20% per year). The implementation of the capital
conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).



The U.S. banking agencies have indicated informally that they
expect to propose regulations implementing Basel III in mid-2011 with final adoption of implementing regulations in mid-2012. Notwithstanding its release of the Basel III framework as a final framework, the Basel Committee is considering further
amendments to Basel III, including the imposition of additional capital surcharges on globally systemically important financial institutions. In addition to Basel III, Dodd-Frank requires or permits the Federal banking agencies to adopt regulations
affecting banking institutions capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Further, new regulations and statutes are regularly
proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nations financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be
adopted or the extent to which our business may be affected by any new regulation or statute.



Regulatory Agencies



The Company is a legal entity separate and distinct from the Bank, is regulated under the Bank Holding Company Act of 1956 (BHCA), and is subject to inspection, examination, and supervision by
the Federal Reserve. We are also under the jurisdiction of the SEC and are subject to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934.



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The Bank is an FDIC-insured, state-chartered banking organization and is subject to various
statutory requirements and rules and regulations promulgated and enforced primarily by the FDIC, as our primary federal regulator and deposit insurer and the South Carolina State Board of Financial Institutions (the State Board), our
chartering agency. The Bank is also a member of the FHLB. The Bank is subject to various statutes, rules, and regulations that govern the insurance of deposits, minimum capital levels, required reserves, allowable investments, loans, mergers,
consolidations, issuance of securities, payment of dividends, establishment of banking offices, and other aspects of the business of the Bank. The Company must file reports with the Federal Reserve, and the Bank must file reports with the FDIC
concerning our activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. The Federal Reserve, the State Board,
and / or the FDIC conduct periodic examinations to test the applicable entitys safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of permitted
activities in which we can engage and is intended primarily for the protection of the federal deposit insurance funds and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.



Holding Company Activities



BHCA.    The Company is a bank
holding company. In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks, and other activities that the Federal Reserve determines to be closely related to banking as to be a proper incident to
the business of banking.



Activities that the
Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:



| |  |  | Factoring accounts receivable,
| | - |  | ------------------------------



| |  |  | Making, acquiring, brokering or servicing loans and usual related activities,
| | - |  | -----------------------------------------------------------------------------



| |  |  | Leasing personal or real property,
| | - |  | ----------------------------------



| |  |  | Operating a non-bank depository institution, such as a savings association,
| | - |  | ---------------------------------------------------------------------------



| |  |  | Trust company functions,
| | - |  | ------------------------



| |  |  | Financial and investment advisory activities,
| | - |  | ---------------------------------------------



| |  |  | Conducting discount securities brokerage activities,
| | - |  | ----------------------------------------------------



| |  |  | Underwriting and dealing in government obligations and money market instruments,
| | - |  | --------------------------------------------------------------------------------



| |  |  | Providing specified management consulting and counseling activities,
| | - |  | --------------------------------------------------------------------



| |  |  | Performing selected data processing services and support services,
| | - |  | ------------------------------------------------------------------



| |  |  | Acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions, and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | Performing selected insurance underwriting activities.
| | - |  | ------------------------------------------------------



The BHCA generally limits acquisitions by bank holding
companies that are not qualified as financial holding companies to commercial banks and companies engaged in activities that the Federal Reserve has determined to be so closely related to banking as to be a proper incident thereto. The Company is
not considered a financial holding company.



The
BHCA also regulates acquisitions of commercial banks and prohibits us from acquiring direct or indirect control of more than 5% of any class of outstanding voting stock, or substantially all of the assets of, any



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bank or merging or consolidating with another bank holding company without prior approval of the Federal Reserve. The BHCA also prohibits us from engaging in or acquiring ownership or control of
more than 5% of the outstanding voting stock of any company engaged in a nonbanking business unless that business is determined by the Federal Reserve to be closely related to banking or managing or controlling banks.



In addition, and subject to certain exceptions, the BHCA and
the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring control of a bank holding company. Control is conclusively presumed to exist if an individual
or company acquires 25% or more of any class of voting securities of a bank holding company. Following the relaxing of these restrictions by the Federal Reserve in September 2008, control will be rebuttably presumed to exist if a person acquires
more than 33% of the total equity of a bank or bank holding company, of which it may own, control, or have the power to vote not more than 15% of any class of voting securities.



Source of Strength Doctrine and other Responsibilities
with Respect to the Bank.    There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to
minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits. Under a policy of the Federal Reserve, 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. Further, any loans by a bank holding company to a subsidiary bank are
subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding companys bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain
the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.



The State Board of Financial Institutions.    As a bank holding company registered under the South Carolina
Banking and Branching Efficiency Act, we are subject to regulation by the State Board. We must file with the State Board periodic reports with respect to our financial condition, results of income, management, and relationships between the Company
and the Bank. Additionally, we must obtain approval from the State Board prior to engaging in acquisitions of banking or nonbanking institutions or assets.



Dividends



The holders of our common stock are entitled to receive dividends, when and if declared by our Board of Directors, out of funds legally
available for such dividends. The Company is a legal entity separate and distinct from the Bank and depends on the payment of dividends from the Bank. The Company and the Bank are subject to regulatory policies and requirements relating to the
payment of dividends, including requirements to maintain adequate capital above regulatory minimums. Federal regulatory authorities are authorized to determine under certain circumstances that the payment of dividends by a bank holding company or a
bank would be an unsafe or unsound practice and to prohibit payment of those dividends. Federal regulatory authorities have indicated that banking organizations should generally pay dividends only out of current income. In addition, as a South
Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. In general, a South Carolina state bank may not pay dividends from its capital. All dividends must be paid out of undivided profits
then on hand, after deducting expenses, including reserves for losses and bad debts. Subject to the restrictions under our Consent Order described below, the Bank is authorized to pay cash dividends up to 100% of net income in any calendar year
without obtaining the prior approval of the State Board, provided that



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the Bank received a composite rating of one or two at the last federal or state regulatory examination. The Bank must obtain approval from the State Board prior to the payment of any other cash
dividends. In addition, under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the FDICIA), the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized.



Under the terms of the Consent Order with the FDIC and the
State Board (the Consent Order), as described in Item 1A., Risk Factors, the Bank is currently prohibited from paying dividends to the Company without the prior consent of the regulatory agencies. Dividends from the Bank are the
Companys primarily source of funds for payment of dividends to its shareholders.



See Item 5. Market For Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities for a further discussion regarding matters related to our common stock
dividends.



Capital Adequacy and Prompt
Corrective Action



Banks and bank holding
companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of
assets, liabilities, and certain off-balance sheet agreements calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk-weighting, and other
factors.



The Federal Reserve and the FDIC have
substantially similar risk-based capital ratio and leverage ratio guidelines for banking organizations. The guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet
agreements. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital, as defined below, and total capital to risk-weighted assets (including certain off-balance sheet agreements such as letters of
credit). For purposes of calculating the ratios, a banking organizations assets and some of its specified off-balance sheet agreements are assigned to various risk categories. A depository institutions or holding companys capital,
in turn, is classified in one of the following three tiers, depending on type:



| |  |  | Core Capital (Tier 1). Tier 1 capital includes common equity, retained earnings, qualifying noncumulative perpetual preferred
stock, a limited amount of qualifying cumulative perpetual preferred stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, qualifying trust preferred securities less goodwill, non-qualifying deferred
tax assets, most intangible assets, and certain other assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities
not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for loan losses, subject to limitations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Market Risk Capital (Tier 3). Tier 3 capital includes qualifying unsecured subordinated debt.
| | - |  | ---------------------------------------------------------------------------------------------



The Company, like other bank holding companies, currently is
required to maintain Tier 1 capital and total capital (the sum of Tier 1, Tier 2, and Tier 3 capital) equal to at least 4.0% and 8.0%, respectively, of our total risk-weighted assets (including various off-balance sheet
agreements such as letters of credit). At least half of the total capital is required to be Tier 1 capital. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet agreements, are multiplied by a
risk-weight based on the risk inherent in the type of asset.The Bank, like other depository institutions, is required to maintain similar capital levels under capital adequacy guidelines. For a depository institution to be considered
well-capitalized under the regulatory framework for prompt corrective action, its Tier 1 and total capital ratios must be at least 6.0% and 10.0% on a risk-weighted basis, respectively.



Bank holding companies and banks subject to the market risk capital guidelines are required to incorporate
market and interest rate risk components into their risk-based capital standards. The Company and the Bank are not subject to the market risk capital guidelines.



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In addition to the risk-based capital guidelines, bank holding companies and banks are also
required to comply with minimum leverage ratio requirements. 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 to its total adjusted quarterly
average assets (as defined for regulatory purposes) of at least 3% in the case of bank holding companies that have the highest regulatory examination ratios and are not contemplating significant growth or expansion. All other bank holding companies
are required to maintain a Tier 1 (leverage) capital ratio of at least 4%, unless an appropriate regulatory authority specifies a different minimum. For a depository institution to be considered well-capitalized under the regulatory framework for
prompt corrective action, its leverage ratio must be at least 5%. The Federal Reserve has not advised the Company of any specific minimum leverage ratio applicable to it. The FDIC also requires state-chartered, nonmember banks, such as the
Bank, to maintain a minimum leverage ratio similar to that adopted by the Federal Reserve. Under the FDICs leverage capital requirement, the Bank is generally required to maintain a minimum Tier 1 (leverage) capital ratio of not less than 4%.
However, under the terms of the Consent Order entered into with the FDIC and the State Board in 2010, the Bank is subject to a minimum Tier 1 (leverage) capital ratio of 8.0%.



The Federal Deposit Insurance Act, as amended (the
FDIA), requires, among other things, the federal banking agencies to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. The FDIA sets forth the following five capital
tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly-undercapitalized, and critically-undercapitalized. A depository institutions capital tier depends upon how its capital levels compares with various relevant
capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio, and the leverage ratio.



Under the regulations adopted by the federal regulatory authorities, a bank will be categorized as:



| |  |  | Well-capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or
greater, a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adequately-capitalized if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or
greater, a leverage ratio of 4.0% or greater, and is not categorized as well-capitalized.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%,
or a leverage ratio of less than 4.0%.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Significantly-undercapitalized if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of
less than 3.0%, or a leverage ratio of less than 3.0%.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critically-undercapitalized if the institutions tangible equity is equal to or less than 2.0% of average quarterly tangible assets.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



In addition, an institution may
be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain
matters. A banks capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of a banks overall financial condition or
prospects for other purposes.



If a bank is not
well-capitalized, it cannot accept brokered deposits without prior FDIC approval and, unless approval is granted, cannot offer an effective yield in excess of 75 basis points on interest paid on deposits of comparable size and maturity in such
institutions normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the banks normal market area. Thus, for deposits in
its own normal market area, the bank must offer rates that are not in excess of 75 basis points over the average local rates. For non-local deposits, the bank must



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offer rates that are not in excess of 75 basis points over either (1) the banks own local rates or (2) the applicable non-local rates. In other words, the bank must adhere to the
prevailing rates in its own normal market area for all deposits (whether local or non-local) and also must adhere to the prevailing rates in the non-local area for any non-local deposits. Thus, the bank would be unable to outbid non-local
institutions for non-local deposits even if the non-local rates are lower than the rates in the banks own normal market area. Moreover, the FDIA generally prohibits a depository institution from making any capital distributions (including
payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be categorized as undercapitalized.



Undercapitalized institutions are subject to growth
limitations (an undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted
capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action) and are required to submit a capital restoration plan. The agencies may not accept a capital restoration plan
without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institutions capital. In addition, for a capital restoration plan to be acceptable, the depository
institutions parent holding company must guarantee that the institution will comply with the capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of an amount equal to 5.0% of the depository
institutions total assets at the time it became categorized as undercapitalized or the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such
institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is categorized as significantly undercapitalized.



Significantly undercapitalized categorized depository
institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately-capitalized, requirements to reduce total assets, and cessation of receipt of deposits
from correspondent banks. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in
any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.



An insured depository institution may not pay a
management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital
distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management
fee or the making of such would cause a bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.



See Item 8. Financial Statements and Supplementary Data, Note 21, Regulatory Capital Requirements and Dividend Restrictions, for
further discussion regarding the capital ratios and leverage ratio of the Company and the Bank.



FDICIA



FDICIA and regulations implementing the FDICIA require, among other things, that management report on the institutions responsibility for preparing financial statements, establishing and maintaining
an internal control structure and procedures for financial reporting, and compliance with designated laws and regulations concerning safety and soundness. The final regulations also require that independent registered public accounting firms attest
to, and report separately on, assertions in managements reports regarding compliance with such laws and regulations using FDIC approved audit procedures. These regulations apply to financial institutions with greater than $1 billion in assets
at the beginning of their fiscal year. Accordingly, the Bank is subject to these regulations.



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Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act)



The Sarbanes-Oxley Act was signed into law on July 30,
2002 in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.



The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to
file periodic reports with the SEC, under the Securities Exchange Act of 1934.



The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure,
corporate governance and related rules and mandates. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state
corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. The Sarbanes-Oxley Act also requires certain SEC registrants to maintain internal control over financial
reporting.



Deposit Insurance



The Banks deposits are insured up to applicable limits
by the DIF and are subject to deposit insurance assessments. The FDIC amended its risk-based assessment system for 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005 (Reform Act). The DIF is the
successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to
require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the
authority to initiate enforcement actions against financial institutions and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.



FDIC-insured institutions are also required to pay Financing
Corporation (FICO) assessments, in order to fund the interest on bonds issued to resolve financial institutions failures in the 1980s.



Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments
based on an insured institutions ranking in one of four risk categories based upon supervisory and capital evaluations. Assessment rates depend upon the category to which an institution is assigned.



In October 2008, the EESA increased FDIC deposit insurance on
most accounts from $100,000 to $250,000. In July 2010, this increase was made permanent by the Dodd-Frank Act. In addition, the FDICs TAGP, which was extended through December 31, 2012, provides that all noninterest-bearing transaction
accounts are fully guaranteed by the FDIC for the entire amount of the account.



During 2009, the FDIC implemented an industry-wide special assessment to bolster the FDIC insurance fund. The FDIC imposed a 5 basis point special assessment on assets less Tier 1 capital with a cap of 10
basis points times deposits. This incremental special assessment was paid by the Bank to the FDIC at the end of the third quarter 2009. Also effective in 2009, initial base assessment rates were increased by seven basis points to range from 12 basis
points to 45 basis points across all risk categories with possible adjustments to these rates based on certain debt-related components. Based on these factors, our FDIC general assessment rates in 2009 and 2010 increased. The increase in the general
assessment was the result of a change in the FDIC assessment matrix, the increase in our deposit base on which the assessment is calculated over the periods presented, and an increase



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due to our total risk-based capital ratio falling below the well-capitalized category during the period. As a result of the capital received in connection with the Private Placement consummated
in October 2010, our total risk-based capital ratio has improved, and, accordingly, we expect an associated decrease in our FDIC general assessment in 2011.



In September 2009, the FDIC adopted a Notice of Proposed Rulemaking to require insured financial institutions to prepay their estimated
quarterly risk-based assessments for the fourth quarter of 2009 and for 2010, 2011 and 2012. Unlike special assessments, prepaid assessments did not immediately impact earnings but require a cash outlay for the full amount of the prepaid assessment.
We applied for and received an exemption to the prepayment assessment which would have required a cash payment to the FDIC of $10.6 million in December 2009. Having been granted the waiver, we continue to pay our FDIC insurance premiums on a
quarterly basis.



In November 2010, the FDIC
approved two proposals that amend the deposit insurance assessment regulations. The first proposal implements a provision in the Dodd-Frank Act that changes the assessment base from one based on domestic deposits (as it has been since 1935) to one
based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity.



The second proposal changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the
Dodd-Frank Act. Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDICs goal of not significantly altering the total amount of revenue collected from the industry. Risk
categories and debt ratings will be eliminated from the assessment calculation for large banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial
institution will continue to be defined as an insured depository institution with at least $10 billion in assets. Both changes in the assessment system will be effective as of April 1, 2011 and will be payable at the end of September.



In December 2010, the FDIC voted to increase the
required amount of reserves for the designated reserve ratio (DRR) to 2.0%. The ratio is higher than the 1.35% set by the Dodd-Frank Act in July 2010 and is an integral part of the FDICs comprehensive, long-range management plan
for the DIF.



In February 2011, the FDIC approved
the final rules that, as noted above, change the assessment base from domestic deposits to average assets minus average tangible equity, adopt a new scorecard-based assessment system for financial institutions with more than $10 billion in assets,
and finalize the DRR target size at 2.0% of insured deposits.



The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is
in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the
permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for
a period of six months to two years, as determined by the FDIC.



Depositor Preference



The FDIA provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee
of insured depositors and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured
depositors, along with the FDIC, will have priority in payment ahead of unsecured, nondeposit creditors, including us, with respect to any extensions of loans they have made to such insured depository institution.



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Community Reinvestment Act of 1977 (CRA)



The CRA requires depository institutions to assist in
meeting the lending needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the lending needs of its market areas by, among other things, providing loans to low
and moderate income individuals and communities. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institutions discretion to develop the types of products and services that it
believes are best suited to its particular community consistent with the CRA. A financial institutions performance is periodically evaluated in the context of information about the institution (financial condition and business strategies), its
community (demographic and economic data), and its competitors. Upon completion of a CRA examination, the FDIC rates the overall CRA performance of the financial institution using a four-tiered rating system. These ratings consist of outstanding,
satisfactory, needs to improve, and substantial noncompliance. For a financial holding company to commence any new activity permitted by the BHCA or to acquire any company engaged in any new activity permitted by the BHCA, each insured depository
institution subsidiary of the financial holding company must have received a rating of at least satisfactory in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of a
proposed transaction. The CRA requires public disclosure of an institutions CRA rating. Our latest CRA rating, as of March 2009, was satisfactory.



Transactions with Affiliates and Insiders



The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Various legal limitations restrict the Bank
from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A of the Federal Reserve
Act places limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The
aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Banks capital and surplus and, as to all affiliates combined, to 20% of the Banks capital and surplus. Furthermore, within the foregoing
limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.



Section 23B of the Federal Reserve Act, among other
things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the
time for comparable transactions with nonaffiliated companies.



Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these
subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the banks capital and surplus.



The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors,
certain principal shareholders, and their related interests. Such 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
third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.



Branching



Under current South Carolina law, we may open branch offices throughout South Carolina with the prior approval of the State Board. In
addition, with prior regulatory approval, the Bank will be able to acquire existing banking operations in South Carolina. Furthermore, federal legislation permits interstate branching, including



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out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removes previous state law restrictions on de novo
interstate branching in states such as South Carolina. This change permits out-of-state banks to open de novo branches in states where the laws of the state where the de novo branch to be opened would permit a bank chartered by that state to open a
de novo branch.



Anti-Tying Restrictions



Under amendments to the BHCA and Federal
Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for
these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit,
property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer
more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in
connection with electronic benefit transfer services.



Finance Subsidiaries



Under the Gramm-Leach-Bliley Act (the GLBA), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form
financial subsidiaries that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on
financial subsidiaries, including that the parent banks equity investment in the financial subsidiary be deducted from the banks assets and tangible equity for purposes of calculating the banks capital adequacy. In addition, the
GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.



Financial Privacy



In accordance with the GLBA, federal banking regulators
adopted rules that limit the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some
circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party.



Consumer Protection Regulations



Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges
collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Banks loan operations are also subject to federal laws applicable to credit transactions, such as:



| |  |  | The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers,
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | The Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to
determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves,
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to
credit reporting agencies, certain identity theft protections and certain credit and other disclosures,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies, and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | The rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



The deposit operations of the
Bank also are subject to:



| |  |  | The Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for
complying with administrative subpoenas of financial records, and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that Act, which governs automatic deposits to and
withdrawals from deposit accounts and customers rights and liabilities arising from the use of automated teller machines and other electronic banking services.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Enforcement Powers



The Bank and its institution-affiliated parties,
including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institutions affairs, are subject to potential civil and
criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the
submission of inaccurate reports. Civil penalties may be as high as $1,000,000 a day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years. In addition, regulators are provided with greater
flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies power to issue cease-and-desist
orders were expanded. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial
institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.



Anti-Money Laundering



Financial institutions must maintain anti-money laundering
programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also
prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and knowing your customer in their dealings with foreign financial institutions and foreign
customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with
increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA PATRIOT Act, enacted in 2001 and renewed in 2006. Bank regulators routinely examine
institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing cease and desist orders and
money penalty sanctions against institutions found to be violating these obligations.



USA PATRIOT Act



The USA PATRIOT Act became effective on October 26, 2001, amended, in part, the Bank Secrecy Act, and provides, in part, for the facilitation of information sharing among governmental entities and
financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering



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and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer
identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by
nonfinancial trades and businesses filed with the Treasury Departments Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports by brokers and dealers if they believe a
customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank
regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.



Under the USA PATRIOT Act, the Federal Bureau of
Investigation (FBI) can send our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The Bank can be requested, to search its records for any relationships or transactions with
persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.



The Office of Foreign Assets Control (OFAC), which is a division of the U.S. Treasury, is responsible for helping to insure
that U.S. entities do not engage in transactions with enemies of the U.S., as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and
organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report, and, as
appropriate, notify the FBI. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists
provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.



Privacy and Credit Reporting



Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic
personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a
nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the
Banks policy not to disclose any personal information unless required by law.



Like other lending institutions, the Bank utilizes credit bureau data in its underwriting activities. Use of such data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis,
including credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 (the FACT Act) authorizes states to enact identity theft laws that are
not inconsistent with the conduct required by the provisions of the FACT Act.



Check 21



The Check Clearing for the 21st Century Act gives substitute checks, such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.
Some of the major provisions include:



| |  |  | Allowing check truncation without making it mandatory,
| | - |  | ------------------------------------------------------



| |  |  | Demanding that every financial institution communicate to accountholders in writing a description of its substitute check processing program and their
rights under the law,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Legalizing substitutions for and replacements of paper checks without agreement from consumers,
| | - |  | -----------------------------------------------------------------------------------------------



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| |  |  | Retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements
are in place,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Requiring that when accountholders request verification, financial institutions produce the original check (or a copy that accurately represents the
original) and demonstrate that the account debit was accurate and valid, and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Requiring the re-crediting of funds to an individuals account on the next business day after a consumer proves that the financial institution has
erred.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



Effect of
Governmental Monetary Policies



Our results
of operations are affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The Federal Reserves monetary policies have had, and are likely to continue to have, an important impact
on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the
levels of bank loans, investments and deposits through its open market operations in U.S. government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits.
It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.



Office of Foreign Assets Control Regulation



The U.S. has imposed economic sanctions that impact
transactions with designated foreign countries, nationals, and others. Such sanctions are typically known as the OFAC rules based on their administration by the U.S. Department of the Treasury Office of Foreign Assets Control. The OFAC administered
sanctions take many different forms. Generally, however, they contain one or more of the following elements:



| |  |  | Restrictions on trade with, or investment in, a sanctioned country, including prohibitions against direct or indirect imports from and exports to a
sanctioned country and prohibitions on U.S. persons engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country, and / or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of
property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off, or transferred in any manner without a
license from OFAC.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Failure to
comply with these sanctions can result in serious legal and reputational consequences.



Incentive Compensation



In June 2010, the Federal Reserve, the FDIC and the OCC issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking
organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either
individually or as part of a group, is based upon the key principles that a banking organizations incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organizations ability
to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organizations
board of directors.



The Federal Reserve will
review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not large, complex banking



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organizations. These reviews will be tailored to each organization based on the scope and complexity of the organizations activities and the prevalence of incentive compensation
arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organizations supervisory ratings, which can affect the organizations ability to make
acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organizations
safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.



Legislative and Regulatory Initiatives



From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by
regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation
could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect
the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would
have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material effect on the business of the Company.



Available Information



Under the Securities Exchange Act of 1934, we are required
to file annual, quarterly, and current reports, proxy statements, and other information with the SEC. One may access, read, and copy any document we file with the SEC at the SECs Public Reference Room at 450 Fifth Street N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file reports electronically with the SEC. The SEC maintains an Internet site that contains reports,
proxy and information statements, and other information regarding issuers that file reports electronically. This site may be accessed at www.sec.gov. Documents filed by us electronically with the SEC may be accessed through this website.



Our Annual Reports on Form 10-K and Quarterly Reports on Form
10-Q, as well as select other documents filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are accessible at no cost on our website, www.palmettobank.com, through the Investor
Relations link. Other documents filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, including our Current Reports on Form 8-K, are accessible at no cost on the SECs website
(www.sec.gov) or through written request directed to 306 East North Street, Greenville, South Carolina 29601, Attention: Chief Financial Officer. In addition, through the Corporate Governance link, we make available our Code of
Ethics as well as various other corporate governance information. We will provide a printed copy of any of the aforementioned documents to any requesting shareholder. Such requests should be directed to 306 East North Street, Greenville, South
Carolina 29601, Attention: Chief Financial Officer.



|ITEM 1A. | RISK FACTORS
|-------- | ------------



The material risks and uncertainties that management believes impact our Company are described below. If any of the following risks
actually occurs, our business, financial condition, results of operations, or cash flows could be materially and adversely impacted. If this were to happen, the value of our stock could decline, and investors could lose all or part of their
investment. The risks described below are not the only risks we face. Additional risks and uncertainties not currently known or currently deemed to be immaterial also may materially and adversely affect our business, financial condition, results of
operations or cash flows.



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We have entered into a Consent Order under which our regulators will require us to take certain
actions.



In November 2009, the FDIC and
the State Board conducted their annual joint examination of the bank. As a result of the examination, the Bank agreed to the issuance of the Consent Order, effective June 10, 2010, with the FDIC and the State Board. The Consent Order seeks to
enhance the banks existing practices and procedures in the areas of credit quality, liquidity, earnings, capital, and other areas.



In response to the companys negative financial results and in preparation for the FDIC and the State Board (collectively, the
Supervisory Authorities) annual joint examination, in June 2009 our Board of Directors and management adopted and began executing a proactive and aggressive Strategic Project Plan (the Plan) to address the issues related to
credit quality, liquidity, earnings, and capital. Since June 2009, our Board of Directors and management have been, and continue to be, keenly focused on executing the Plan and, through execution of this Plan, have already complied with numerous
requirements of the Consent Order. Specific to the capital requirements of the Consent Order, on October 7, 2010 we consummated the Private Placement transaction pursuant to which we issued 39,975,980 shares of our common stock at $2.60 per
share for an aggregate purchase price of approximately $103.9 million, which resulted in the Company and the Bank being categorized as well capitalized.



We intend to take all actions necessary to enable the Bank to
comply with the requirements of the Consent Order, and as of the date hereof we have submitted all documentation required as of this date to the Supervisory Authorities. There can be no assurance that the Bank will be able to comply fully with the
provisions of the Consent Order, and the determination of our compliance will be made by the Supervisory Authorities. However, we believe we are currently in compliance with all provisions of the Consent Order except for the requirement to reduce
the total amount of our criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first date being
December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. We reduced our criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. Our next incremental deadline, June 5,
2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of February 22, 2011, we have reduced our criticized assets by 53.2% ($114.9 million). Failure to meet the requirements of the
Consent Order could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC. In addition, the Supervisory Authorities may amend the Consent Order based on the results of their
ongoing examinations.



We may have higher loan losses than
we have allowed for in our allowance for loan losses.



Our actual loan losses could exceed our allowance for loan losses and therefore our historic allowance for loan losses may not be adequate. As of December 31, 2010, approximately 66.8% of our loan
portfolio, including commercial loans held for sale, was secured by commercial real estate. Repayment of such loans is generally considered more subject to market risk than residential mortgage loans. Industry experience shows that a portion of
loans will become delinquent and a portion of loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including among other
things, changes in market conditions affecting the value of loan collateral and problems affecting borrower credit.



In September 2010, we decided to market for sale commercial loans totaling $90.9 million at September 30, 2010, of which $66.2
million remain in the commercial loans held for sale portfolio at December 31, 2010. As part of the marketing process, we evaluate the bids received on a loan by loan basis. In general, we believe potential buyers are making bids at heavily
discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of
problem assets prior to year end. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell assets at amounts less than their recorded book values to continue to reduce our
criticized assets and our concentration in commercial real estate as required by the Consent Order. During the fourth quarter of 2010, we



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sold five loans, representing two relationships, with a gross book value of $10.4 million for a recorded loss of $3.5 million. During the fourth quarter of 2010, we transferred $6.0 million of
commercial loans held for sale back to loans held for investment, as our intentions with respect to these loans had changed. We are continuing our efforts to sell the remaining loans held for sale. At December 31, 2010, we had commercial loans
held for sale aggregating $66.2 million, of which $2.0 million were under contract for sale and expected to close in the first quarter 2011. Writedowns of $1.1 million were recorded in the fourth quarter 2010 to reduce the value of these loans to
the contract value less estimated costs to sell.



There can be no assurances that the loans will be sold, or that the bids offered will be at the currently recorded balances. Accordingly,
to the extent that we accept bids for these loans, we may receive significantly less than the current net carrying amount of the loans and incur a corresponding loss on any such loan sales, which would result in incremental losses.



We have a concentration of credit exposure in commercial real estate
and a downturn in commercial real estate could adversely affect our business, financial condition, and results of operations.



At December 31, 2010, 66.8% of our loan portfolio, including commercial loans held for sale, was secured by commercial real estate.
Loans secured by commercial real estate are generally viewed as having more risk of default than loans secured by residential real estate or consumer loans because repayment of the loans often depends on the successful operation of the property, the
income stream of the borrowers, the accuracy of the estimate of the propertys value at completion of construction, and the estimated cost of construction. Such loans are generally more risky than loans secured by residential real estate or
consumer loans because those loans are typically not secured by real estate collateral. An adverse development with respect to one lending relationship can expose us to a significantly greater risk of loss compared with a single-family residential
mortgage loan because we typically have more than one loan with such borrowers. Additionally, these loans typically involve larger loan balances to single borrowers or groups of related borrowers compared with single-family residential mortgage
loans. Therefore, the deterioration of one or a few of these loans could cause a significant decline in the related asset quality. In addition, many economists believe that deterioration in income producing commercial real estate is likely to worsen
as vacancy rates continue to rise and absorption rates of existing square footage and/or units continue to decline. Because of the general economic slowdown we are currently experiencing, these loans represent higher risk and could result in a sharp
increase in loans charged-off and could require us to significantly increase our allowance for loan losses, which could have a material adverse impact on our business, financial condition, results of operations, and cash flows.



A significant portion of our loan portfolio is secured by real estate,
and events that negatively impact the real estate market could hurt our business.



At December 31, 2010, approximately 88.6% of our loans, including commercial loans held for sale, had real estate as a primary or secondary component of collateral. The real estate collateral in each
case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. We have identified credit concerns with respect to certain loans in our loan portfolio which
are primarily related to the downturn in the real estate market. The real estate market has been substantially impacted by the current economic environment, increased levels of inventories of unsold homes, and higher foreclosure rates. As a result,
property values for this type of collateral have declined substantially and market appraisal assumptions continue to trend downward significantly. These loans carry a higher degree of risk than long-term financing of existing real estate since
repayment is dependent on the ultimate completion of the project or home and usually on the sale of the property or permanent financing. Slow housing conditions have affected some of these borrowers ability to sell the completed projects in a
timely manner, and we believe that these trends are likely to continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure. As a result, we
incurred substantially higher charge-offs in 2009 and 2010 and increased our allowance for loan losses during these periods to address the probable credit risks inherent within our loan portfolio. Further deterioration in the South Carolina real
estate



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market may cause us to adjust our opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an additional increase in our provisions for loan losses, which
could also adversely impact our business, financial condition, and results of operations.



Recent legislation and administrative actions authorizing the U.S. government to take direct actions within the financial services industry may not stabilize the U.S. financial system.



Under the EESA, which was enacted on
October 3, 2008, the U.S. Treasury has the authority to, among other things, invest in financial institutions and purchase up to $700 billion of troubled assets and mortgages from financial institutions for the purpose of stabilizing and
providing liquidity to the U.S. financial markets. Under the CPP, the U.S. Treasury committed to purchase up to $250 billion of preferred stock and warrants in eligible institutions. The EESA also temporarily increased FDIC deposit insurance
coverage to $250,000 per depositor through December 31, 2009, which was recently permanently increased to $250,000 under the Dodd-Frank Act.



On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan which, among other things, provides a forward-looking
supervisory capital assessment program that is mandatory for banking institutions with over $100 billion of assets and makes capital available to financial institutions qualifying under a process and criteria similar to the CPP. In addition, the
American Recovery and Reinvestment Act of 2009 (the ARRA) was signed into law on February 17, 2009, and includes, among other things, extensive new restrictions on the compensation and governance arrangements of financial
institutions.



On July 21, 2010, the
President signed into law the Dodd-Frank Act, a comprehensive regulatory framework that will affect every financial institution in the U.S. The Dodd-Frank Act includes, among other measures, changes to the deposit insurance and financial regulatory
systems, enhanced bank capital requirements and provisions designed to protect consumers in financial transactions. Regulatory agencies will implement new regulations in the future which will establish the parameters of the new regulatory framework
and provide a clearer understanding of the legislations effect on banks. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon
us more stringent capital, liquidity, and leverage requirements or otherwise adversely affect our business. In particular, the potential impact of the Dodd-Frank Act on our operations and activities, both currently and prospectively, include, among
others:



| |  |  | a reduction in our ability to generate or originate revenue-producing assets as a result of compliance with heightened capital standards;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increased cost of operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, and higher deposit
insurance premiums;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the limitation on our ability to raise capital through the use of trust preferred securities as these securities may no longer be included as Tier 1
capital going forward; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the limitation on our ability to expand consumer product and service offerings due to anticipated stricter consumer protection laws and regulations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



Numerous actions have been
taken by the U.S. Congress, the Federal Reserve, the U.S. Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that followed the sub-prime mortgage crisis that commenced in 2007, including the Financial Stability
Program adopted by the U.S. Treasury. We cannot predict the actual effects of EESA, ARRA, the Dodd-Frank Act, and various other governmental, regulatory, monetary and fiscal initiatives which have been and may be enacted on the economy, the
financial markets, or on us. The terms and costs of these activities, or the failure of these actions to help stabilize the financial markets, asset prices, market liquidity and a continuation or worsening of current financial market and economic
conditions, could materially and adversely affect our business, financial condition, results of operations, and the price of our common stock.



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Recent negative developments in the financial industry and the domestic and international credit
markets may adversely affect our operations and results.



Negative developments in the global credit and securitization markets have resulted in uncertainty in the financial markets in general with the expectation of continued uncertainty in 2011. As a result of
this credit crunch, commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate
collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and
bank holding companies to raise capital or borrow in the debt markets. Bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement
orders. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business
operations, including our ability to originate or sell loans, and adversely impact our financial performance. We can provide no assurance regarding the manner in which any new laws and regulations will affect us.



Our focus on lending to small to mid-sized community-based businesses
may increase our credit risk.



Most of
our commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a
heightened vulnerability to economic conditions. If general economic conditions in the markets in which we operate negatively impact this important customer sector, our results of operations and financial condition and the value of our common stock
may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers businesses may
hinder their ability to repay their loans with us, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.



Our decisions regarding credit risk and allowance for loan losses may
materially and adversely affect our business.



Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and
other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:



| |  |  | the duration of the credit;
| | - |  | ---------------------------



| |  |  | credit risks of a particular customer;
| | - |  | --------------------------------------



| |  |  | changes in economic and industry conditions; and
| | - |  | ------------------------------------------------



| |  |  | in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.
| | - |  | ------------------------------------------------------------------------------------------------------------------



We attempt to maintain an appropriate allowance for loan
losses to provide for inherent losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:



| |  |  | evaluations of the collectability of loans in our portfolio, including consideration of factors such as the balance of impaired loans, the quality,
mix, and size of our overall loan portfolio;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | economic conditions that may impact the overall loan portfolio or an individual borrowers ability to repay;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | the amount and quality of collateral securing the loans;
| | - |  | --------------------------------------------------------



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| |  |  | our historical loan loss experience, and
| | - |  | ----------------------------------------



| |  |  | borrower and collateral specific considerations for loans individually evaluated for impairment.
| | - |  | ------------------------------------------------------------------------------------------------



There is no precise method of predicting credit losses;
therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in a
decrease of our net income (or increase in our net loss), and possibly our capital.



Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments
different than those of our management. Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.



Continuation of the economic downturn could reduce our customer base,
our level of deposits, and demand for financial products such as loans.



Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. The current economic downturn has negatively affected the markets in which we
operate and, in turn, the quality of our loan portfolio. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally remain unfavorable, our business may not succeed. A continuation of the economic
downturn or prolonged recession would likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately
91.1% of our interest income for the year ended December 31, 2009, and 92.5% for the year ended December 31, 2010. If the economic downturn continues or a prolonged economic recession occurs in the economy as a whole, borrowers will be
less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be negatively affected. Unlike
many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses that materially and adversely
affect our business.



Liquidity risks could affect
operations and jeopardize our financial condition.



The goal of liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities and withdrawals, and other cash commitments under both normal operating conditions and
under unpredictable circumstances of industry or market stress. To achieve this goal, our Asset/Liability Committee establishes liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid
over-dependence on volatile, less reliable funding sources.



Liquidity is essential to our business. An inability to raise funds through traditional deposits, borrowings, the sale of securities or loans, issuance of additional equity securities, and other sources
could have a substantial negative impact on our liquidity. Our access to funding sources in amounts adequate to finance our activities and with terms acceptable to us could be impaired by factors that impact us specifically or the financial services
industry in general. Factors that could detrimentally impact access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or regulatory action
against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as the current disruption in the financial markets and negative views and expectations about the prospects for the financial services industry as a
result of the continuing turmoil and deterioration in the credit markets.



Historically, we have relied on traditional and nontraditional deposits, advances from the FHLB, funding from correspondent banks, and other borrowings to fund our operations. As a result of negative
financial performance indicators, some of the Banks various sources of liquidity are now restricted. The Banks credit risk



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rating at the FHLB has been negatively impacted, resulting in more restrictive borrowing requirements. During most of 2010, the FHLB would not allow us to borrow incremental advances; however, in
December 2010, the FHLB informed us that our contingent funding ability had been restored up to 10% of our total assets based on meeting certain collateral requirements. In addition, the maximum maturity for Federal Reserve Discount Window
borrowings is overnight. Any future potential borrowings from the Federal Reserve Discount Window are at the secondary credit rate and must be used for operational issues, and the Federal Reserve has the discretion to deny approval of borrowing
requests.



We actively monitor the depository
institutions that hold our federal funds sold and due from banks cash balances. We cannot provide assurances that access to our cash and cash equivalents and federal funds sold will not be impacted by adverse conditions in the financial markets. Our
emphasis is primarily on safety of principal, and we diversify cash, due from banks, and federal funds sold among counterparties to minimize exposure relating to any one of these entities. We routinely review the financials of our counterparties as
part of our risk management process. Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if
the correspondent financial institutions fail.



Due to the Consent Order, we may not accept brokered deposits unless a waiver is granted by the FDIC. Although we currently do not utilize
brokered deposits as a funding source, if we were to seek to begin using such funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our
liquidity. Additionally, we would normally be restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website. However, on April 1, 2010, we were
notified by the FDIC that they had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, we are able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in our
geographic areas. This high-rate determination, as confirmed by the FDIC on December 27, 2010, is effective for calendar year 2011 as well.



There can be no assurance that our sources of funds will be adequate for our liquidity needs, and we may be compelled to seek additional
sources of financing in the future. Specifically, we may seek additional debt in the future to achieve our business objectives. There can be no assurance that additional borrowings, if sought, would be available to us or, if available, would be on
favorable terms. Bank and holding company stock prices have been negatively impacted by the recent adverse economic conditions, as has the ability of banks and holding companies to raise capital or borrow in the debt markets. If additional financing
sources are unavailable or not available on reasonable terms, our business, financial condition, results of operations, cash flows, and future prospects could be materially adversely impacted.



We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher
interest rates to attract customers.



The
banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance
companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and
elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are
well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There is a risk that we will not be able to compete successfully with other financial
institutions in our market, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive
regulations that apply to us.



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Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.



As discussed in Item 1. Business,
the Banks deposits are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, we are required to pay quarterly deposit insurance
premium assessments to the FDIC.



Although we
cannot predict what the insurance assessment rates will be in the future, further deterioration in either risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial
condition, results of operations, and cash flows.



The FDIC may terminate deposit insurance of any insured depository institution if it determines that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. It also may suspend deposit insurance temporarily if the
institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as
determined by the FDIC.



Changes in prevailing interest rates
may reduce our profitability.



One of the
key measures of our success is our amount of net interest income. Net interest income is the difference between interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities. Interest rates are highly
sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve.



We are subject to interest rate risk because:



| |  |  | Assets and liabilities may mature or reprice at different times (for example, if assets reprice faster than liabilities and interest rates are
generally falling, net income will initially decline),
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Assets and liabilities may reprice at the same time but by different amounts (for example, when the general level of interest rates is falling, we may
reduce rates paid on transaction and savings deposit accounts by an amount that is less than the general decline in market interest rates),
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Short-term and long-term market interest rates may change by different amounts (for example, the shape of the yield curve may impact new or repricing
loan yields and funding costs differently), and/or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, if long-term mortgage interest
rates decline sharply, mortgage-backed securities held in the investment securities available for sale portfolio may prepay significantly earlier than anticipated, which could reduce portfolio income).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Interest rates may also have a direct or indirect impact on
loan demand, credit losses, mortgage origination volume, the mortgage-servicing rights portfolio, the value of our pension plan assets and liabilities, and other financial instruments directly or indirectly impacting net income.



Any substantial, unexpected, prolonged change in market
interest rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.



We are dependent on key management individuals and the loss of one or more of these key individuals could curtail our growth and adversely affect
our prospects.



We depend on a limited
number of key management personnel. The loss of key personnel could have a material adverse impact on our operations because other personnel may not have the experience and expertise to readily replace these individuals. As a result, our Board of
Directors may have to search outside of the bank for qualified permanent replacements. This search may be prolonged, and we cannot provide assurance that we would be able to locate and hire qualified replacements.



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We are subject to extensive regulation that could limit or restrict our activities.



We operate in a highly regulated
industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and
acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to
support our growth.



The laws and regulations
applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial
banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably. See also Risk FactorsRecent negative developments in the financial services industry and the domestic and international
credit markets may adversely affect our operations and results.



The Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and
disclosure practices. To comply with the Sarbanes-Oxley Act, we have previously hired outside consultants to assist with our internal audit and internal control functions. We have experienced, and we expect to continue to experience, greater
compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act.



We have performed the system and process evaluation and testing required to comply with the management certification for 2010. In the
event internal control deficiencies are identified in the future that we are unable to remediate in a timely manner or if we are not able to maintain the requirements of Section 404, we could be subject to scrutiny by regulatory authorities and
the trading price of our common stock could decline. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we cannot provide reliable financial
reports or prevent fraud, our business and operating results could be harmed, investors and regulators could lose confidence in our reported financial information, and the trading price of our stock could drop significantly. We currently anticipate
that we will continue to comply with the requirements relating to internal controls and all other aspects of Section 404 within required time frames.



If we were to grow in the future or incur additional credit losses, we may need to raise additional capital in the future, but that capital may not
be available when it is needed.



We are
required by regulatory authorities, and under terms of the Consent Order, to maintain adequate levels of capital to support our operations. If we grow in the future or incur additional credit losses, we may need to raise additional capital. Our
ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot be assured of our ability to raise additional capital, if needed, on terms
acceptable to us. If we cannot raise additional capital on acceptable terms when needed, our ability to expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity
capital, existing shareholder interests could be diluted.



We will face risks with respect to expansion through acquisitions, mergers or other business expansion.



From time to time we may seek to acquire other financial
institutions or parts of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:



| |  |  | the potential inaccuracy of the estimates and judgments used to evaluate credit, operations, management, and market risks with respect to a target
institution;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the time and costs of evaluating new markets, hiring or retaining experienced local management, and opening new offices and the time lags between these
activities and the generation of sufficient assets and deposits to support the costs of the expansion;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse effects on our results of operations; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the risk of loss of key employees and customers.
| | - |  | ------------------------------------------------



We may incur substantial costs to expand, and such expansion
may not result in the levels of profits we seek. Integration efforts for any future mergers and acquisitions may not be successful and following any future merger or acquisition, after giving it effect, we may not achieve our expected benefits of
the acquisition within the desired time frame, if at all.



We are not currently eligible to participate in FDIC-assisted acquisitions of assets and liabilities of failed banks, and there can be no assurances that we will be eligible to participate in such
acquisitions in the future or that, if we were eligible, we would seek to participate in such acquisitions. However, we may possibly seek opportunities in the future to acquire the assets and liabilities of failed banks in FDIC-assisted
transactions. FDIC-assisted acquisitions present the risks of general acquisitions as well as some risks specific to these transactions. Although these FDIC-assisted transactions often provide for FDIC assistance to an acquirer to mitigate certain
risks, which may include loss-sharing, where the FDIC absorbs most losses on covered assets and provides some indemnity, we would be subject to many of the same risks we would face in acquiring another bank in a negotiated transaction, without FDIC
assistance. Such risks could include, among others, risks associated with pricing such transactions, the risks of loss of deposits and maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and
within the timeframes we expect. In addition, because these acquisitions provide for limited diligence and negotiation of terms, these transactions may require additional resources and time. For example we may be required to service acquired problem
loans, incur costs related to integration of personnel and operating systems, establish processes to service acquired assets, or raise additional capital, which may be dilutive to our existing shareholders. If we decided to participate in
FDIC-assisted acquisitions and were unable to manage these risks, then such acquisitions could have a material adverse effect on our business, financial condition and results of operations.



Our underwriting decisions may materially and adversely affect our business.



While we generally underwrite the loans in our portfolio in
accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. The number of
loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio as well as the amount of resulting credit losses.



We are exposed to the possibility of technology failure.



We rely on our computer systems and the
technology of outside service providers. Our daily operations depend on the operational effectiveness of this technology. We rely on our systems to accurately track and record our assets and liabilities. If our computer systems or outside technology
sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition.



Failure to comply with government regulation and supervision could
result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation.



Our operations are subject to extensive regulation by federal, state, and local governmental authorities. Given the current disruption in
the financial markets, we expect that the government will continue to pass new regulations and laws that will impact us. Compliance with such regulations may increase our costs and limit our



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ability to pursue business opportunities. Failure to comply with laws, regulations, and policies could result in sanctions by regulatory agencies, civil money penalties, and damage to our
reputation. While we have policies and procedures in place that are designed to prevent violations of these laws, regulations, and policies, there can be no assurance that such violations will not occur.



If our deferred tax asset continues to remain impaired in the future,
our earnings and capital position may continue to be adversely impacted.



Deferred income tax represents the tax impact of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by us to determine if they are
realizable. Factors in our determination include the ability to carry back or carry forward net operating losses and the performance of the business including the ability to generate taxable income from a variety of sources and tax planning
strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance against the deferred tax asset must be established with a corresponding charge to income
tax expense.



As of December 31, 2010, prior
to any valuation allowance, net deferred tax assets totaling $20.5 million were recorded in the Companys Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the
previous three years, net operating loss carry forward limitations as discussed below and available tax planning strategies, we recorded a valuation allowance against the net deferred tax asset at December 31, 2010. The Private Placement that
was consummated on October 7, 2010 is considered to be a change in control under the Internal Revenue Service rules. Accordingly, with the assistance of third party specialists, we were required to determine the fair value of the Company and
our assets for the purpose of evaluating any potential limitation or deferral of our ability to carry forward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses as of October 7, 2010, which also
limits the amount of net operating losses that may be used in the future. As a result of the valuations and tax analysis, we currently estimate that future utilization of net operating loss carry forwards and built-in losses of $46 million generated
prior to October 7, 2010 will be limited to $1.1 million per year.



Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be
predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to
twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance
for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and, therefore, how much of the valuation allowance that may be reversed and the timing is based on our future results of
operations and the amount and timing of actual loan charge-offs and asset writedowns.



Risks Related to our Common Stock



Our ability to pay dividends on our common stock is restricted.



We have not paid a dividend on our common stock since the first quarter of 2009. The holders of our common stock are entitled to receive
dividends, when and if declared by the Board of Directors, out of funds legally available for such dividends. We are a legal entity separate and distinct from the bank and have historically relied on dividends from the bank as a viable source of
funds to service our operating expenses, which typically include dividends to holders of our common stock; however, given the banks recent losses and the restrictions imposed by the Consent Order with the Supervisory Authorities, this source
of liquidity is not currently available nor is it expected to be available for the foreseeable future. We and the bank are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to maintain
adequate capital above regulatory minimums. Federal regulatory authorities are authorized to determine under



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certain circumstances that the payment of dividends by a bank holding company or a bank would be an unsafe or unsound practice and to prohibit payment of those dividends. Federal regulatory
authorities have indicated that banking organizations should generally pay dividends only out of current income. In addition, as a South Carolina chartered bank, the bank is subject to limitations on the amount of dividends that it is permitted to
pay.



We may issue additional shares of common or preferred
stock securities, which may dilute the interests of our shareholders and may adversely affect the market price of our common stock.



We are currently authorized to issue up to 75,000,000 shares of common stock, of which 50,513,722 shares were outstanding as of
February 22, 2011, and up to 2,500,000 shares of preferred stock, of which no shares are outstanding. Our Board of Directors has authority, without action or vote of the shareholders, to issue all or part of the remaining authorized but
unissued shares and to establish the terms of any series of preferred stock. We may seek additional equity capital in the future as we expand our operations. Any issuance of additional shares of common stock or preferred stock will dilute the
percentage ownership interest of our shareholders and may dilute the book value per share of our common stock.



Because there is a limited public trading market for our common stock, investors that purchase our common stock may not be able to resell their shares at or above the purchase price paid by them.



Our common stock is not listed on any
national securities exchange or quoted on the OTC Bulletin Board. Our common stock is, however, quoted on the Pink Sheets under the symbol PLMT.PK. Although our common stock is quoted on the Pink Sheets, there is currently only a limited
public trading market of our common stock and the market price of our common stock may be difficult to ascertain. As a result, investors in our common stock may not be able to resell their shares at or above the purchase price paid by them or may
not be able to resell them at all. While it is our intent to seek to list our common stock on NASDAQ by July 5, 2011 as a condition of the Private Placement, there can be no assurances that NASDAQ will approve our application.



Our common stock is controlled by one or more shareholders whose
interests may conflict with those of our other shareholders.



An affiliate of CapGen Financial Partners (CapGen) and affiliates of Patriot Financial Partners (Patriot) own approximately 45.3% and 19.2%, respectively, of our outstanding shares
of common stock as of February 22, 2011. As a result, CapGen and Patriot are able, individually or collectively, to exercise significant influence on our business as shareholders, including influence over election of our Board of Directors and
the authorization of other corporate actions requiring shareholder approval. In deciding on how to vote on certain proposals, our shareholders should be aware that CapGen and Patriot may have interests that are different from, or in addition to, the
interests of our other shareholders.



A holder with as
little as a 5% interest in our company could, under certain circumstances, be subject to regulation as a bank holding company and possibly other restrictions.



Any entity (including a group composed of
natural persons) owning 25% or more of our outstanding common stock, or 5% or more if such holder otherwise exercises a controlling influence over us, may be subject to regulation as a bank holding company in accordance with
the BHCA. In addition, (1) any bank holding company or foreign bank with a U.S. presence may be required to obtain the approval of the Federal Reserve under the BHCA to acquire or retain 5% or more of our outstanding common stock and
(2) any person other than a bank holding company may be required to obtain regulatory approval under the Change in Bank Control Act of 1978 to acquire or retain 10% or more of our outstanding common stock. Becoming a bank holding company
imposes certain statutory and regulatory restrictions and burdens, and might require the holder to divest all or a portion of the holders investment in our common stock. In addition, because a bank holding company is required to provide
managerial and financial strength for its bank subsidiary, such a holder may be required to divest investments that may be deemed incompatible with bank holding company status, such as a



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material investment in a company unrelated to banking. Further, subject to an FDIC policy statement published in August 2009, under certain circumstances, holders of 5% or more of our securities
could be required to be subject to certain restrictions, such as an inability to sell or trade their securities for a period of three years, among others, in order for us to participate in an FDIC-assisted transaction of a failed bank.



|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------



None.



|ITEM 2. | PROPERTIES
|------- | ----------



General



At December 31, 2010 and 2009, the total net book value of the premises and equipment owned, excluding those held for sale, was $28.1
million and $29.6 million, respectively. None of our owned properties are subject to mortgages or liens.



At December 31, 2010, one parcel of land with a book value of $235 thousand was listed for sale and is included within Other assets
in the Consolidated Balance Sheets. On an ongoing basis, we evaluate the suitability and adequacy of all of our properties and have active programs of relocating, remodeling, consolidating, or closing properties, as necessary, to maintain
efficient and attractive facilities. We believe that all of our properties are suitable and adequate for their intended purposes. Additionally, all of our properties are protected by alarm and security systems.



See Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations, Item 8. Financial Statements and Supplementary Data, Note 1, Summary of Significant Accounting Policies, and Item 8. Financial Statements and Supplementary Data, Note 6, Premises and
Equipment, for further discussion.



Corporate Headquarters and Operations Center



The Companys corporate headquarters are located at 306
East North Street, Greenville, South Carolina in a leased facility. The Company owns a 55,000 square foot operations center in Laurens, South Carolina where a substantial portion of our back-office operations are conducted.



Banking Offices



At December 31, 2010, the Bank operated 29 full-service
banking offices in the following counties: Laurens County (4), Greenville County (9), Spartanburg County (5), Greenwood County (4), Anderson County (2), Cherokee County (2), Pickens County (1), Oconee County (1), and York County (1). Of our 29
full-service banking offices at December 31, 2010, seven were leased and 22 were owned.



In addition to our 29 full-service banking offices at December 31, 2010, the Bank operated six limited service banking offices located in retirement centers in the Upstate.



Additionally, we have ground leases with regard to three of
our banking office locations.



Other
Properties



In addition to the banking
offices noted above, we had the following activity during 2010:



| |  |  | Sold one vacant bank owned branch with a net book value of $46 thousand at a gain of $14 thousand.
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | Allowed two operating leases of vacant branch facilities to expire. These vacant branches were the result of consolidation of our banking office
network in 2008.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Continued to lease one vacant branch facility which is also the result of consolidation of our banking office network in 2008.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Subleased to a third party one of our previous banking offices that we leased from a third party. The lease and sublease expired in February 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Transferred one vacant branch facility with a net book value of $235 thousand as held for sale and included it within Other assets in the Consolidated
Balance Sheets.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Utilized an owned Laurens location, previously occupied by Palmetto Capital, for operations purposes.
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | Continued to lease parking spaces near the headquarters in downtown Greenville, on a month-to-month basis.
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | Held for investment a parcel of land located in Spartanburg County for possible future banking office expansion.
| | - |  | ----------------------------------------------------------------------------------------------------------------



Automatic Teller Machines



At December 31, 2010, we operated 37 automatic teller
machines, including nine in nonbanking office locations.



The Bank has ground leases with regard to eight of our automatic teller machines, all of which are located at nonbanking office locations.



Palmetto Capital Independent Offices



During the year ended December 31, 2010, Palmetto Capital utilized one office independent of banking
offices, which is leased.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



We are subject to actual and threatened legal proceedings and other claims against us arising out of the conduct of our business. Some of
these suits and proceedings seek damages, fines, or penalties. These suits and proceedings are being defended by, or contested on behalf of, us. On the basis of information presently available, we do not believe that existing proceedings and claims
will have a material effect on our financial position or results of operations.



|ITEM 4. | (REMOVED AND RESERVED).
|------- | -----------------------



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PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



Common Stock Market Prices and Dividends



Our common stock is not listed on any
national securities exchange or quoted on the OTC Bulletin Board. Our common stock is, however, quoted on the Pink Sheets under the symbol PLMT.PK. Although our common stock is quoted on the Pink Sheets, there is currently only a limited
public trading market of our common stock. Private trading of our common stock has been limited but has been conducted through the Private Trading System which was implemented on our website (www.palmettobank.com) on June 26, 2009. The Private
Trading System is a passive mechanism created to assist buyers and sellers in facilitating trades in our common stock. In addition, buyers and sellers may privately negotiate transactions in our common stock. Because there is not an established
private market for our common stock, we may not be aware of all prices at which our common stock has been traded. Additionally, we have not determined whether the trades of which we are aware were the result of arms-length negotiations between
the parties.

One of the requirements of the Private Placement is that the Company will use its reasonable best efforts to list
the shares of our common stock on NASDAQ or another national securities exchange within nine months of the closing date of the Private Placement on October 7, 2010. While it is our intent to seek to list our common stock on NASDAQ by July 5, 2011,
no assurances can be provided at this time that we will meet such listing requirements.

As of February 22, 2011, there were
50,513,722 shares of our common stock outstanding held by approximately 1,826 shareholders of record. Based on information available to us on the Private Trading System and reported trading on the Pink Sheets, the traded prices of our common stock
and dividend information are summarized as follows for the periods indicated.

|               |  |      |       |  |     |  |       |               |  |  |      | 
|-------------- |  | ---- | ----- |  | --- |  | ----- | ------------- |  |  | ---- | 
|               |  | High |       |  | Low |  |       | Cash dividend | 
|2010           |  |      |       |  |     |  |       |               |  |  |      | 
|First quarter  |  | $    | 8.00  |  |     |  | 5.75  |               |  |  |     | 
|Second quarter |  |      | 9.00  |  |     |  | 2.50  |               |  |  |     | 
|Third quarter* |  |      |      |  |     |  |      |               |  |  |     | 
|Fourth quarter |  |      | 5.00  |  |     |  | 2.50  |               |  |  |     | 
|               |  |      |      
|2009           |  |      |       |  |     |  |       |               |  |  |      | 
|First quarter  |  | $    | 42.00 |  |     |  | 27.12 |               |  |  | 0.06 | 
|Second quarter |  |      | 40.00 |  |     |  | 33.75 |               |  |  |     | 
|Third quarter  |  |      | 33.75 |  |     |  | 15.00 |               |  |  |     | 
|Fourth quarter |  |      | 15.00 |  |     |  | 8.00  |               |  |  |     | 



|* |  | There were no trades in our common stock in the third quarter of 2010 reported on the Private Trading System or the Pink Sheets.
|- |  | --------------------------------------------------------------------------------------------------------------------------------



We have not paid a dividend on our common stock since the
first quarter of 2009. The holders of our common stock are entitled to receive dividends, when and if declared by the Board of Directors, out of funds legally available for such dividends. We are a legal entity separate and distinct from the bank
and have historically relied on dividends from the bank as a viable source of funds to service our operating expenses, which typically include dividends to holders of our common stock; however, given the Banks recent losses and the
restrictions imposed by the Consent Order with the Supervisory Authorities, this source of liquidity is not



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currently available nor is it expected to be available for the foreseeable future. We and the Bank are subject to regulatory policies and requirements relating to the payment of dividends,
including requirements to maintain adequate capital above regulatory minimums. Federal regulatory authorities are authorized to determine under certain circumstances that the payment of dividends by a bank holding company or a bank would be an
unsafe or unsound practice and to prohibit payment of those dividends. Federal regulatory authorities have indicated that banking organizations should generally pay dividends only out of current income. In addition, as a South Carolina chartered
bank, the bank is subject to limitations on the amount of dividends that it is permitted to pay.



See Item 1. Business for further discussion regarding supervision and regulations regarding dividends.



Equity Based Compensation Plan Information



The following table summarizes information regarding equity
based compensation awards outstanding and available for future grants at December 31, 2010.



|                                                             |  |                                                                                            |         |  |                                                                             |   |       |                                                                                                                                             |  |  |         | 
|------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------ | ------- |  | --------------------------------------------------------------------------- | - | ----- | ------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ------- | 
|                                                             |  | (a)Number
ofsecurities to beissued upon exercise ofoutstanding options,warrants and rights |         |  | (b)Weighted averageexercise
price ofoutstanding options,warrants and rights |   |       | (c)Number of 
securitiesremaining available forfuture issuances underequity compensation plans(excluding securitiesreflected in column (a)) | 
|Equity based compensation plans approved
by shareholders     |  |                                                                                            |         |  |                                                                             |   |       |                                                                                                                                             |  |  |         | 
|1997 Stock Compensation Plan                                 |  |                                                                                            | 120,010 |  |                                                                             | $ | 22.93 |                                                                                                                                             |  |  |        | 
|2008 Restricted Stock Plan                                   |  |                                                                                            |        |  |                                                                             |   |      |                                                                                                                                             |  |  | 189,260 | 
|Equity based compensation plans not approved by shareholders |  |                                                                                            |        |  |                                                                             |   |      |                                                                                                                                             |  |  |        | 
|                                                             |  |                                                                                            |         |  |                                                                             |   |       |                                                                                                                                             |  |  |         | 
|Total equity compensation plans                              |  |                                                                                            | 120,010 |  |                                                                             | $ | 22.93 |                                                                                                                                             |  |  | 189,260 | 
|                                                             |  |                                                                                            |         |  |                                                                             |   |       |                                                                                                                                             |  |  |         | 



In February 2011, with advice
from a national benefits consulting firm, the Board of Directors approved the 2011 Palmetto Bancshares, Inc. Stock Plan (the 2011 Plan) to further support the alignment of management and shareholder interests. The 2011 Plan allows for
the Board of Directors to grant stock options and restricted stock awards to key management personnel with vesting provisions including a combination of time vesting and performance metrics related to the Bank successfully resolving the Consent
Order and our return to profitability. The Board has recommended that 2,000,000 shares be designated for issuance under the 2011 Plan. The Board will seek shareholder approval for the 2011 Plan, and it is our intention to include a proposal for
approval of the 2011 Plan in the proxy statement for the next annual shareholders meeting currently scheduled for May 19, 2011.



See Item 8. Financial Statements and Supplementary Data, Note 1, Summary of Significant Accounting Policies, and Note 15, Equity
Based Compensation, for a discussion regarding matters related to our equity based compensation.



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Total Shareholder Return



The following graph sets forth the performance of our common
stock for the five year period ended December 31, 2010 as compared to the S&P 500 Index, and the SNL $1B$5B Bank Index. The graph assumes $100 originally invested on December 31, 2005 and that all subsequent dividends were
reinvested in additional shares. The performance graph represents past performance and should not be considered to be an indication of future performance.



LOGO



The following table summarizes
the cumulative total return for the Company, the S&P 500 Index, and the SNL $1B$5B Bank Index at the dates indicated.



|                          |  |                       |        |  |          |  |        |          |  |  |          |  |  |          |        |  |          |  |       |  |  |  |        | 
|------------------------- |  | --------------------- | ------ |  | -------- |  | ------ | -------- |  |  | -------- |  |  | -------- | ------ |  | -------- |  | ----- |  |  |  | ------ | 
|                          |  | For the period ending |       
|Index                     |  | 12/31/05              |        |  | 12/31/06 |  |        | 12/31/07 |  |  | 12/31/08 |  |  | 12/31/09 |        |  | 12/31/10 | 
|Palmetto Bancshares, Inc. |  |                       | 100.00 |  |          |  | 110.76 |          |  |  | 121.82   |  |  |          | 127.20 |  |          |  | 30.33 |  |  |  | 7.89   | 
|S&P 500                   |  |                       | 100.00 |  |          |  | 115.79 |          |  |  | 122.16   |  |  |          | 76.96  |  |          |  | 97.33 |  |  |  | 111.99 | 
|SNL Bank $1B-$5B          |  |                       | 100.00 |  |          |  | 115.72 |          |  |  | 84.29    |  |  |          | 69.91  |  |          |  | 50.11 |  |  |  | 56.81  | 



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|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



The following consolidated selected financial data should be read in conjunction with Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data (dollars in thousands, except per share data).



|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------------------------------------------------------------------------ |  | --------------------------------------- | ---------- | -- | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                                                                       |  | At and for the years ended December 31, |           
|                                                                                                       |  | 2010                                    |            |    | 2009 |   |           | 2008 |  |   | 2007      |   |  | 2006 |          
|STATEMENTS OF INCOME (LOSS)                                                                            |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Interest income                                                                                        |  | $                                       | 56,627     |    |      | $ | 66,210    |      |  | $ | 78,245    |   |  | $    | 83,551    |   |  | $ | 76,126    |  
|Interest expense                                                                                       |  |                                         | 15,366     |    |      |   | 21,439    |      |  |   | 26,606    |   |  |      | 32,758    |   |  |   | 27,297    |  
|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income                                                                                    |  |                                         | 41,261     |    |      |   | 44,771    |      |  |   | 51,639    |   |  |      | 50,793    |   |  |   | 48,829    |  
|Provision for loan losses                                                                              |  |                                         | 47,100     |    |      |   | 73,400    |      |  |   | 5,619     |   |  |      | 988       |   |  |   | 1,625     |  
|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income (expense) after provision for loan losses                                          |  |                                         | (5,839     | )  |      |   | (28,629   | )    |  |   | 46,020    |   |  |      | 49,805    |   |  |   | 47,204    |  
|Noninterest income                                                                                     |  |                                         | 17,601     |    |      |   | 17,431    |      |  |   | 18,017    |   |  |      | 16,868    |   |  |   | 17,278    |  
|Noninterest expense                                                                                    |  |                                         | 73,306     |    |      |   | 51,015    |      |  |   | 42,974    |   |  |      | 42,259    |   |  |   | 41,279    |  
|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income (loss) before provision (benefit) for income taxes                                          |  |                                         | (61,544    | )  |      |   | (62,213   | )    |  |   | 21,063    |   |  |      | 24,414    |   |  |   | 23,203    |  
|Provision (benefit) for income taxes                                                                   |  |                                         | (1,342     | )  |      |   | (22,128   | )    |  |   | 7,464     |   |  |      | 8,399     |   |  |   | 7,962     |  
|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income (loss)                                                                                      |  | $                                       | (60,202    | )  |      | $ | (40,085   | )    |  | $ | 13,599    |   |  | $    | 16,015    |   |  | $ | 15,241    |  
|                                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|COMMON AND PER SHARE DATA                                                                              |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income (loss) per common share:                                                                    |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                                                                                  |  | $                                       | (3.78      | )  |      | $ | (6.21     | )    |  | $ | 2.11      |   |  | $    | 2.51      |   |  | $ | 2.40      |  
|Diluted                                                                                                |  |                                         | (3.78      | )  |      |   | (6.21     | )    |  |   | 2.09      |   |  |      | 2.47      |   |  |   | 2.37      |  
|Cash dividends per common share                                                                        |  |                                         |           |    |      |   | 0.06      |      |  |   | 0.80      |   |  |      | 0.77      |   |  |   | 0.73      |  
|Book value per common share                                                                            |  |                                         | 2.40       |    |      |   | 11.55     |      |  |   | 17.96     |   |  |      | 17.17     |   |  |   | 15.76     |  
|Outstanding common shares                                                                              |  |                                         | 47,409,078 |    |      |   | 6,495,130 |      |  |   | 6,446,090 |   |  |      | 6,421,765 |   |  |   | 6,367,450 |  
|Weighted average common shares outstandingbasic                                                       |  |                                         | 15,913,000 |    |      |   | 6,449,754 |      |  |   | 6,438,071 |   |  |      | 6,390,858 |   |  |   | 6,353,752 |  
|Weighted average common shares outstandingdiluted                                                     |  |                                         | 15,913,000 |    |      |   | 6,449,754 |      |  |   | 6,519,849 |   |  |      | 6,477,663 |   |  |   | 6,421,742 |  
|Dividend payout ratio                                                                                  |  |                                         | n/a        | %  |      |   | n/a       | %    |  |   | 37.89     | % |  |      | 30.76     | % |  |   | 30.45     | %
|PERIOD-END BALANCES                                                                                    |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Assets                                                                                                 |  | $                                       | 1,355,247  |    |      | $ | 1,435,763 |      |  | $ | 1,368,328 |   |  | $    | 1,246,680 |   |  | $ | 1,152,701 |  
|Investment securities available for sale, at fair value                                                |  |                                         | 218,755    |    |      |   | 119,986   |      |  |   | 125,596   |   |  |      | 95,715    |   |  |   | 116,567   |  
|Total loans                                                                                            |  |                                         | 864,376    |    |      |   | 1,044,196 |      |  |   | 1,165,895 |   |  |      | 1,049,775 |   |  |   | 947,583   |  
|Deposits (including traditional and nontraditional)                                                    |  |                                         | 1,194,082  |    |      |   | 1,249,520 |      |  |   | 1,115,808 |   |  |      | 1,097,209 |   |  |   | 1,029,602 |  
|Other short-term borrowings                                                                            |  |                                         |           |    |      |   |          |      |  |   | 35,785    |   |  |      | 18,000    |   |  |   | 6,000     |  
|FHLB borrowings                                                                                        |  |                                         | 35,000     |    |      |   | 101,000   |      |  |   | 96,000    |   |  |      | 12,000    |   |  |   | 10,000    |  
|Shareholders equity                                                                                   |  |                                         | 113,899    |    |      |   | 75,015    |      |  |   | 115,776   |   |  |      | 110,256   |   |  |   | 100,376   |  
|AVERAGE BALANCES                                                                                       |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Assets                                                                                                 |  | $                                       | 1,399,592  |    |      | $ | 1,428,723 |      |  | $ | 1,321,723 |   |  | $    | 1,182,289 |   |  | $ | 1,113,830 |  
|Interest-earning assets                                                                                |  |                                         | 1,325,651  |    |      |   | 1,352,956 |      |  |   | 1,249,992 |   |  |      | 1,113,461 |   |  |   | 1,045,556 |  
|Investment securities available for sale, at fair value                                                |  |                                         | 135,379    |    |      |   | 119,238   |      |  |   | 123,551   |   |  |      | 104,757   |   |  |   | 120,395   |  
|Total loans                                                                                            |  |                                         | 967,882    |    |      |   | 1,130,809 |      |  |   | 1,111,436 |   |  |      | 987,707   |   |  |   | 896,503   |  
|Deposits (including traditional and nontraditional)                                                    |  |                                         | 1,204,835  |    |      |   | 1,232,526 |      |  |   | 1,107,275 |   |  |      | 1,050,315 |   |  |   | 994,665   |  
|Other short-term borrowings                                                                            |  |                                         | 1          |    |      |   | 5,335     |      |  |   | 13,240    |   |  |      | 3,610     |   |  |   | 847       |  
|FHLB borrowings                                                                                        |  |                                         | 95,231     |    |      |   | 78,166    |      |  |   | 76,718    |   |  |      | 13,947    |   |  |   | 17,981    |  
|Shareholders equity                                                                                   |  |                                         | 87,463     |    |      |   | 106,906   |      |  |   | 116,222   |   |  |      | 106,615   |   |  |   | 95,077    |  
|SELECT PERFORMANCE RATIOS                                                                              |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average assets                                                                               |  |                                         | (4.30      | )% |      |   | (2.81     | )%   |  |   | 1.03      | % |  |      | 1.35      | % |  |   | 1.37      | %
|Return on average shareholders equity                                                                 |  |                                         | (68.83     | )  |      |   | (37.50    | )    |  |   | 11.70     |   |  |      | 15.02     |   |  |   | 16.03     |  
|Net interest margin                                                                                    |  |                                         | 3.11       |    |      |   | 3.31      |      |  |   | 4.13      |   |  |      | 4.56      |   |  |   | 4.67      |  
|CAPITAL RATIOS                                                                                         |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Average shareholders equity as a percentage of average assets                                         |  |                                         | 6.25       | %  |      |   | 7.48      | %    |  |   | 8.79      | % |  |      | 9.02      | % |  |   | 8.54      | %
|Shareholders equity as a percentage of assets, at period end                                          |  |                                         | 8.40       |    |      |   | 5.22      |      |  |   | 8.46      |   |  |      | 8.84      |   |  |   | 8.71      |  
|Tier 1 risk-based capital                                                                              |  |                                         | 13.16      |    |      |   | 6.99      |      |  |   | 9.55      |   |  |      | 9.61      |   |  |   | 9.37      |  
|Total risk-based capital                                                                               |  |                                         | 14.43      |    |      |   | 8.25      |      |  |   | 10.44     |   |  |      | 10.27     |   |  |   | 10.19     |  
|Tier 1 leverage ratio                                                                                  |  |                                         | 8.22       |    |      |   | 5.55      |      |  |   | 8.70      |   |  |      | 8.97      |   |  |   | 8.59      |  
|ASSET QUALITY INFORMATION                                                                              |  |                                         |            |    |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Allowance for loan losses                                                                              |  | $                                       | 26,934     |    |      | $ | 24,079    |      |  | $ | 11,000    |   |  | $    | 7,418     |   |  | $ | 8,527     |  
|Nonaccrual loans                                                                                       |  |                                         | 91,405     |    |      |   | 96,936    |      |  |   | 42,968    |   |  |      | 4,810     |   |  |   | 6,999     |  
|Nonperforming assets                                                                                   |  |                                         | 111,492    |    |      |   | 124,950   |      |  |   | 50,251    |   |  |      | 12,956    |   |  |   | 7,918     |  
|Net loans charged-off                                                                                  |  |                                         | 41,435     |    |      |   | 60,321    |      |  |   | 2,037     |   |  |      | 2,097     |   |  |   | 1,529     |  
|Allowance for loan losses as a percentage of gross loans                                               |  |                                         | 3.39       | %  |      |   | 2.31      | %    |  |   | 0.95      | % |  |      | 0.71      | % |  |   | 0.90      | %
|Nonaccrual loans as a percentage of gross loans, commercial loans held for sale, and foreclosed assets |  |                                         | 10.39      |    |      |   | 9.07      |      |  |   | 3.69      |   |  |      | 0.46      |   |  |   | 0.74      |  
|Nonperforming assets as a percentage of assets                                                         |  |                                         | 8.23       |    |      |   | 8.70      |      |  |   | 3.67      |   |  |      | 1.04      |   |  |   | 0.69      |  
|Net loans charged-off as a percentage of average gross loans                                           |  |                                         | 4.39       |    |      |   | 5.36      |      |  |   | 0.18      |   |  |      | 0.21      |   |  |   | 0.17      |  



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



The following discussion and analysis presents the more
significant factors impacting our financial condition as of December 31, 2010 and 2009 and results of operations and cash flows for the years ended December 31, 2010, 2009, and 2008. This discussion should be read in conjunction with, and
is intended to supplement, all of the other Items presented in this Annual Report on Form 10-K. Percentage calculations contained herein have been calculated based on actual not rounded results.



Critical Accounting Policies
and Estimates



General



The Companys accounting and financial reporting
policies are in conformity, in all material respects, to accounting principles generally accepted in the U.S. and to general practices within the financial services industry. The preparation of financial statements in conformity with such principles
requires management to make estimates and assumptions that impact the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities during the reporting period, and the reported amounts of income and expense during
the reporting period. While we base estimates on historical experience, current information, and other factors deemed to be relevant, actual results could differ from those estimates. Management, in conjunction with the Companys independent
registered public accounting firm, has discussed the development and selection of the critical accounting estimates discussed herein with the Audit Committee of our Board of Directors.



We consider accounting policies and estimates to be critical to our financial condition, results of operations,
or cash flows if the accounting policy or estimate requires management to make assumptions about matters that are highly uncertain and for which different estimates that management reasonably could have used for the accounting estimate in
the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial condition, results of operations, or cash flows.



Our significant accounting policies are discussed in
Item 8. Financial Statements and Supplementary Data, Note 1. Of those significant accounting policies, we have determined that accounting for our allowance for loan losses and the related reserve for unfunded commitments, valuation of loans
held for sale, mortgage-servicing rights, goodwill, foreclosed real estate, the realization of our deferred tax asset, defined benefit pension plan, the valuation of our common stock, and the determination of fair value of financial instruments are
deemed critical because of the valuation techniques used and the sensitivity of the amounts recorded in our Consolidated Financial Statements to the methods, assumptions, and estimates underlying these balances. Accounting for these critical areas
requires subjective and complex judgments and could be subject to revision as new information becomes available.



Allowance for Loan Losses



We consider our accounting policies related to the allowance for loan losses to be critical, as these policies involve considerable
subjective judgment and estimation by management. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense. The allowance for loan losses represents our best estimate of probable inherent losses
that have been incurred within the existing portfolio of loans. The allowance for loan losses is necessary to reserve for estimated probable loan losses inherent in the loan portfolio. Our allowance for loan losses methodology is based on historical
loss experience by loan type, specific homogeneous risk pools, and specific loss allocations. Our process for determining the appropriate level of the allowance for loan losses is designed to account for asset deterioration as it occurs. The
provision for loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans, potential problem loans, criticized loans, and loans charged-off or recovered, among other factors.



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The level of the allowance for loan losses reflects our continuing evaluation of specific
lending risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. Portions of the allowance for loan losses may be allocated
for specific loans. However, the entire allowance for loan losses is available for any loan that, in our judgment, should be charged-off. While we utilize our best judgment and information available, the ultimate adequacy of the allowance for loan
losses is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications and collateral
valuation.



We record allowances for loan losses
on specific loans when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. Specific allowances for loans considered individually significant and
that exhibit probable or observed weaknesses are determined by analyzing, among other things, the borrowers ability to repay amounts owed, guarantor support, collateral deficiencies, the relative risk rating of the loan, and economic
conditions impacting the borrowers industry.



The starting point for the general component of the allowance is the historical loss experience of specific types of loans. We calculate
historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual loan net charge-offs to the total population of loans in the pool. We use a five-year look-back period when computing historical loss
rates. However, given the increase in loan charge-offs beginning in 2009, we also utilized a three-year look-back period during 2010 for computing historical loss rates as an additional reference point in determining the allowance for loan losses.



We adjust these historical loss percentages for
qualitative environmental factors derived from macroeconomic indicators and other factors. Qualitative factors we considered in the determination of the December 31, 2010 allowance for loan losses include pervasive factors that generally
impact borrowers across the loan portfolio (such as unemployment and consumer price index) and factors that have specific implications to particular loan portfolios (such as residential home sales or commercial development). Factors evaluated may
include, without limitation, changes in delinquent, nonaccrual and troubled debt restructured loan trends, trends in risk ratings and net loans charged-off, concentrations of credit, competition and legal and regulatory requirements, trends in the
nature and volume of the loan portfolio, national and local economic and business conditions, collateral valuations, the experience and depth of lending management, lending policies and procedures, underwriting standards and practices, the quality
of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other external factors. The general reserve portion of the allowance for loan losses calculated using the historical loss rates and qualitative factors
is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.



Loans identified as losses by management, internal loan review, and / or bank examiners are charged-off. We review each impaired loan on a
loan-by-loan basis to determine whether the impairment should be recorded as a charge-off or a reserve based on our assessment of the status of the borrower and the underlying collateral. In general, for collateral dependent loans, the impairment is
recorded as a charge-off unless the fair value was based on an internal valuation pending receipt of a third party appraisal or other extenuating circumstances. Consumer loan accounts are charged-off generally based on pre-defined past due time
periods.



In addition to our portfolio review
process as discussed elsewhere in this item, various regulatory agencies, as part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance for loan losses
based on their judgments and information available to them at the time of their examination. While we use available information to recognize inherent losses on loans, future adjustments to the allowance for loan losses may be necessary based on
changes in economic conditions and other factors and the impact of such changes on the Banks borrowers.



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We believe that the allowance for loan losses at December 31, 2010 is adequate to cover
probable inherent losses in the loan portfolio. However, underlying assumptions may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers
which was not known to management at the time of the issuance of the Companys Consolidated Financial Statements. Therefore, our assumptions may or may not prove valid. Thus, there can be no assurance that loan losses in future periods,
including potential incremental losses resulting from the sale of the commercial loans held for sale, will not exceed the current allowance for loan losses amount or that future increases in the allowance for loan losses will not be required.
Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses, thus
adversely impacting the Companys business, financial condition, results of operations, and cash flows.



See Item 1A. Risk Factors contained herein for discussion regarding the material risks and uncertainties that we believe impact our
allowance for loan losses.



Commercial Loans
Held for Sale



Commercial loans held for sale
are carried at the lower of cost or fair value less estimated selling costs. A valuation allowance is recorded to reflect the excess of the recorded investment in the loan and the fair value less estimated selling costs. Commercial loans held for
sale for which binding sales contracts have been entered into as of the balance sheet date are accounted for at the contract amount. Collateral dependent commercial loans held for sale are valued based on independent collateral appraisals less
estimated selling costs. If quoted market prices, binding sales contracts or appraised collateral values are not available, we consider discounted cash flow analyses with market assumptions.



There can be no assurances that the loans will be sold, or that any bids offered will be at the currently
recorded balances. Accordingly, to the extent that we accept bids for these loans, we may receive significantly less than the current net carrying amount of the loans and incur a corresponding incremental loss on any such loan sales.



Mortgage-Servicing Rights



The value of our mortgage-servicing rights is an accounting
estimate that depends heavily on current economic conditions specifically the interest rate environment and managements judgments. We utilize the expertise of a third party consultant on a quarterly basis to assess the portfolios value
including, but not limited to, capitalization, impairment, and amortization rates. Estimates of the amount and timing of prepayment rates, loan loss experience, costs to service loans, and discount rates are used to estimate the fair value of our
mortgage-servicing rights portfolio. Amortization of the mortgage-servicing rights portfolio 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
mortgage-servicing rights portfolio. Projected net servicing income is determined based on the estimated future balance of the underlying mortgage loan portfolio that declines over time from prepayments and scheduled loan amortization. Future
prepayment rates are estimated based on current interest rate levels, other economic conditions, market forecasts, and relevant characteristics of the mortgage-servicing rights portfolio such as loan types, interest rate stratification, and recent
prepayment experience. We believe that the modeling techniques and assumptions used are reasonable; however, such assumptions may or may not prove valid. Thus, there can be no assurance that mortgage-servicing rights portfolio capitalization,
amortization, and impairment in future periods will not exceed the current capitalization, amortization, and impairment amounts. Moreover, no assurance can be given that changing economic conditions and other relevant factors impacting our
mortgage-servicing rights portfolio will not cause actual occurrences to differ from underlying assumptions thus adversely impacting our business, financial condition, results of operations, and cash flows.



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Goodwill



In the third quarter 2010, the Company recorded a goodwill
impairment charge of $3.7 million. Goodwill resulted from past business combinations from 1988 through 1999. We perform our annual impairment testing as of June 30 each year. However, due to the overall adverse economic environment and the
negative impact on the banking industry as a whole, including the impact to the Company resulting in net losses and a decline in market capitalization based on our common stock price, we also performed impairment tests of our goodwill quarterly in
2010.



Our common stock is not listed on any
national securities exchange or quoted on the OTC Bulletin Board. Our common stock is, however, quoted on the Pink Sheets under the symbol PLMT.PK. Although our common stock is quoted on the Pink Sheets, there is currently only a limited
public trading market for our common stock. Private trading of our common stock also has been limited and has typically been conducted through the Private Trading System on our website. The Private Trading System is a passive mechanism created to
assist buyers and sellers in facilitating trades in our common stock. In addition, buyers and sellers may privately negotiate transactions in our common stock. Because there is not an established market for our common stock, management may not be
aware of all prices at which our common stock has been traded. Accordingly, we normally determine the value of our common stock based on the last five trades of the stock facilitated by the Company through the Private Trading System.



While there were trades in our common stock in the first and
second quarters of 2010 through the Private Trading System, there were not any trades through the Private Trading System during the three month period ended September 30, 2010. The Private Placement was consummated on October 7, 2010
pursuant to which the Company issued 39,975,980 million shares of common stock at $2.60 per share. This per share issue price was negotiated by the Company at arms length with the investors and was supported by a fairness opinion from the
investment banking firm engaged by the Companys Board of Directors, including a comparison to common stock prices as a percentage of book value for publicly traded banks with similar asset quality and financial condition of the Company, and in
comparison to recent merger and acquisition transactions. Accordingly, we believe it was appropriate to utilize the $2.60 issue price in our goodwill impairment evaluation.



The first step of the goodwill impairment evaluation was
performed by comparing the fair value of our reporting unit with its carrying amount, including goodwill. Since the carrying amount of the reporting unit exceeded its fair value, the second step of the goodwill impairment test was performed to
measure the amount of impairment loss. The second step of the goodwill impairment test compared the implied fair value of our reporting unit goodwill with the carrying amount of that goodwill. Since the carrying amount of reporting unit goodwill
exceeded the implied fair value of that goodwill, an impairment loss was recognized in an amount equal to that excess. The evaluation at September 30, 2010 indicated that the carrying value of the Companys goodwill exceeded the fair
value and resulted in a third quarter noncash charge of $3.7 million, eliminating the goodwill as an asset on the Companys Consolidated Balance Sheets. This charge had no effect on the liquidity, regulatory capital, or daily operations of
the Company and was recorded as a component of noninterest expense on the Consolidated Statement of Income (Loss).



Foreclosed Real Estate



The value of our foreclosed real estate portfolio represents another accounting estimate that depends heavily on current economic
conditions. Foreclosed real estate is carried at fair value less estimated selling costs, establishing a new cost basis. Fair value of such real estate is reviewed regularly and writedowns are recorded when it is determined that the carrying value
of the real estate exceeds the fair value less estimated costs to sell. Writedowns resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are
charged against income. Costs relating to the development and improvement of such properties are capitalized.



The fair value of properties in the foreclosed real estate portfolio is generally determined from appraisals obtained from independent
appraisers. We review the appraisal assumptions for reasonableness and may make



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adjustments when necessary to reflect current market conditions. Such assumptions may not prove to be valid. Moreover, no assurance can be given that changing economic conditions and other
relevant factors impacting our foreclosed real estate portfolio will not cause actual occurrences to differ from underlying assumptions thus adversely impacting our business, financial condition, results of operations, and cash flows.



Realization of Net Deferred Tax Asset



We use certain assumptions and estimates in determining
income taxes payable or refundable, deferred income tax liabilities and assets for events recognized differently in our financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain
transactions and interpretation of tax laws and regulations. We exercise considerable judgment in evaluating the amount and timing of recognition of the resulting income tax liabilities and assets. These judgments and estimates are reevaluated on a
periodic basis as regulatory and business factors change.



We include the current and deferred tax impact of our tax positions in the financial statements only when it is more likely than not (likelihood of greater than 50%) that such positions will be sustained
by taxing authorities, with full knowledge of relevant information, based on the technical merits of the tax position. While we support our tax positions by unambiguous tax law, prior experience with the taxing authority, and analysis that considers
all relevant facts, circumstances and regulations, we must still rely on assumptions and estimates to determine the overall likelihood of success and proper quantification of a given tax position.



As of December 31, 2010, prior to the valuation
allowance, net deferred tax assets totaling $20.5 million were recorded in the Companys Consolidated Balance Sheets. Based on our projections of future operating results over the next several years, cumulative tax losses over the previous
three years, tax loss deductibility limitations as discussed below and available tax planning strategies, we recorded a valuation allowance against the net deferred tax asset at December 31, 2010. The Private Placement that was consummated on
October 7, 2010 is considered to be a change in control under the Internal Revenue Service rules. Accordingly, with the assistance of third party specialists, we were required to determine the fair value of the Company and our assets for the
purpose of evaluating any potential limitation or deferral of our ability to carry forward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses as of October 7, 2010, which also limits the amount of
net operating losses that may be used in the future. As a result of the valuations and tax analysis, we currently estimate that future utilization of net operating loss carry forwards and built-in losses of $46 million generated prior to
October 7, 2010 will be limited to $1.1 million per year.



Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be
predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at December 31, 2010, the net operating losses are able to be carried forward for income tax purposes for up
to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to utilize a portion of the net operating losses for income tax purposes and reverse a portion of the valuation
allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and, therefore, how much of the valuation allowance that may be reversed and the timing is based on our future results
of operations and the amount and timing of actual loan charge-offs and asset writedowns.



Additionally, for regulatory capital purposes, deferred tax assets are limited to the assets which can be realized through (i) carryback to prior years or (ii) taxable income in the next twelve
months. At December 31, 2010, all of our net deferred tax asset was excluded from Tier 1 and total capital based on these criteria. We will continue to evaluate the realizability of our deferred tax asset on a quarterly basis for both financial
reporting purposes and regulatory capital purposes. The evaluation may result in the inclusion of a portion of the deferred tax asset in our regulatory capital calculation in future periods.



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Defined Benefit Pension Plan



We account for our defined benefit pension plans on an
actuarial basis. Pension assumptions are significant inputs to the actuarial models that measure pension benefit obligations and related impacts on income. In particular, the assumed discount rate and expected return on assets are important
elements of defined benefit pension plan expense and asset / liability measurement with regard to the plan. We evaluate these critical assumptions annually. Lower discount rates increase present values and subsequent year pension expense, while
higher discount rates decrease present values and subsequent year pension expense. To determine the expected long-term rate of return on defined benefit pension plan assets, we consider asset allocations and historical returns on various categories
of plan assets. Both of these key assumptions are sensitive to changes. In addition, the pension plan includes common stock of the Company, which is not traded on an exchange and the value of which is subject to change based on our financial
results. At December 31, 2010, the fair value of Companys common stock included in the plan was 0.3% of total fair value of assets of the plan. Additionally, we periodically evaluate other assumptions involving demographic factors, such
as retirement age, mortality, and turnover and update such factors to reflect experience and expectations for the future.



Effective 2008, we ceased accruing pension benefits for employees under our noncontributory, defined benefit pension plan. Although no
previously accrued benefits were lost, employees no longer accrue benefits for service subsequent to 2007. Amounts recognized within our Consolidated Financial Statements with regard to this change to our defined benefit pension plan were also
computed on an actuarial basis. Because of the considerable judgment necessary in the determination of all such assumptions, actual results in any given year may differ from actuarial assumptions. In addition, we may decide to terminate the pension
plan which, based on the valuation of the plan assets and actuarial valuation of the accrued benefits to the participants at that time, would require a cash contribution to the plan for any resulting unfunded liability. While not computed on such
basis, the current unfunded liability was $5.2 million at December 31, 2010.



Valuation of Common Stock



On a periodic basis, we utilize the market price of our common stock within various valuations and calculations relating to our defined benefit pension plan assets, our trust department assets under
management, our employee retirement accounts, our impairment analysis of goodwill, our granting of awards under our 2008 Restricted Stock Plan, our calculation of earnings per share on a diluted basis, and our valuation of such stock serving as loan
collateral.



Our common stock is not listed on any
national securities exchange or quoted on the OTC Bulletin Board. Our common stock is, however, quoted on the Pink Sheets under the symbol PLMT.PK. Although our common stock is quoted on the Pink Sheets, there is currently only a limited
public trading market for our common stock. Private trading of our common stock also has been limited and has typically been conducted through the Private Trading System on our website. In addition, buyers and sellers may privately negotiate
transactions in our common stock. Because there is not an established market for our common stock, we may not be aware of all prices at which our common stock has been traded. Additionally, we have not determined whether the trades of which we are
aware were the result of arms-length negotiations between the parties. We normally determine the value of our common stock based on the last five trades of the stock facilitated by the Company through the Private Trading System. The liquidity
of our common stock depends upon the presence in the marketplace of willing buyers and sellers.



One of the requirements of the Private Placement is that the Company will use its reasonable best efforts to list the shares of our common stock on NASDAQ or another national securities exchange within
nine months of the closing date of the Private Placement on October 7, 2010. While it is our intent to seek to list our common stock on NASDAQ, no assurances can be provided at this time that we will meet such listing requirements.



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Fair Value Measurements



We use fair value measurements to record fair value adjustments to certain financial instruments and to
determine fair value disclosures. Additionally, we may be required to record other assets at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or
writedowns of individual assets. Further, we include in the Notes to the Consolidated Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used, and the related
impact to income. Additionally, for financial instruments not recorded at fair value, we disclose the estimate of their fair value.



Fair value is defined as the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction
between market participants at the measurement date. Accounting standards establish a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based
on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our
estimates about market data. The three levels of inputs that are used to classify fair value measurements are as follows:



| |  |  | Level 1  Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments generally include
securities traded on active exchange markets, such as the New York Stock Exchange, as well as securities that are traded by dealers or brokers in active over-the-counter markets. Instruments we classify as Level 1 are instruments that have been
priced directly from dealer trading desks and represent actual prices at which such securities have traded within active markets. Level 1 instruments also include commercial loans held for sale for which binding sales contracts have been entered
into as of the balance sheet date.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 2  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in
markets that are not active, and model-based valuation techniques, such as matrix pricing, for which all significant assumptions are observable in the market. Instruments we classify as Level 2 include securities that are valued based on pricing
models that use relevant observable information generated by transactions that have occurred in the market place that involve similar securities. Level 2 instruments also include mortgage loans held for sale that are valued based on prices for other
mortgage whole loans with similar characteristics and commercial loans held for sale that are based on independent collateral appraisals.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3  Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable
assumptions reflect the Companys estimates of assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models, and similar techniques.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We attempt to maximize the use
of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon
models that use primarily market-based or independently-sourced market parameters. Most of our financial instruments use either of the foregoing methodologies, collectively Level 1 and Level 2 measurements, to determine fair value adjustments
recorded to our financial statements. However, in certain cases, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in
estimating the fair value of the financial instrument.



The degree of management judgment involved in determining the fair value of an instrument is dependent upon the availability of quoted market prices or observable market parameters. For instruments that
trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management



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judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the
capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. When significant adjustments are required to available observable inputs, it may be appropriate to utilize an estimate based
primarily on unobservable inputs. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is
acceptable.



Significant judgment may be required
to determine whether certain assets measured at fair value are included in Level 2 or Level 3. If fair value measurement is based upon recent observable market activity of such assets or comparable assets (other than forced or distressed
transactions) that occur in sufficient volume and do not require significant adjustment using unobservable inputs, those assets are classified as Level 2. If not, they are classified as Level 3. Making this assessment requires significant judgment.



Executive
Summary of 2010 Financial Results



Context for 2010 and the Company



The Palmetto Bank has been operating since 1906 and the Banks holding company, Palmetto Bancshares, Inc., was incorporated in 1982.
Given the Companys 104 year history, the Company has developed long-standing relationships with customers in the communities in which we operate and a recognizable name, which has resulted in a well-established branch network and loyal deposit
base. As a result, the Company has historically had a lower cost of deposits than its peers due to a higher core deposit mix.



The Company operated under the same executive management team for more than 30 years until 2009. During that time, the Company grew to
become the fifth largest banking institution headquartered in South Carolina and one of the most profitable banking franchises in the Carolinas. From 1999 to 2008, the Company averaged a return on average assets and return on average equity of 1.25%
and 15.2%, respectively, and the Companys net interest margin averaged 4.78%. In addition, over the same time period, noninterest income to average assets averaged 1.60%.



As a result of the challenges that developed in 2008, the
Company accelerated its management succession plan and in early 2009 the board of directors hired a new Chief Executive Officer and Chief Operating Officer. As the impact of the recession worsened, the Companys new management team quickly
developed and implemented a comprehensive Strategic Project Plan to address all areas of the Company with an immediate emphasis on aggressively resolving the Companys asset quality issues, including through the hiring in July 2009 of a new
Chief Credit Officer who brought over 25 years of credit experience to the Company.



Both 2009 and 2010 were very challenging years for the Company, the banking industry, and the U.S. economy in general. In relation to the Company, the overall economic context for our financial condition
and results of operations include the following:



| |  |  | Ongoing financial stress in the overall U.S. economy during 2010 that generally started with an economic crisis in August 2008 and continued into 2009,
for which the banking industry and the Company continue to be adversely affected.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Volatile equity markets that declined significantly during the first half of 2009 and have since begun to improve although daily volatility continues.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Significant stress on the banking industry resulting in significant governmental financial assistance to many financial institutions, extensive
regulatory and congressional scrutiny, and new comprehensive reform legislation, including unknown regulations to be adopted as a result.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | General anxiety on the part of our customers and the general public.
| | - |  | --------------------------------------------------------------------



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| |  |  | Uncertainty about the future and when the economy will return to normal and questions about what will be the new normal.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | Low and uncertain interest rate environment particularly given government intervention in the financial markets, with current expectations of rising
interest rates although the timing is uncertain.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | High levels of unemployment nationally and in our local markets, and uncertainty about when the trend will begin to improve.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



Additional context specific to
the Company includes the following:



| |  |  | Fast growth from 2004 through the first quarter of 2009, growing total assets 57% during that period which resulted in the Company reaching a natural
maturity/life cycle hump that is typical for banks that reach that asset size. Typical challenges associated with this stage of our life cycle include:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stress on our infrastructure requiring investment in the number and expertise of employees and refinement of policies and procedures.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Required investments in technology to invest in the future, and rationalization of the technology investments versus our historical investment in
facilities.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adapting products and services and related pricing and fees to remain relevant to our current and evolving customer base and competitiveness in the
market place, and developing broader distribution channels for delivery of our products and services.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Application of a more sophisticated risk management approach, including a comprehensive view of risk, processes and procedures, internal and vendor
expertise, and the way we do business.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Executive management succession plan implemented effective July 1, 2009 and resulting organizational changes.
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | In planning for the retirement of the former Chief Executive Officer of the Company and the Chief Executive Officer of the Bank (who also served as the
President, Chief Operating Officer, and Chief Accounting Officer of the Company), effective July 1, 2009 the Company named Samuel L. Erwin as Chief Executive Officer and President of the Bank and Lee S. Dixon as Chief Operating Officer of the
Company and the Bank. Subsequently, Mr. Erwin also assumed the title of Chief Executive Officer of the Company on January 1, 2010, and Mr. Dixon assumed additional responsibilities as Chief Risk Officer of the Company and the Bank in
October 2009 and as the Chief Financial Officer of the Company and the Bank as of July 1, 2010. Messrs. Erwin and Dixon have proven bank turn around and operational capabilities and rapidly developed and implemented the Companys Strategic
Project Plan in June 2009 as summarized below.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and 2010, we realigned our organizational structure and began the process of more specifically delineating our businesses. Additional
organizational and senior management changes included designating an internal executive to be responsible for our Commercial Bank in August 2009 and another internal executive to be responsible for our Wealth Management business in October 2010. In
addition, the Company hired a new Chief Credit Officer in July 2009, new Retail Banking Executive in October 2010, and a new Chief Financial Officer in November 2010.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Significant deterioration in asset quality during 2009 resulting in a net loss for 2009 which was the first annual net loss in the history of the
Company since the Great Depression in the 1930s. Asset quality challenges continued in 2010, and we also incurred a net loss in 2010 driven primarily by credit losses.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increased regulatory scrutiny given declining asset quality, financial results and capital position, which resulted in the Bank agreeing to the
issuance of a Consent Order with its primary bank regulatory agencies in June 2010.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Strategic repositioning and reduction of the balance sheet to reduce commercial real estate loan concentrations and individually larger and more
complex loans originated during 2004 through 2008, as well as intentional reduction in the amount of federal funds purchased, FHLB advances, and higher
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | priced certificates of deposit used to fund loan growth during that period. Gross loans decreased $362.9 million from March 31, 2009 (peak quarter end loans) to December 31,
2010. Borrowings and certificates of deposits also decreased $145.9 million from June 30, 2009 (peak quarter end borrowings).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In light of the above, in 2009, management and the Board of Directors reacted quickly and defined three strategic initiatives, which are
currently summarized as follows:



|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                         
|-------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------
|Component                  |  | Primary Emphasis                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | Time Horizon            
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Strategic Project Plan     |  |    Manage through the extended recession and volatile economic
environment 
   Execute the Strategic Project Plan related to credit quality, earnings, liquidity, and
capital (the Strategic Project Plan is described in more detail below), including preparation for a potential formal agreement with the bank regulatory agencies and raising additional capital                                                                                                                                                                                                                                                                                                          |  | June 2009  October 2010
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|2010 Annual Strategic Plan |  |    Strategic planning at the corporate and department level for calendar
year 2010 in the context of the uncertain economic environment     Acceleration of overcoming the growth hump/life cycle stage of maturity resulting from fast growth reaching a high of $1.5 billion in assets
    Positioning
the Bank to return to profitability in the post-capital raise and post-recession environment  These efforts will continue as part of the execution of our annual strategic plan in 2011.                                                                                                                                                                             |  | Calendar year 2010      
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Bank of the Future         |  |    Reinventing the Bank to be the bank of the
future 
   Determining the customer of tomorrow and refining our products, services, and
distributions channels to meet their expectations     Adapting to the rapidly changing financial services landscape, including lower earnings due to the low interest rate environment, potential regulatory restrictions on historical
sources of income, and higher compliance costs     Intended listing of common stock on the NASDAQ stock exchange 
   Preparing for growth through organic growth given banking market disruption in our
geographic markets and the potential for growth through mergers and acquisitions |  | Two to five years       



We believe it is critical to focus on all three strategic initiatives simultaneously to optimize long-term shareholder value. As a result,
management and the Board of Directors focused a tremendous amount of time and effort on addressing all three initiatives in 2009 and 2010 with the overall objectives being: 1) to aggressively deal with our credit quality, earnings and capital issues
as quickly as possible and 2) to accelerate into a much shorter time frame the reinvention of The Palmetto Bank that might otherwise normally take several years to accomplish. While the National Bureau of Economic Research concluded that
the recession officially ended in June 2009, the impact of



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the recession is continuing to be felt by the banking industry and the Company. Accordingly, our focus has been and continues to be centered on managing through the effects of the recession to
position the Company to return to profitability once the economy begins to recover.



The consummation of the Private Placement on October 7, 2010 in which the Company received $103.9 million of gross proceeds is a significant step forward in the implementation of these strategic
initiatives. The Private Placement resulted in the Companys and the Banks capital adequacy ratios exceeding the well-capitalized minimums. In addition, while financial challenges remain, the completion of the Private Placement
repositioned the Company from a defensive posture to a more offensive oriented posture in terms of balance sheet management, market presence, customer retention, and new customer acquisition.



As summarized in more detail below, we are continuing our keen focus on improving credit quality and earnings.
Overall, with the completion of the Private Placement in October 2010, we are in the process of repositioning the balance sheet as part of our balance sheet management efforts to utilize our excess cash more effectively to improve our net interest
margin. This includes investing in higher yielding investment securities until loan growth resumes, as well as paying down higher priced funding such as FHLB advances and maturing CDs. We are also continuing to adapt our organizational structure to
fit the current and future size and scope of our business activities and operations. Such efforts include hiring management personnel with specialized industry experience, more specifically delineating our businesses, and preparing go to
market strategies with relevant products and services and marketing plans by business.



Summary Financial Results and Company Response



The national and local economy and the banking industry continue to deal with the effects of the most pronounced recession in decades. In South Carolina, unemployment rose significantly throughout 2009
and into 2010 and is higher than the national average, and residential and commercial real estate projects are depressed with significant deterioration in values. As a result, the impact in our geographic area and to individual borrowers was severe.
As a result of the extended recession, our financial results in the years ended December 31, 2009 and 2010 were significantly impacted by the following in comparison to our historical financial results in the year ended December 31, 2008:



| |  |  | Provision for loan losses totaling $47.1 million and $73.4 million in 2010 and 2009, respectively, compared to $5.6 million for 2008.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loss on commercial loans held for sale totaling $7.6 million in 2010 compared to none in 2009 and 2008.
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Net loss from writedowns, expenses, operations, and sales of foreclosed real estate totaling $11.7 million and $3.2 million in 2010 and 2009,
respectively, compared to $516 thousand in 2008.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Foregone interest of $4.7 million and $3.7 million in 2010 and 2009, respectively, compared to none in 2008 on cash invested at the Federal Reserve at
25 basis points to maintain liquidity versus the average yield on our investment securities of 2.75% and 4.75%, respectively.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Higher FDIC deposit insurance assessments totaling $4.5 million and $3.3 million in 2010 and 2009, respectively, compared to $786 thousand in 2008 due
to industry wide increases in general assessment rates, our voluntary participation in the FDICs Transaction Account Guarantee Program, our capital classification being below well-capitalized throughout most of 2010, and an industry-wide
special assessment in 2009.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Goodwill impairment totaling $3.7 million in 2010.
| | - |  | --------------------------------------------------



| |  |  | Higher credit-related expenses for problem asset workout and other expenses to execute the Strategic Project Plan, which were not incurred prior to the
third quarter of 2009.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Valuation allowance of $20.5 million recorded against deferred tax assets in 2010 resulting in the elimination or deferral of tax benefits that would
have otherwise been available to reduce our net loss in 2010.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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In total, the above events reduced our earnings by approximately $91.9 million and $76.7
million for the years ended December 31, 2010 and 2009, respectively, compared to the year ended December 31, 2008. Accordingly, we believe consummation of the Private Placement and successful completion of the Strategic Project Plan will
result in significant improvement to our earnings going forward.



The credit-related costs for banks associated with the recession are significant. Beginning in the fourth quarter of 2008 and continuing throughout 2010, construction, acquisition and development real
estate projects have slowed down, guarantors are financially stressed, and increasing credit losses have surfaced. During 2009 and 2010, delinquencies over 90 days increased resulting in an increase in nonaccrual loans indicating significant credit
quality deterioration and probable losses. In particular, loans secured by real estate including acquisition, construction and development projects demonstrated stress given reduced cash flows of individual borrowers, limited bank financing and
credit availability, and slow property sales. This deterioration has manifested itself in our borrowers in several ways: decreases in cash flows from underlying properties supporting the loans (e.g., slower property sales for development type
projects or lower occupancy rates or rental rates for operating properties), decreases in cash flows from the borrowers themselves, increased pressure on guarantors due to illiquid and diminished personal balance sheets resulting from investing
additional personal capital in the projects, and declines in fair values of real estate related assets, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers are no longer willing to sell the assets at such
deep discounts.



This resulted in a significant
increase in the level of nonperforming assets through March 31, 2010, with a continued elevated level of such assets through December 31, 2010. While nonperforming assets are still high, we have now experienced three consecutive quarters
of a reduction with an overall reduction of 21.6% since the peak at March 31, 2010.



In addition, many of these loans are collateral dependent real estate loans for which we are required to write down the loans to fair value less estimated selling costs with the fair values determined
primarily based on third party appraisals. During 2009 and 2010, appraised values decreased significantly, even in comparison to appraisals received when the loans were originated in 2006 to 2009, and upon reappraisal since origination. As a result,
our evaluation of our loan portfolio and foreclosed assets in 2010 and 2009 resulted in significant credit losses.



Recent Regulatory Developments



As a result of these circumstances and the examination of the Supervisory Authorities in November 2009, the Bank agreed to the issuance of
the Consent Order with the Supervisory Authorities effective on June 10, 2010. A summary of the requirements of the Consent Order and the Banks status on complying with the Consent Order is as follows:



|                                                                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                   |  | Banks Compliance Status                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                    | 
|Achieve and maintain, within 120 days from the effective
date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets. |  | On October 7, 2010, the Company consummated the Private Placement pursuant to which the
Company received gross proceeds of $103.9 million from the issuance of shares of the Companys common stock. Substantially all of the net proceeds of the Private Placement were contributed to the Bank as a capital contribution, resulting in the
Companys and the Banks capital levels being above the amounts specified in the Consent Order and to be categorized as well-capitalized.



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|                                                                                                                                                                                                                                                                                                                                                  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                                                                                                                                                 |  | Banks Compliance Status                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                  | 
|Determine, within 30 days of the last day of the calendar
quarter, its capital ratios. If any capital measure falls below the established minimum, within 30 days provide a written plan to the supervisory authorities describing the means and timing by which the Bank shall increase such ratios to or in
excess of the established minimums. |  | At December 31, 2010, as a result of the Private Placement consummated on October 7, 2010,
as noted above, the Company received gross proceeds of $103.9 million from the issuance of shares of the Companys common stock. Substantially all of the net proceeds of the Private Placement were contributed to the Bank as a capital
contribution, resulting in the Banks capital levels being above the amounts specified in the Consent Order.
|                                                                                                                                                                                                                                                                                                                                                  | 
|Establish, within 30 days from the effective date of the
Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored by the Banks Board of Directors.                                                                                                                                                           |  | We have implemented a plan to monitor compliance with the Consent Order.                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                  | 
|Develop, within 60 days from the effective date of the
Consent Order, a written analysis and assessment of the Banks management and staffing needs.                                                                                                                                                                                              |  | We prepared a written analysis and assessment of the Banks management and staffing
needs and submitted the plan to the Supervisory Authorities in August 2010.                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                  | 
|Notify the supervisory authorities in writing of the
resignation or termination of any of the Banks directors or senior executive officers.                                                                                                                                                                                                      |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                  | 
|Eliminate, within 10 days from the effective date of the
Consent Order, by charge-off or collection, all assets or portions of assets classified Loss and 50% of those assets classified Doubtful.                                                                                                                                            |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                  | 
|Review and update, within 60 days from the effective date of
the Consent Order, its policy to ensure the adequacy of the Banks allowance for loan and lease losses, which must provide for a review of the Banks allowance for loan and lease losses at least once each calendar quarter.                                                       |  | We believe we have complied with this provision of the Consent Order. We submitted our
revised policy to the Supervisory Authorities in July 2010.                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                  | 
|Submit, within 60 days from the effective date of the
Consent Order, a written plan to reduce classified assets, which shall include, among other things, a reduction of the Banks risk exposure in relationships with assets in excess of $1,000,000 which are criticized as Substandard,
Doubtful, or Special Mention.                   |  | As part of our Strategic Project Plan summarized below, we have developed written loan
workout plans to reduce classified assets, and we submitted our plans to the Supervisory Authorities in July 2010. The Supervisory Authorities may also amend the requirements of the Consent Order based on the results of their ongoing
examinations.                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                  | 
|Revise, within 60 days from the effective date of the
Consent Order, its policies and procedures for managing the Banks Adversely Classified Other Real Estate Owned.                                                                                                                                                                            |  | As part of our Strategic Project Plan summarized below, we have revised our policies and
procedures for managing our real estate acquired in foreclosure, and we submitted our policies and procedures to the Supervisory Authorities in July 2010.                                                                                                                                                                                              



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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | Banks Compliance Status                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 
|Not extend any additional credit to any borrower who has a
loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, Loss or Doubtful and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who
has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, Substandard or Special Mention and is uncollected, unless the Banks board of directors determines that failure to
extend further credit to a particular borrower would be detrimental to the best interests of the Bank. |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 
|Perform, within 90 days from the effective date of the
Consent Order, a risk segmentation analysis with respect to the Banks Concentrations of Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit.                                                                                                                                                                                                                                                                                                                                                   |  | As part of our Strategic Project Plan summarized below, we have performed a risk
segmentation analysis of our concentrations of credit and developed a plan to reduce our concentration in commercial real estate. We continue to monitor our concentrations and, in particular, are working aggressively to reduce our concentrations in
commercial real estate. We submitted our plan to the Supervisory Authorities in August 2010.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 
|Review, within 60 days from the effective date of the
Consent Order and annually thereafter, the Banks loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Banks lending functions and
ensure their implementation.                                                                                                                                                                                                                                                                                                     |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed our
loan policies and procedures for adequacy and made appropriate revisions to enhance our lending and credit administration functions. We have continued to refine our policies and procedures in 2010. We submitted the revised policy to the Supervisory
Authorities in July 2010.                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | 
|Adopt, within 60 days from the effective date of the Consent
Order, an effective internal loan review and grading system to provide for the periodic review of the Banks loan portfolio in order to identify and categorize the Banks loans, and other extensions of credit which are carried on the
Banks books as loans, on the basis of credit quality.                                                                                                                                                                                                                                                                       |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed our
loan review and grading system to provide for the periodic review of our loan portfolio to review and categorize our loans. As described in more detail elsewhere in this report, we have conducted internal and external loan reviews in 2009 and 2010.
We submitted the revised policy to the Supervisory Authorities in July 2010.        



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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Banks Compliance Status                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review and update, within 60 days from the effective date of
the Consent Order, its written profit plan to ensure the Bank has a realistic, comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank,
the major areas in and means by which the Bank will seek to improve the Banks operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with
budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Banks loan, investment, and operating policies and budget and
profit planning with the funds management policy. |  | We have prepared annual budgets for 2010 and 2011 that were approved by the Banks
Board of Directors. We submitted the budgets to the Supervisory Authorities in August 2010.                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Review and update, within 60 days from the effective date of
the Consent Order, its written plan addressing liquidity, contingent funding, and asset liability management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | As part of our Strategic Project Plan summarized below, in 2009 and 2010 we reviewed and
updated our written Asset Liability and Investments Plan, and we submitted the plan to the Supervisory Authorities in July 2010.                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Eliminate, within 30 days from the effective date of the
Consent Order, all violations of law and regulation or contraventions of policy set forth in the FDICs safety and soundness examination of the Bank in November 2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | At June 30, 2010, we had eliminated all matters set forth in the FDICs safety and
soundness examination of the Bank in November 2009.                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Not accept, renew, or rollover any brokered deposits unless
it is in compliance with the requirements of 12 C.F.R. § 337.6(b).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | Prior to and at December 31, 2010, the Bank did not have any brokered
deposits.                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Limit asset growth to 10% per annum.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Not declare or pay any dividends or bonuses or make any
distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the Supervisory Authorities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | We believe we have complied with this provision of the Consent Order.                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Not offer an effective yield on deposits of more than 75
basis points over the national rates published by the FDIC weekly on its website unless otherwise specifically permitted by the FDIC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | We believe we have complied with this provision of the Consent Order. On April 1, 2010, we
were notified by the FDIC that it had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, the Bank is able to offer interest rates on deposits up to 75 basis points over the prevailing interest
rates in our geographic areas. The FDIC has informed us that this high-rate determination is also effective for calendar year 2011.



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|                                                                                                                                                                                                                                                                                          |  |                                                                                                                                                          
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Requirements of the Consent Order                                                                                                                                                                                                                                                         |  | Banks Compliance Status                                                                                                                                 
|                                                                                                                                                                                                                                                                                          | 
|Furnish, by within 30 days from the effective date of the
Consent Order and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order. |  | We believe we have complied with this provision of the Consent Order, and we have
submitted the required progress reports to the Supervisory Authorities.



We intend to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof we have submitted all documentation required thus far to the
Supervisory Authorities. There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of our compliance will be made by the Supervisory Authorities. However, we believe we are
currently in compliance with all provisions of the Consent Order except for the requirement to reduce the total amount of our criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction
in criticized assets by specified percentages by certain dates, with the first date being December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. We reduced our criticized assets by more than the amount
necessary to meet the December 6, 2010 deadline. Our next incremental deadline, June 7, 2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of February 22, 2011, we have
reduced our criticized assets by 53.2% ($114.9 million). Failure to meet the requirements of the Consent Order could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC. In
addition, the Supervisory Authorities may amend the Consent Order based on the results of their ongoing examinations.



Strategic Project Plan



In response to the challenging economic environment and our negative financial results and in preparation for a potential formal agreement
from the banking regulatory agencies, in June 2009 the Board of Directors and management adopted and began executing a proactive and aggressive Strategic Project Plan (the Plan) to address the issues related to credit quality, liquidity,
earnings, and capital. Execution of the Plan is being overseen by the special Regulatory Oversight Committee of the Board of Directors, and we have engaged external expertise to assist with its implementation. The Plan contemplated substantially all
of the requirements of the Consent Order and therefore we believe we have already made substantial progress towards complying with the requirements of the Consent Order. However, certain provision of the Consent Order required us to submit written
plans to the Supervisory Authorities for their review and / or approval, and all provisions of the Consent Order are subject to examination by the Supervisory Authorities in subsequent examinations.



Since June 2009, we have been, and continue to be, keenly
focused on executing the Plan which now also reflects the requirements of the Consent Order. No one can predict the ongoing impact of the recession given its length and severity. However, it is our expectation that our hard work, the eventual
improvement in the economy and the real estate markets, and raising additional capital, will help our borrowers and us weather this storm and continue our road to recovery and return to profitability.



Credit Quality.    Given the
negative asset quality trends within our loan portfolio, which began in 2008, accelerated during 2009, and continued throughout 2010, we have worked aggressively to identify and quantify potential losses and execute plans to reduce problem assets.
The credit quality plan includes, among other things:



| |  |  | Performing detailed loan reviews of our loan portfolio in 2009 and 2010. The loan reviews were performed by management as well as by an independent
loan review firm that reported their results directly to the Board of Directors. These internal and independent loan reviews will continue in 2011.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For problem loans identified, we prepared written workout plans that are borrower specific to determine how best to resolve the loans which could
include restructuring the loans, requesting additional collateral, demanding payment from guarantors, sale of the loans, or foreclosure and sale of the collateral.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | We also increased our monitoring of borrower and industry sector concentrations and are limiting additional credit exposure to these concentrations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2009, we hired a new Chief Credit Officer and reevaluated our lending policies and procedures and credit administration function and
implemented significant enhancements. Among other changes, we reorganized our credit administration function, hired additional internal resources and external consulting assistance, and reorganized our line of business lending roles and
responsibilities including separate designation of a commercial lending business with more direct oversight and clearer accountability.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In 2010, we hired additional personnel with expertise in problem asset workout and disposition, and in June 2010 we hired a seasoned department manager
for our Special Assets Department which is now comprised of five individuals.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We are actively marketing problem assets for sale. Nonperforming assets declined $13.5 million (10.8%) during 2010, and by 21.6% since the peak at
March 31, 2010. The decline during the fourth quarter 2010 was the third consecutive quarterly decline in nonperforming assets.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In September 2010, we decided to market for sale commercial loans totaling $90.9 million at September 30, 2010. During the fourth quarter of 2010,
we sold five loans, representing two relationships, with a gross book value of $10.4 million, and we are continuing our efforts to sell the remaining loans held for sale. At December 31, 2010, we had commercial loans held for sale aggregating
$66.2 million, of which $2.0 million were under contract for sale and expected to close in the first quarter 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Liquidity.    In June 2009, we implemented a forward-looking liquidity plan and increased our liquidity
monitoring. The liquidity plan includes, among other things:



| |  |  | Implementing proactive customer deposit retention initiatives specific to large deposit customers and our deposit customers in general.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Executing targeted deposit growth and retention campaigns which resulted in retained and new certificates of deposit through June 30, 2010. Since
June 30, 2010, our deposits have remained stable through our normal growth and retention efforts, and therefore we have not utilized any special campaigns. In addition, given our cash position, in the fourth quarter 2010 continuing into the
first quarter 2011, we are not pursuing special CD campaigns and have reduced our deposit pricing to allow our higher priced CDs to roll off as they mature.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB and Federal Reserve borrowings.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accelerating the filing of our 2009 income tax refund claims resulting in refunds received totaling $20.9 million, all of which were received during
the three month period ended March 31, 2010, reduced by $661 thousand as a result of the filing of an amended 2009 federal income tax return in June 2010.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Anticipated filing of our 2008 income tax refund claims for the carryback of net operating losses generated in 2010. The carryback of these losses is
expected to result in the refund of $7.4 million of income taxes previously paid for the 2008 tax year. The refund is expected to be received in 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in
other earning assets. Maintaining this cash balance has reduced our interest income by $4.7 million for the year ended December 31, 2010 when compared with investing these funds at the average yield of 2.75% on our investment securities.
Following the consummation of our Private Placement on October 7, 2010, we have redeployed, through February 22, 2011, $96.0 million of this cash into investment securities and prepaid $91 million of FHLB advances which were scheduled to
mature in January through April 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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At February 22, 2011, funding sources included cash invested at the Federal Reserve
totaling $156.4 million, approximately $4.1 million in available repurchase agreement capacity, $82.8 million from the FHLB, and our correspondent bank line of credit totaling $5 million.



Capital.    At December 31, 2010, as a result of the consummation of the
Private Placement on October 7, 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds and the requirements of the Consent Order. In addition, to preserve our capital, we have:



| |  |  | Not paid a dividend on our common stock since the first quarter of 2009.
| | - |  | ------------------------------------------------------------------------



| |  |  | Reduced our loan portfolio by $362.9 million and total assets by $48.3 million since March 31, 2009.
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | Evaluated other capital saving alternatives such as asset sales and reducing outstanding credit commitments.
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Issued unsecured convertible debt from the Company in March 2010 of $380 thousand, the proceeds of which were contributed to the Bank as a capital
contribution. On October 7, 2010, as a result of the Private Placement, these notes were converted into common stock of the Company.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As a condition of the Private Placement, conducted a $10 million follow-on common stock offering to our legacy shareholders as of October 6, 2010
and institutional investors in the Private Placement. The follow-on offering was fully subscribed resulting in the issuance of common stock for gross proceeds of $10.0 million in December 2010 and the first quarter 2011. The net proceeds of the
offering were invested in the Bank.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Earnings.    We have been implementing an earnings plan that is focused on improvement through a combination of revenue increases and expense reductions, including assistance
from external consulting firms to review our current and potential new products and services and related rates and fees, and to identify process and efficiency improvements.



| |  |  | With respect to net interest income, we implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain criteria.
At December 31, 2010, loans aggregating $214.6 million had interest rate floors, of which $196.1 million had floors greater than or equal to 5%. In June and July 2010, we began loan specials intended to generate additional loan volume for
residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest rates,
during 2010 we also borrowed longer-term advances from the FHLB, and extended maturities on certain CD specials to lock in the low interest rates at the time of the specials. In December 2010 and January 2011, we used excess cash earning 0.25 basis
points to prepay $91.0 million of FHLB advances bearing interest at an average rate of 1.58%.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We are evaluating additional sources of noninterest income. For example, in March 2010, we introduced a new checking account, MyPal checking, and a new
savings account, Smart Savings, both of which provide noninterest income resulting from service charges or debit card transactions. We also evaluated the profitability of all of our pre-existing checking accounts and in October 2010 upgraded a large
number of unprofitable checking accounts to the MyPal account. In addition, we revised our existing fees and implemented new fees, with various implementation dates generally between October 1, 2010 and March 31, 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We identified specific opportunities for noninterest expense reductions, which were realized in 2009 and 2010, and are continuing to review other
expense areas for additional reductions. These expense reductions have been and will continue to be partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of
nonperforming assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We continue to critically evaluate each of our businesses to determine their contribution to our financial performance and their relative risk / return
relationship. Based on the evaluation to date, we sold two product lines during 2010. In March 2010, we sold our merchant services business and entered into a
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | referral and services agreement with Global Direct Payments, Inc. (Global Direct) related to our merchant services business which resulted in a net gain of $587 thousand. Similarly,
in December 2010, we sold our credit card portfolio and entered into a joint marketing agreement with Elan Financial Services, Inc., which resulted in a net gain of $1.2 million.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Summary



In summary, during the year ended December 31, 2010, we
continued to be impacted by the negative financial conditions of our borrowers and the economy in general, but we have also made substantial progress on the execution of the Strategic Project Plan adopted in June 2009. We completed a significant
component of the Plan by consummation of the Private Placement on October 7, 2010. We believe that raising capital, combined with an improving economy and our continued focus on credit quality and earnings improvements, will accelerate our road
to recovery and return to profitability in the post-recession environment. We believe that we may return to profitability, on a quarterly basis, at some point during 2012. However, as discussed in this report, our performance is subject to numerous
risks and uncertainties, many of which are beyond our control, and we can provide no assurances regarding when or if we will return to profitability.



Financial Condition



During 2009 and 2010, we realigned our organizational
structure and began the process of more specifically delineating our businesses. However, at this time we do not yet have in place a reporting structure to separately report and evaluate our various lines of businesses. Our organization structure
delineation and more granular line of business management reporting efforts will continue in 2011. Accordingly, the discussion and analysis of our financial condition and results of operations herein is provided on a consolidated basis, with
commentary on business specific implications if more granular information is available.



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Overview



PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Consolidated Balance Sheets

(dollars in thousands)



|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|------------------------------------------------------- |  | ------------ | --------- | - | -------------- | - | --------- | --------------- |  | - | -------- | - |  |  | ------- | --
|                                                        |  | December 31, |           |   | Dollarvariance |   |           | Percentvariance | 
|                                                        |  | 2010         |           |   | 2009           |   |           |                
|Assets                                                  |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Cash and cash equivalents                               |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Cash and due from banks                                 |  | $            | 223,017   |   |                | $ | 188,084   |                 |  | $ | 34,933   |   |  |  | 18.6    | % 
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total cash and cash equivalents                         |  |              | 223,017   |   |                |   | 188,084   |                 |  |   | 34,933   |   |  |  | 18.6    |   
|FHLB stock, at cost                                     |  |              | 6,785     |   |                |   | 7,010     |                 |  |   | (225     | ) |  |  | (3.2    | ) 
|Investment securities available for sale, at fair value |  |              | 218,775   |   |                |   | 119,986   |                 |  |   | 98,789   |   |  |  | 82.3    |   
|Mortgage loans held for sale                            |  |              | 4,793     |   |                |   | 3,884     |                 |  |   | 909      |   |  |  | 23.4    |   
|Commercial loans held for sale                          |  |              | 66,157    |   |                |   |          |                 |  |   | 66,157   |   |  |  | 100.0   |   
|Loans, gross                                            |  |              | 793,426   |   |                |   | 1,040,312 |                 |  |   | (246,886 | ) |  |  | (23.7   | ) 
|Less: allowance for loan losses                         |  |              | (26,934   | ) |                |   | (24,079   | )               |  |   | (2,855   | ) |  |  | 11.9    |   
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Loans, net                                              |  |              | 766,492   |   |                |   | 1,016,233 |                 |  |   | (249,741 | ) |  |  | (24.6   | ) 
|Premises and equipment, net                             |  |              | 28,109    |   |                |   | 29,605    |                 |  |   | (1,496   | ) |  |  | (5.1    | ) 
|Goodwill                                                |  |              |          |   |                |   | 3,691     |                 |  |   | (3,691   | ) |  |  | (100.0  | ) 
|Accrued interest receivable                             |  |              | 4,702     |   |                |   | 4,322     |                 |  |   | 380      |   |  |  | 8.8     |   
|Foreclosed real estate                                  |  |              | 19,983    |   |                |   | 27,826    |                 |  |   | (7,843   | ) |  |  | (28.2   | ) 
|Income tax refund receivable                            |  |              | 7,436     |   |                |   | 20,869    |                 |  |   | (13,433  | ) |  |  | (64.4   | ) 
|Deferred tax asset                                      |  |              |          |   |                |   | 5,799     |                 |  |   | (5,799   | ) |  |  | (100.0  | ) 
|Other                                                   |  |              | 8,998     |   |                |   | 8,454     |                 |  |   | 544      |   |  |  | 6.4     |   
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total assets                                            |  | $            | 1,355,247 |   |                | $ | 1,435,763 |                 |  | $ | (80,516  | ) |  |  | (5.6    | )%
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Liabilities and shareholders equity                    |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Liabilities                                             |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Deposits                                                |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Noninterest-bearing                                     |  | $            | 141,281   |   |                | $ | 142,609   |                 |  | $ | (1,328   | ) |  |  | (0.9    | )%
|Interest-bearing                                        |  |              | 1,032,081 |   |                |   | 1,072,305 |                 |  |   | (40,224  | ) |  |  | (3.8    | ) 
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total deposits                                          |  |              | 1,173,362 |   |                |   | 1,214,914 |                 |  |   | (41,552  | ) |  |  | (3.4    | ) 
|Retail repurchase agreements                            |  |              | 20,720    |   |                |   | 15,545    |                 |  |   | 5,175    |   |  |  | 33.3    |   
|Commercial paper (Master notes)                         |  |              |          |   |                |   | 19,061    |                 |  |   | (19,061  | ) |  |  | (100.0  | ) 
|FHLB borrowings                                         |  |              | 35,000    |   |                |   | 101,000   |                 |  |   | (66,000  | ) |  |  | (65.3   | ) 
|Accrued interest payable                                |  |              | 1,187     |   |                |   | 2,020     |                 |  |   | (833     | ) |  |  | (41.2   | ) 
|Other                                                   |  |              | 11,079    |   |                |   | 8,208     |                 |  |   | 2,871    |   |  |  | 35.0    |   
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total liabilities                                       |  |              | 1,241,348 |   |                |   | 1,360,748 |                 |  |   | (119,400 | ) |  |  | (8.8    | ) 
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Shareholders equity                                    |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Preferred stock                                         |  |              |          |   |                |   |          |                 |  |   |         |   |  |  |        |   
|Common stock                                            |  |              | 474       |   |                |   | 32,282    |                 |  |   | (31,808  | ) |  |  | (98.5   | ) 
|Capital surplus                                         |  |              | 133,112   |   |                |   | 2,599     |                 |  |   | 130,513  |   |  |  | 5,021.7 |   
|Retained earnings (deficit)                             |  |              | (13,108   | ) |                |   | 47,094    |                 |  |   | (60,202  | ) |  |  | (127.8  | ) 
|Accumulated other comprehensive loss, net of tax        |  |              | (6,579    | ) |                |   | (6,960    | )               |  |   | 381      |   |  |  | (5.5    | ) 
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total shareholders equity                              |  |              | 113,899   |   |                |   | 75,015    |                 |  |   | 38,884   |   |  |  | 51.8    |   
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   
|Total liabilities and shareholders equity              |  | $            | 1,355,247 |   |                | $ | 1,435,763 |                 |  | $ | (80,516  | ) |  |  | (5.6    | )%
|                                                        |  |              |           |   |                |   |           |                 |  |   |          |   |  |  |         |   



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Cash and Cash Equivalents



Cash and cash equivalents increased $34.9 million at December 31, 2010 over December 31, 2009 due
primarily as a result of maintaining our excess cash with the Federal Reserve to provide liquidity, notwithstanding the negative impact to our interest income since we only earn 25 basis points on our deposits with the Federal Reserve versus
investing this cash in higher earning assets. For the year ended December 31, 2010, the difference between the interest earned on the cash at the Federal Reserve at 25 basis points and the interest that could have been earned by investing this
cash in the securities portfolio at the average yield on the portfolio of 2.75% was $4.7 million. Upon consummation of the Private Placement in October 2010, we began redeploying this cash balance by investing $100 million in investment securities
in the fourth quarter 2010 and prepaying $91.0 million of FHLB advances in December 2010 and January 2011. We also plan to redeploy an additional $55 million into investment securities in the first quarter 2011. We believe that redeploying our
excess cash will improve our net interest margin going forward.



Concentrations and Restrictions.    In an effort to manage counterparty risk, we generally do not sell federal funds to other financial institutions because they are essentially
uncollateralized loans. We regularly evaluate the risk associated with the counterparties to these potential transactions to ensure that we would not be exposed to any significant risks with regard to our cash and cash equivalent balances.



The following table summarizes cash and cash
equivalents pledged as collateral and therefore restricted at the dates indicated (in thousands).



|                                |  |                  |     |  |                  |   |       | 
|------------------------------- |  | ---------------- | --- |  | ---------------- | - | ----- | 
|                                |  | December 31,2010 |     |  | December 31,2009 |  
|Secure a letter of credit       |  | $                |    |  |                  | $ | 512   | 
|Merchant credit card agreements |  |                  | 451 |  |                  |   | 836   | 
|                                |  |                  |     |  |                  |   |       | 
|Total                           |  | $                | 451 |  |                  | $ | 1,348 | 
|                                |  |                  |     |  |                  |   |       | 



FHLB Stock



We are a member of the FHLB of Atlanta, which is one of
twelve regional FHLBs that administer home financing credit for depository institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale
of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing
Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. At December 31, 2010, we had $35.0 million of outstanding advances from the FHLB under an available
credit facility of 10% of assets, which is limited to available collateral. We have the capacity to borrow an additional $53.3 million from the FHLB based on available collateral as of December 31, 2010.



As an FHLB member, the Company is required to purchase and
maintain stock in the FHLB. At December 31, 2010, we had $6.8 million in FHLB stock, which was in compliance with this requirement. No ready market exists for this stock, and it has no quoted market value. Purchases and redemptions
are normally transacted each quarter to adjust our investment to the required amount based on the FHLB requirements, and requests for redemptions are met at the discretion of the FHLB. We have experienced no interruption in such redemptions.
Historically, redemption of this stock has been at par value. Dividends are paid on this stock also at the discretion of the FHLB. We have received dividends on our FHLB stock and the average dividend yield for 2010 was 0.33%; however, there can be
no guarantee of future dividends. The carrying value of FHLB stock approximates fair value. The carrying value of this stock was $7.0 million at December 31, 2009.



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Investment Activities



General.    Our primary objective in managing the investment portfolio is to
maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a
continuing assessment of cash flows, the level of loan production, current interest rate risk strategies, and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default,
interest rate, liquidity, and expected rate of return risk.



Composition.    The following table summarizes the composition of our investment securities available for sale portfolio at the dates indicated (dollars in thousands).



|                                               |  |                   |         |  |                   |  |       |                   |  |   |            |  |  |       |       |   |            |   |         |  |  |  |       |  
|---------------------------------------------- |  | ----------------- | ------- |  | ----------------- |  | ----- | ----------------- |  | - | ---------- |  |  | ----- | ----- | - | ---------- | - | ------- |  |  |  | ----- | -
|                                               |  | December 31, 2010 |         |  | December 31, 2009 |  |       | December 31, 2008 | 
|                                               |  | Total             |         |  | % of total        |  |       | Total             |  |   | % of total |  |  | Total |       |   | % of total |  
|U.S. Treasury and federal agencies             |  | $                 | 37,426  |  |                   |  | 17.1  | %                 |  | $ | 16,297     |  |  |       | 13.6  | % |            | $ |        |  |  |  |      | %
|State and municipal                            |  |                   | 52,462  |  |                   |  | 24.0  |                   |  |   | 46,785     |  |  |       | 39.0  |   |            |   | 50,830  |  |  |  | 40.5  |  
|Collateralized mortgage obligations            |  |                   | 108,171 |  |                   |  | 49.4  |                   |  |   | 40,318     |  |  |       | 33.6  |   |            |   | 54,639  |  |  |  | 43.5  |  
|Other mortgage-backed (federal agencies)       |  |                   | 20,716  |  |                   |  | 9.5   |                   |  |   | 16,586     |  |  |       | 13.8  |   |            |   | 20,127  |  |  |  | 16.0  |  
|                                               |  |                   |         |  |                   |  |       |                   |  |   |            |  |  |       |       |   |            |   |         |  |  |  |       |  
|Total investment securities available for sale |  | $                 | 218,775 |  |                   |  | 100.0 | %                 |  | $ | 119,986    |  |  |       | 100.0 | % |            | $ | 125,596 |  |  |  | 100.0 | %
|                                               |  |                   |         |  |                   |  |       |                   |  |   |            |  |  |       |       |   |            |   |         |  |  |  |       |  



Average balances of investment
securities available for sale increased to $135.4 million during the year ended December 31, 2010 from $119.2 million during the same period of 2009. This increase was the result of purchases in July 2010 of U.S. Treasury and federal agencies
purchased to acquire additional securities to pledge as collateral for FHLB borrowings, as well as reinvestment of our excess cash into securities in the fourth quarter 2010.



The fair value of the investment securities available for
sale portfolio represented 16.1% of total assets at December 31, 2010 and 8.4% of total assets at December 31, 2009.



Through February 22, 2011, we purchased additional state and municipal, collateralized mortgage obligations, and other
mortgage-backed investment securities aggregating approximately $53.3 million.



Unrealized Position.    The following table summarizes the amortized cost and fair value composition of our investment securities available for sale portfolio at the dates
indicated (dollars in thousands).



|                                               |  |                   |         |  |                   |   |         |                   |  |   |           |  |  |               |         |  |           |   |         |  |  |   |         | 
|---------------------------------------------- |  | ----------------- | ------- |  | ----------------- | - | ------- | ----------------- |  | - | --------- |  |  | ------------- | ------- |  | --------- | - | ------- |  |  | - | ------- | 
|                                               |  | December 31, 2010 |         |  | December 31, 2009 |   |         | December 31, 2008 | 
|                                               |  | Amortizedcost     |         |  | Fairvalue         |   |         | Amortizedcost     |  |   | Fairvalue |  |  | Amortizedcost |         |  | Fairvalue |  
|U.S. Treasury and federal agencies             |  | $                 | 37,430  |  |                   | $ | 37,426  |                   |  | $ | 16,294    |  |  | $             | 16,297  |  |           | $ |        |  |  | $ |        | 
|State and municipal                            |  |                   | 51,243  |  |                   |   | 52,462  |                   |  |   | 44,908    |  |  |               | 46,785  |  |           |   | 50,297  |  |  |   | 50,830  | 
|Collateralized mortgage obligations            |  |                   | 107,876 |  |                   |   | 108,171 |                   |  |   | 42,508    |  |  |               | 40,318  |  |           |   | 58,033  |  |  |   | 54,639  | 
|Other mortgage-backed (federal agencies)       |  |                   | 20,189  |  |                   |   | 20,716  |                   |  |   | 15,783    |  |  |               | 16,586  |  |           |   | 19,876  |  |  |   | 20,127  | 
|                                               |  |                   |         |  |                   |   |         |                   |  |   |           |  |  |               |         |  |           |   |         |  |  |   |         | 
|Total investment securities available for sale |  | $                 | 216,738 |  |                   | $ | 218,775 |                   |  | $ | 119,493   |  |  | $             | 119,986 |  |           | $ | 128,206 |  |  | $ | 125,596 | 
|                                               |  |                   |         |  |                   |   |         |                   |  |   |           |  |  |               |         |  |           |   |         |  |  |   |         | 



U.S. Treasury and federal agency
securities are government debts issued by the U.S. Treasury through the Bureau of the Public Debt. U.S. Treasury and federal agency securities are the debt financing instruments of the U.S. federal government. Our U.S. Treasury and federal agency
securities are very liquid and are heavily traded.



State and municipal investment securities are debt investment securities issued by a state, municipality, or county in order to finance
its capital expenditures. The most substantial risk associated with buying state and



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municipal investment securities is the financial risk associated with the municipality from which the securities are purchased. Although municipal bonds in smaller municipalities can sometimes be
difficult to sell quickly, we do not currently anticipate that we will liquidate this portfolio in the near term.



Collateralized mortgage obligations are a mortgage-backed security sub-type in which the mortgages are ordered into tranches by some
quality (such as repayment time) with each tranche sold as a separate security. These mortgage-backed securities separate the mortgage pools into short, medium, and long-term tranches. Our collateralized mortgage obligations are all fixed rate and
are paid a fixed rate of interest at regular intervals. Monthly fluctuations in income occur only as there are changes in amortization or accretions due to changes in prepayment speeds.



Other mortgage-backed investment securities include investment instruments that represent ownership of an
undivided interest in a group of mortgages. Principal and interest from the individual mortgages are used to pay principal and interest on the mortgage-backed investment security. Monthly income from other mortgage-backed investment securities may
fluctuate as interest rates change due to the volume of mortgage prepayments.



We use prices from third party pricing services and, to a lesser extent, indicative (non-binding) quotes from third party brokers, to measure fair value of our investment securities. We utilize multiple
third party pricing services and brokers to obtain fair values; however, we generally obtain one price / quote for each individual security. For securities priced by third party pricing services, we determine the most appropriate and relevant
pricing service for each security class and have that vendor provide the price for each security in the class. We record the unadjusted value provided by the third party pricing service / broker in our Consolidated Financial Statements, subject to
our internal price verification procedures.



Pledged.    Public depositors from state and local municipalities typically require that the Bank pledge
investment grade securities to the accounts to ensure repayment. Although the funds are usually a low cost, relatively stable source of funding for the Bank, availability depends on the particular governments fiscal policies and cash flow
needs.



Investments securities were pledged as
collateral for the following at the dates indicated (in thousands).



|                                       |  |                  |         |  |                  |   |         | 
|-------------------------------------- |  | ---------------- | ------- |  | ---------------- | - | ------- | 
|                                       |  | December 31,2010 |         |  | December 31,2009 |  
|Public funds deposits                  |  | $                | 67,260  |  |                  | $ | 73,185  | 
|Federal funds from correspondent banks |  |                  |        |  |                  |   | 6,300   | 
|FHLB advances and line of credit       |  |                  | 48,344  |  |                  |   | 29,767  | 
|                                       |  |                  |         |  |                  |   |         | 
|Total                                  |  | $                | 115,604 |  |                  | $ | 109,252 | 
|                                       |  |                  |         |  |                  |   |         | 



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Other-Than-Temporary Impairment.    The following tables
summarize the number of securities in each category of investment securities available for sale, the fair value, and the gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a
continuous unrealized loss position, at the dates indicated (dollars in thousands).



|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |            |   |  |                       |   |        |   |  |   |            |  |  |                       |    |  |  |   |        |  |  |   |       | 
|---------------------------------------------- |  | ------------------- | -- |  | ------------------- | - | ------ | --------------------- |  | - | --- |  |  | ---------- | - |  | --------------------- | - | ------ | - |  | - | ---------- |  |  | --------------------- | -- |  |  | - | ------ |  |  | - | ----- | 
|                                               |  | December 31, 2010   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #   |  |  | Fair value |   |  | Grossunrealizedlosses |   |        | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 2  |  |                     | $ | 21,428 |                       |  | $ | 6   |  |  |            |  |  |                       | $ |       |   |  | $ |           |  |  |                       | 2  |  |  | $ | 21,428 |  |  | $ | 6     | 
|State and municipal                            |  |                     | 12 |  |                     |   | 7,211  |                       |  |   | 468 |  |  |            |  |  |                       |   |       |   |  |   |           |  |  |                       | 12 |  |  |   | 7,211  |  |  |   | 468   | 
|Collateralized mortgage obligations            |  |                     | 10 |  |                     |   | 38,295 |                       |  |   | 376 |  |  |            |  |  |                       |   |       |   |  |   |           |  |  |                       | 10 |  |  |   | 38,295 |  |  |   | 376   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,861  |                       |  |   | 120 |  |  |            |  |  |                       |   |       |   |  |   |           |  |  |                       | 3  |  |  |   | 6,861  |  |  |   | 120   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |            |   |  |                       |   |        |   |  |   |            |  |  |                       |    |  |  |   |        |  |  |   |       | 
|Total investment securities available for sale |  |                     | 27 |  |                     | $ | 73,795 |                       |  | $ | 970 |  |  |            |  |  |                       | $ |       |   |  | $ |           |  |  |                       | 27 |  |  | $ | 73,795 |  |  | $ | 970   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |            |   |  |                       |   |        |   |  |   |            |  |  |                       |    |  |  |   |        |  |  |   |       | 
|                                               | 
|                                               |  | December 31, 2009   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fair value          |   |        | Grossunrealizedlosses |  |   | #   |  |  | Fair value |   |  | Grossunrealizedlosses |   |        | # |  |   | Fair value |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 1  |  |                     | $ | 300    |                       |  | $ |    |  |  |            |  |  |                       | $ |       |   |  | $ |           |  |  |                       | 1  |  |  | $ | 300    |  |  | $ |      | 
|State and municipal                            |  |                     | 2  |  |                     |   | 662    |                       |  |   | 3   |  |  |            |  |  |                       |   |       |   |  |   |           |  |  |                       | 2  |  |  |   | 662    |  |  |   | 3     | 
|Collateralized mortgage obligations            |  |                     | 3  |  |                     |   | 10,323 |                       |  |   | 412 |  |  |            | 6 |  |                       |   | 16,624 |   |  |   | 1,946      |  |  |                       | 9  |  |  |   | 26,947 |  |  |   | 2,358 | 
|Other mortgage-backed (federal agencies)       |  |                     | 2  |  |                     |   | 1,444  |                       |  |   | 35  |  |  |            |  |  |                       |   |       |   |  |   |           |  |  |                       | 2  |  |  |   | 1,444  |  |  |   | 35    | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |            |   |  |                       |   |        |   |  |   |            |  |  |                       |    |  |  |   |        |  |  |   |       | 
|Total investment securities available for sale |  |                     | 8  |  |                     | $ | 12,729 |                       |  | $ | 450 |  |  |            | 6 |  |                       | $ | 16,624 |   |  | $ | 1,946      |  |  |                       | 14 |  |  | $ | 29,353 |  |  | $ | 2,396 | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |            |   |  |                       |   |        |   |  |   |            |  |  |                       |    |  |  |   |        |  |  |   |       | 



Gross unrealized losses
decreased $1.4 million from December 31, 2009 to December 31, 2010, primarily within the collateralized mortgage obligation sector of the investment securities portfolio. Eleven collateralized mortgage obligations were sold during the year
ended December 31, 2010. The gross unrealized losses on the sold collateralized mortgage obligations totaled $2.0 million at December 31, 2009.



Based on our other-than-temporary impairment analysis at December 31, 2010, we concluded that gross unrealized losses detailed in the
preceding table were not other-than-temporarily impaired as of that date.



Based on our other-than-temporary impairment analysis at December 31, 2009, one collateralized mortgage obligation with a fair value of $2.3 million and amortized cost of $3.3 million was
other-than-temporarily impaired. We reached this conclusion based on the fair value of the security being below the amortized cost and our analysis of broker-provided fair values as verified by other external sources. Due to the fact that
at the time of the analysis we did not intend to sell this security nor was it more likely than not that we would have to sell the security prior to the recovery of its amortized cost basis less any current period credit loss, the amount of
impairment related to credit loss was recognized in earnings and the amount of impairment related to other matters was recognized in other comprehensive income. For the year ended December 31, 2009, a $49 thousand other-than-temporary
credit impairment was recognized in Other noninterest expense in the Consolidated Statements of Income (Loss).



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Fair values of the investment securities portfolio could decline in the future if the
underlying performance of the collateral for collateralized mortgage obligations or other securities deteriorates and the levels do not provide sufficient protection for contractual principal and interest. As a result, there is risk that additional
other-than-temporary impairments may occur in the future particularly in light of the current economic environment.



Ratings.    The following table summarizes Moodys Investors Services (Moodys)
ratings, by segment, of the investment securities available for sale based on fair value, at December 31, 2010. An Aaa rating is based not only on the credit of the issuer, but may also include consideration of the structure of the securities
and the credit quality of the collateral.



|                              |  |                                   |     |   |                    |  |     |                                    |  |  |                                         |   |  |  |     |  
|----------------------------- |  | --------------------------------- | --- | - | ------------------ |  | --- | ---------------------------------- |  |  | --------------------------------------- | - |  |  | --- | -
|                              |  | U.S. Treasury andfederal agencies |     |   | State andmunicipal |  |     | Collateralizedmortgage obligations |  |  | Other mortgage-backed(federal agencies) |  
|Aaa                           |  |                                   | 100 | % |                    |  | 8   | %                                  |  |  | 100                                     | % |  |  | 100 | %
|Aa1-A1                        |  |                                   |    |   |                    |  | 64  |                                    |  |  |                                        |   |  |  |    |  
|Baa1                          |  |                                   |    |   |                    |  | 10  |                                    |  |  |                                        |   |  |  |    |  
|Not rated or withdrawn rating |  |                                   |    |   |                    |  | 18  |                                    |  |  |                                        |   |  |  |    |  
|                              |  |                                   |     |   |                    |  |     |                                    |  |  |                                         |   |  |  |     |  
|Total                         |  |                                   | 100 | % |                    |  | 100 | %                                  |  |  | 100                                     | % |  |  | 100 | %
|                              |  |                                   |     |   |                    |  |     |                                    |  |  |                                         |   |  |  |     |  



Of the state and municipal
investment securities not rated or with withdrawn ratings by Moodys at December 31, 2010, 24% were rated AAA by Standard and Poors, 47% were rated AA+, 22% were rated AA, 5% were rated AA-, and 2%, or $204 thousand, were not rated
by Standard and Poors.



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Maturities.    The following table summarizes the maturity
distribution schedule with corresponding weighted-average yields of amortized cost of investment securities available for sale at and for the period ended December 31, 2010 (dollars in thousands). Weighted-average yields have not been computed
on a fully taxable-equivalent basis. Collateralized mortgage obligations and other mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations.



|                                               |  |               |         |  |           |  |     |  
|---------------------------------------------- |  | ------------- | ------- |  | --------- |  | --- | -
|                                               |  | Amortizedcost |         |  | Bookyield | 
|U.S. Treasury and federal agencies             |  |               |         |  |           |  |     |  
|In one year or less                            |  | $             | 37,430  |  |           |  | 0.2 | %
|After 1 through 5 years                        |  |               |        |  |           |  |    |  
|After 5 through 10 years                       |  |               |        |  |           |  |    |  
|After 10 years                                 |  |               |        |  |           |  |    |  
|                                               |  |               |         |  |           |  |     |  
|Total U.S. Treasury and federal agencies       |  |               | 37,430  |  |           |  | 0.2 |  
|State and municipal                            |  |               |         |  |           |  |     |  
|In one year or less                            |  |               | 3,389   |  |           |  | 3.3 |  
|After 1 through 5 years                        |  |               | 24,924  |  |           |  | 3.5 |  
|After 5 through 10 years                       |  |               | 13,220  |  |           |  | 3.5 |  
|After 10 years                                 |  |               | 9,710   |  |           |  | 3.1 |  
|                                               |  |               |         |  |           |  |     |  
|Total state and municipal                      |  |               | 51,243  |  |           |  | 3.4 |  
|Collateralized mortgage obligations            |  |               |         |  |           |  |     |  
|In one year or less                            |  |               |        |  |           |  |    |  
|After 1 through 5 years                        |  |               |        |  |           |  |    |  
|After 5 through 10 years                       |  |               | 12,564  |  |           |  | 1.5 | %
|After 10 years                                 |  |               | 95,312  |  |           |  | 1.7 | %
|                                               |  |               |         |  |           |  |     |  
|Total collateralized mortgage obligations      |  |               | 107,876 |  |           |  | 1.6 | %
|Other mortgage-backed (federal agencies)       |  |               |         |  |           |  |     |  
|In one year or less                            |  |               |        |  |           |  |    |  
|After 1 through 5 years                        |  |               | 49      |  |           |  | 4.0 |  
|After 5 through 10 years                       |  |               | 2,639   |  |           |  | 5.2 |  
|After 10 years                                 |  |               | 17,501  |  |           |  | 4.1 |  
|                                               |  |               |         |  |           |  |     |  
|Total other mortgage-backed (federal agencies) |  |               | 20,189  |  |           |  | 4.2 |  
|                                               |  |               |         |  |           |  |     |  
|Total investment securities available for sale |  | $             | 216,738 |  |           |  | 1.2 | %
|                                               |  |               |         |  |           |  |     |  



The weighted average life of
investment securities available for sale was 3.0 years, based on expected prepayment activity, at December 31, 2010. Since 59% of the portfolio, based on amortized cost, is collateralized mortgage obligations or other mortgage-backed
securities, the expected remaining maturity may differ from contractual maturity because borrowers generally have the right to prepay obligations before the underlying mortgages mature. Given the general expectation of a rising interest rate
environment, we are intentionally investing in shorter-term duration securities to minimize our interest rate risk if interest rates begin to rise.



Concentrations.    The following table summarizes issuer concentrations of collateralized mortgage obligations
whose aggregate book values exceed 10% of shareholders equity at December 31, 2010 (dollars in thousands).



|            |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|----------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer      |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Freddie Mac |  | $                   | 30,226 |  |                         | $ | 30,112 |                                              |  |  | 26.4 | %
|Fannie Mae  |  |                     | 24,930 |  |                         |   | 24,934 |                                              |  |  | 21.9 | %
|Ginnie Mae  |  |                     | 50,387 |  |                         |   | 50,394 |                                              |  |  | 44.2 | %



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The following table summarizes issuer concentrations of other mortgage-backed investment
securities whose book values exceed 10% of shareholders equity at December 31, 2010 (dollars in thousands).



|           |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|---------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer     |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Fannie Mae |  | $                   | 15,523 |  |                         | $ | 15,014 |                                              |  |  | 13.2 | %



Realized Gains and Losses.    The following table summarizes the gross realized gains and losses on investment securities available for sale for the periods indicated (in
thousands).



|                   |  |                                 |        |   |      |   |   |      |  |   |   | 
|------------------ |  | ------------------------------- | ------ | - | ---- | - | - | ---- |  | - | - | 
|                   |  | For the years endedDecember 31, |       
|                   |  | 2010                            |        |   | 2009 |   |   | 2008 | 
|Realized gains     |  | $                               | 1,149  |   |      | $ | 2 |      |  | $ | 1 | 
|Realized losses    |  |                                 | (1,139 | ) |      |   |  |      |  |   |  | 
|                   |  |                                 |        |   |      |   |   |      |  |   |   | 
|Net realized gains |  | $                               | 10     |   |      | $ | 2 |      |  | $ | 1 | 
|                   |  |                                 |        |   |      |   |   |      |  |   |   | 



Lending Activities



General.    Loans
continue to be the largest component of our assets. During the year ended December 31, 2010, gross loans declined approximately $246.9 million (23.7%), including the net transfer of $84.9 million commercial real estate loans to the held for
sale portfolio in 2010, as we actively seek to reduce our commercial real estate loan portfolio to improve our credit quality and preserve capital. Based on our risk assessment of borrowers, we also implemented risk-based loan pricing and interest
rate floors, or minimum interest rates, both at origination and renewal. In addition, we are proactively addressing the reduction of our nonperforming assets through restructurings, charge-offs, and sales.



Commercial Loans Held for
Sale.    In September 2010, we decided to market for sale commercial loans totaling $90.9 million at September 30, 2010, and we are evaluating the bids received on a loan by loan basis. In general, we believe potential
buyers are making bids at heavily discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as
banks sought to rid themselves of problem assets prior to year end. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded
book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order.



During the fourth quarter of 2010, we entered into contracts to sell loans with a gross book value of $13.9 million, of which $10.4
million closed in the fourth quarter. During the fourth quarter of 2010, we transferred $6.0 million of commercial loans held for sale back to loans held for investment, as our intentions with respect to these loans had changed. We are continuing
our efforts to sell the remaining loans held for sale. At December 31, 2010, we had commercial loans held for sale aggregating $66.2 million, of which $2.0 million were under contract for sale and expected to close in the first quarter 2011.
Writedowns of $1.1 million were recorded in the fourth quarter 2010 to reduce the value of these assets to fair value, some of which were based on the contract values, less estimated costs to sell.



The loans held for sale were marketed for sale by loan sale
advisory firms and through our own efforts, and we made the strategic decision in the fourth quarter to accept bids on certain loans that were lower than their appraised values which were the basis for their initial carrying amounts in loans held
for sale. In making this decision, we attempted to balance the negative capital impact of selling loans at a loss with the positive impact of reducing our nonperforming assets, with the reduction in nonperforming assets also a requirement of the
Consent Order.



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At December 31, 2010, commercial loans held for sale are carried at the lower of cost
or fair value, and a valuation allowance of $2.3 million is recorded against the loans held for sale resulting in a net carrying amount in the Consolidated Balance Sheets of $66.2 million. Of the aggregate balance of commercial loans held for sale,
98.6% are commercial real estate loans based on FDIC code.



Loans Composition.    Disclosure guidance related to a companys allowance for loan losses and the credit quality of its financing receivables require the loans and
allowance for loan losses disclosures to be provided on a disaggregated basis. This disaggregated basis has been defined as portfolio segments, the level at which we develop and document our methodology to determine our allowance for loan losses,
and classes, a level of information below the portfolio segment that provides an understanding as to the nature and extent of exposure in our loan portfolio. For reporting purposes, loan classes are based on FDIC code, and portfolio segments are an
aggregation of those classes based on the way we develop and document our allowance for loan losses. FDIC codes are based on the underlying loan collateral.



The following table summarizes gross loans, categorized by portfolio segment, at the dates indicated (dollars in thousands).



|                                     |  |                  |         |   |                  |  |       |                  |  |   |                  |  |  |                  |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|------------------------------------ |  | ---------------- | ------- | - | ---------------- |  | ----- | ---------------- |  | - | ---------------- |  |  | ---------------- | ----- | - | --------- | - | --------- | ----- |  |  | --------- | - |  | ----- | --------- |  | --------- |  | ----- | - |  | - | ------- |  |  |  | ----- | -
|                                     |  | December 31,2010 |         |   | December 31,2009 |  |       | December 31,2008 |  |   | December 31,2007 |  |  | December 31,2006 |      
|                                     |  | Total            |         |   | % oftotal        |  |       | Total            |  |   | % oftotal        |  |  | Total            |       |   | % oftotal |   |           | Total |  |  | % oftotal |   |  | Total |           |  | % oftotal | 
|Commercial real estate               |  | $                | 573,822 |   |                  |  | 66.8  | %                |  | $ | 695,263          |  |  |                  | 66.8  | % |           | $ | 781,745   |       |  |  | 67.5      | % |  | $     | 659,615   |  |           |  | 63.2  | % |  | $ | 559,748 |  |  |  | 59.2  | %
|Single-family residential            |  |                  | 178,980 |   |                  |  | 20.8  |                  |  |   | 203,330          |  |  |                  | 19.6  |   |           |   | 217,734   |       |  |  | 18.8      |   |  |       | 209,274   |  |           |  | 20.0  |   |  |   | 156,238 |  |  |  | 16.5  |  
|Commercial and industrial            |  |                  | 47,812  |   |                  |  | 5.6   |                  |  |   | 61,788           |  |  |                  | 5.9   |   |           |   | 73,609    |       |  |  | 6.4       |   |  |       | 77,555    |  |           |  | 7.4   |   |  |   | 126,742 |  |  |  | 13.4  |  
|Consumer                             |  |                  | 52,652  |   |                  |  | 6.1   |                  |  |   | 76,296           |  |  |                  | 7.3   |   |           |   | 79,295    |       |  |  | 6.8       |   |  |       | 93,983    |  |           |  | 9.0   |   |  |   | 101,098 |  |  |  | 10.7  |  
|Other                                |  |                  | 6,317   |   |                  |  | 0.7   |                  |  |   | 3,635            |  |  |                  | 0.4   |   |           |   | 6,097     |       |  |  | 0.5       |   |  |       | 4,343     |  |           |  | 0.4   |   |  |   | 2,087   |  |  |  | 0.2   |  
|                                     |  |                  |         |   |                  |  |       |                  |  |   |                  |  |  |                  |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|Total loans                          |  | $                | 859,583 |   |                  |  | 100.0 | %                |  | $ | 1,040,312        |  |  |                  | 100.0 | % |           | $ | 1,158,480 |       |  |  | 100.0     | % |  | $     | 1,044,770 |  |           |  | 100.0 | % |  | $ | 945,913 |  |  |  | 100.0 | %
|                                     |  |                  |         |   |                  |  |       |                  |  |   |                  |  |  |                  |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|Less: Commercial loans held for sale |  |                  | (66,157 | ) |                  |  |       |                  |  |   |                 |  |  |                  |       |   |           |   |          |       |  |  |           |   |  |       |          |  |           |  |       |   |  |   |        |  |  |  |       |  
|                                     |  |                  |         |   |                  |  |       |                  |  |   |                  |  |  |                  |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|Loans, gross                         |  | $                | 793,426 |   |                  |  |       |                  |  | $ | 1,040,312        |  |  |                  |       |   |           | $ | 1,158,480 |       |  |  |           |   |  | $     | 1,044,770 |  |           |  |       |   |  | $ | 945,913 |  |  |  |       |  
|                                     |  |                  |         |   |                  |  |       |                  |  |   |                  |  |  |                  |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  



Loans included in the
preceding loan composition table are net of participations sold. Participations sold totaled $12.5 million (2 loans) at both December 31, 2010 and 2009, respectively. With regard to participations sold, we serve as the lead bank and are
therefore responsible for certain administration and other management functions as agent to the participating banks. We are in active discussions with the participating banks to keep them informed of the status of these loans and determine loan
workout plans.



Mortgage loans serviced for the
benefit of others amounted to $423.6 million and $426.6 million at December 31, 2010 and December 31, 2009, respectively, and are not included in our Consolidated Balance Sheets.



Underwriting.    General. There are inherent risks associated with our lending
activities. Prudent risk taking requires sound policies intended to manage the risk within the portfolio and control processes intended to ensure compliance with those policies. We continue to review our lending policies and procedures and credit
administration function. During 2009 and 2010, we implemented several enhancements, including centralized controls over construction draws, reduction of lending limit approval authorities, prohibition of out-of-market loans to borrowers for which we
do not have a previously existing relationship, hiring and reassignment of personnel with expertise in credit administration and special assets management, and internal and external training in areas of negotiation and financial statement analysis.



We do not generally originate loan in excess of
100% of collateral value, offer loan payment arrangements resulting in negative amortization, engage in lending practices subjecting borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only
periods, etc.), nor do we offer loan payment arrangements with minimum payments that are less than accrued interest.



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Loan Scoring and Approval. We have established and follow guidelines with regard to the
scoring and approval of loans. Our loan approval process is multi-layered and incorporates a computer-based scoring analysis for all consumer loans and all commercial loans whereby the total corporate exposure is less than $500 thousand. All
commercial loans with total corporate exposure greater than or equal to $500 thousand are reviewed and approved by individuals with the process and our officers credit committee if greater than $5.0 million, and, if over certain higher limits,
by the Board of Directors.



Monitoring and
Validation. Compliance with our underwriting policies and procedures is monitored through a loan approval and documentation review process and the resulting exception reports.



We perform, internally and through the use of an independent
third party, independent loan reviews to validate our loan risk program on a periodic basis. Although all of the loans within our loan portfolio are included in the population from which to select loans subject to review, commercial real estate
loans are given more weight in the loan review selection process as a result of their risk characteristics and their concentration within our loan portfolio. Loan review reports are submitted to the management Credit Committee and the Board of
Directors, and the third party loan review firm meets independently with the Credit Committee of the Board of Directors. The loan review process complements and reinforces our risk identification and assessment decisions.



Given our significant credit losses in 2009 and 2010, we
implemented several enhancements including detailed loan reviews, written workout plans for problem loans, increased monitoring of borrower and industry sectors, hiring and reassignment of personnel with expertise in credit administration and
special assets management, and active marketing and reduction of problem assets from our portfolio. During 2009 and 2010, we also significantly enhanced our internal loan reporting and reporting to the Board of Directors.



Commercial Real Estate. Commercial real estate loans are
subject to underwriting standards and processes similar to commercial business loans with additional standards with regard to real estate collateral. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real
estate. We monitor and evaluate commercial real estate loans based on collateral type. In addition, we analyze the loans based on owner occupied commercial real estate loans versus nonowner occupied loans.



We make commercial real estate loans to businesses within
varying industry sectors. Interest rates charged on these real estate loans are determined by market conditions existing at the time of the loan commitment. Generally, loans have adjustable rates, although the rate may be fixed, generally for three
to five years, for the term of the loan depending on market conditions, collateral, and our relationship with the borrower. Amortization of commercial and installment real estate loans varies but typically does not exceed 20 years. Normally, we have
collateral securing real estate loans appraised by independent third party appraisers prior to originating the loan.



We originate loans to developers and builders that are secured by nonowner occupied properties. Such loans are typically approved based on
predetermined loan-to-collateral values. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates, and / or financial analysis of the developers and property
owners. Construction loans are generally based upon estimates of costs and values associated with the complete projects and often involve the disbursement of funds with repayment dependent on the success of the ultimate project. Sources of repayment
for these types of loans may be precommitted permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from us until permanent financing is obtained. We monitor these loans by conducting onsite
inspections. During 2009 and 2010, we centralized the oversight and disbursement of construction draws to contractors working for borrowers, and we hired a construction draw manager to review advance requests before funds are advanced to borrowers.
We believe that these loans have higher risks than other real estate loans because their repayment is sensitive to interest rate changes, governmental regulation of real property, general economic and market conditions, and the availability of
long-term financing particularly in the current economic environment. During 2009 and 2010, the higher risk nature of these loans was evidenced by the higher concentration of charge-offs of these types of loans.



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Commercial and Industrial. Commercial and industrial loans are underwritten after
evaluating and understanding the borrowers ability to operate profitably while prudently expanding the borrowers business. Underwriting standards are designed to promote relationship banking rather than transactional banking. If we
believe that the borrowers management possesses sound ethics and solid business acumen, we examine current and projected cash flows to determine the likelihood that the borrower will repay its obligations as agreed. Commercial and industrial
loans are primarily made based on the projected cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The actual cash flows of borrowers, however, may not be as expected, and the collateral securing loans
may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and generally incorporate a personal guarantee. However, we make some
short-term loans on an unsecured basis. In the case of loans secured by accounts receivable or inventory, the availability of funds for the repayment of these loans may depend substantially on the ability of the borrower to collect amounts due from
its customers or to liquidate inventory at sufficient prices. During 2009 and 2010, we increased our procedures for monitoring loans secured by commercial and industrial collateral by centralizing the monitoring of all accounts receivable and
inventory lines under Credit Underwriting, which monitors and tests the collateral. Also, as each loan matures and is considered for renewal, we place a defined monitoring schedule in the approval package and track it centrally for adherence to our
policy. Results are reported to the management Credit Committee on a quarterly basis.



Our commercial and industrial loans are generally made with terms that do not exceed five years. Such loans may have fixed or variable interest rates with variable rates that change at periods ranging
from one day to one year based on the prime lending rate as the interest rate index.



Single-family Residential. Underwriting standards for single-family real estate purpose loans are heavily regulated by statutory requirements, which include, but are not limited to, maximum loan-to-value
percentages.



Our mortgage lenders make both
fixed-rate and adjustable-rate single-family mortgage loans with terms generally ranging from 10 to 30 years. We may offer loans that have interest rates that adjust annually or adjust annually after being fixed for a period of several years in
accordance with a designated index.



Adjustable-rate mortgage loans may be originated with a limit on any increase or decrease in the interest rate per year further limited by
the amount by which the interest rate can increase or decrease over the life of the loan. In order to encourage the origination of adjustable-rate mortgage loans with interest rates that adjust annually, we generally offer a more attractive rate of
interest on such loans than on fixed-rate mortgage loans.



Effective January 1, 2010, to better manage our regulatory compliance and provide more consistent underwriting and loan pricing, we began originating all new single-family first mortgage and
closed-end second mortgage loans through our Mortgage department rather than through our branch network.



A large percentage of our originated single-family mortgage loans are underwritten pursuant to guidelines that permit the sale of these
loans in the secondary market to government or private agencies. We participate in secondary market activities by selling whole loans and participations in loans primarily to the FHLB under its Mortgage Partnership Program and Freddie Mac. This
practice enables us to satisfy demand for these loans in our local communities, to meet our asset and liability objectives and to develop a source of fee income through the servicing of these loans. We may sell fixed-rate, adjustable-rate, and
balloon-term loans. Based on current interest rates as well as other factors, we normally sell most of our originations of conforming residential mortgage loans to Freddie Mac and retain the servicing of the underlying loans. Recently, there has
been extensive media reporting related to potential recourse relating to residential mortgage loan sales. In certain loan sales, we provide recourse whereby we are required to repurchase loans on the occurrence of certain specific events. In 2009
and 2010, we repurchased three loans associated with our mortgage loan sales, and at December 31, 2010 we do not believe we have any outstanding obligations to repurchase mortgage loans previously sold.



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To protect against declines in collateral value, when we originate and underwrite
single-family mortgage loans to be retained in our residential mortgage portfolio, if the loan exceeds 80% of the collateral value, we generally require private mortgage insurance that protects us against losses of at least 20% of the mortgage loan
amount.



Consumer. Our loan scoring and approval
policies and procedures, as outlined previously, coupled with relatively small loan amounts that are spread across many individual borrowers, minimize risk within the consumer sectors of our loan portfolio.



Pledged.    To borrow from the
FHLB, members must pledge collateral. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. At December 31, 2010 and 2009, $346.3
million and $407.0 million of gross loans were pledged to collateralize FHLB advances and letters of credit, respectively, of which $92.5 million and $162.0 million, respectively, was available as lendable collateral.



At December 31, 2010 and December 31, 2009, $10.9
million and $ 108.8 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that we utilize.



Concentrations.    General. During 2009 and continuing into 2010, we increased our monitoring of borrower and
industry sector concentrations and are limiting additional credit exposure to these concentrations, in particular the segments of our loan portfolio secured by commercial real estate. In addition, we are proactively executing loan workout plans with
a particular focus on reducing our concentrations in these segments. In addition, we are evaluating the potential sale, individually or in bulk, of performing and nonperforming commercial loans. In September 2010, we decided to market for sale
commercial loans to reduce our nonperforming assets and concentration in commercial real estate. During the fourth quarter of 2010, we sold five loans, representing two relationships, with a gross book value of $10.4 million and we are continuing
our efforts to sell the remaining commercial loans held for sale. At December 31, 2010, commercial loans held for sale aggregated $66.2 million, of which $2.0 million were under contract for sale and expected to close in the first quarter 2011.
Sale of these loans is reducing our commercial real estate concentration.



Loan Type/Industry Concentration. The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at December 31, 2010 (dollars in thousands).



|                                                     |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|---------------------------------------------------- |  | -------------------------------------------- | ------- |  | -------------------------------------------------------------- | - | ------ | --------------------------------- |  | - | ------------------------------------------------ |  |  | ---------------------------------- | ---- | - |  |  | ----- | -
|                                                     |  | Commercial realestate included ingross loans |         |  | Commercial realestate included incommercial loansheld for
sale |   |        | Total commercialreal estate loans |  |   | % of gross loansand commercialloans held forsale |  |  | % of Bankstotal regulatorycapital |     
|Secured by commercial real estate                    |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Construction, land development, and other land loans |  | $                                            | 125,331 |  |                                                                | $ | 11,122 |                                   |  | $ | 136,453                                          |  |  |                                    | 15.9 | % |  |  | 104.5 | %
|Multifamily residential                              |  |                                              | 18,327  |  |                                                                |   | 7,943  |                                   |  |   | 26,270                                           |  |  |                                    | 3.1  |   |  |  | 20.1  |  
|Nonfarm nonresidential                               |  |                                              | 364,939 |  |                                                                |   | 46,160 |                                   |  |   | 411,099                                          |  |  |                                    | 47.8 |   |  |  | 314.7 |  
|                                                     |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Total loans secured by commercial real estate        |  | $                                            | 508,597 |  |                                                                | $ | 65,225 |                                   |  | $ | 573,822                                          |  |  |                                    | 66.8 | % |  |  | 439.3 | %
|                                                     |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  



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The following table further categorizes loans secured by commercial real estate at
December 31, 2010 (dollars in thousands).



|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|----------------------------------------------------------------- |  | -------------------------------------------- | ------- |  | -------------------------------------------------------------- | - | ------ | --------------------------------- |  | - | ------------------------------------------------ |  |  | ---------------------------------- | ---- | - |  |  | ----- | -
|                                                                  |  | Commercial realestate included ingross loans |         |  | Commercial realestate included incommercial loansheld for
sale |   |        | Total commercialreal estate loans |  |   | % of gross loansand commercialloans held forsale |  |  | % of Bankstotal regulatorycapital |     
|Development commercial real estate loans                          |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Landunimproved (commercial or residential)                       |  | $                                            | 46,286  |  |                                                                | $ | 2,174  |                                   |  | $ | 48,460                                           |  |  |                                    | 5.7  | % |  |  | 37.1  | %
|Land developmentcommercial                                       |  |                                              | 12,676  |  |                                                                |   | 463    |                                   |  |   | 13,139                                           |  |  |                                    | 1.5  |   |  |  | 10.1  |  
|Land developmentresidential                                      |  |                                              | 45,858  |  |                                                                |   | 7,939  |                                   |  |   | 53,797                                           |  |  |                                    | 6.3  |   |  |  | 41.2  |  
|Commercial construction:                                          |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Retail                                                            |  |                                              | 4,425   |  |                                                                |   |       |                                   |  |   | 4,425                                            |  |  |                                    | 0.5  |   |  |  | 3.4   |  
|Office                                                            |  |                                              | 241     |  |                                                                |   |       |                                   |  |   | 241                                              |  |  |                                    |     |   |  |  | 0.2   |  
|Multifamily                                                       |  |                                              | 1,693   |  |                                                                |   |       |                                   |  |   | 1,693                                            |  |  |                                    | 0.2  |   |  |  | 1.3   |  
|Industrial and warehouse                                          |  |                                              | 947     |  |                                                                |   |       |                                   |  |   | 947                                              |  |  |                                    | 0.1  |   |  |  | 0.7   |  
|Miscellaneous commercial                                          |  |                                              | 3,275   |  |                                                                |   |       |                                   |  |   | 3,275                                            |  |  |                                    | 0.4  |   |  |  | 2.4   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Total development commercial real estate loans                    |  |                                              | 115,401 |  |                                                                |   | 10,576 |                                   |  |   | 125,977                                          |  |  |                                    | 14.7 |   |  |  | 96.4  |  
|Existing and other commercial real estate loans                   |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Hotel / motel                                                     |  |                                              | 62,036  |  |                                                                |   | 33,533 |                                   |  |   | 95,569                                           |  |  |                                    | 11.1 |   |  |  | 73.2  |  
|Retail                                                            |  |                                              | 17,650  |  |                                                                |   | 6,375  |                                   |  |   | 24,025                                           |  |  |                                    | 2.8  |   |  |  | 18.4  |  
|Office                                                            |  |                                              | 23,469  |  |                                                                |   | 1,656  |                                   |  |   | 25,125                                           |  |  |                                    | 2.9  |   |  |  | 19.2  |  
|Multifamily                                                       |  |                                              | 18,327  |  |                                                                |   | 7,943  |                                   |  |   | 26,270                                           |  |  |                                    | 3.1  |   |  |  | 20.1  |  
|Industrial and warehouse                                          |  |                                              | 11,538  |  |                                                                |   | 1,488  |                                   |  |   | 13,026                                           |  |  |                                    | 1.5  |   |  |  | 10.0  |  
|Healthcare                                                        |  |                                              | 13,008  |  |                                                                |   |       |                                   |  |   | 13,008                                           |  |  |                                    | 1.5  |   |  |  | 10.0  |  
|Miscellaneous commercial                                          |  |                                              | 119,191 |  |                                                                |   | 2,637  |                                   |  |   | 121,828                                          |  |  |                                    | 14.2 |   |  |  | 93.3  |  
|Residential constructionspeculative                              |  |                                              | 820     |  |                                                                |   | 546    |                                   |  |   | 1,366                                            |  |  |                                    | 0.2  |   |  |  | 1.0   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Total existing and other commercial real estate loans             |  |                                              | 266,039 |  |                                                                |   | 54,178 |                                   |  |   | 320,217                                          |  |  |                                    | 37.3 |   |  |  | 245.2 |  
|Commercial real estate owner occupied and residential loans       |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Commercialowner occupied                                         |  |                                              | 118,046 |  |                                                                |   | 471    |                                   |  |   | 118,517                                          |  |  |                                    | 13.8 |   |  |  | 90.7  |  
|Commercial constructionowner occupied                            |  |                                              | 3,525   |  |                                                                |   |       |                                   |  |   | 3,525                                            |  |  |                                    | 0.4  |   |  |  | 2.7   |  
|Residential constructioncontract                                 |  |                                              | 5,586   |  |                                                                |   |       |                                   |  |   | 5,586                                            |  |  |                                    | 0.6  |   |  |  | 4.3   |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Total commercial real estate owner occupied and residential loans |  |                                              | 127,157 |  |                                                                |   | 471    |                                   |  |   | 127,628                                          |  |  |                                    | 14.8 |   |  |  | 97.7  |  
|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  
|Total loans secured by commercial real estate                     |  | $                                            | 508,597 |  |                                                                | $ | 65,225 |                                   |  | $ | 573,822                                          |  |  |                                    | 66.8 | % |  |  | 439.3 | %
|                                                                  |  |                                              |         |  |                                                                |   |        |                                   |  |   |                                                  |  |  |                                    |      |   |  |  |       |  



Geographic Concentration. Unlike
larger national or regional banks that are more geographically diversified, we primarily provide our services to customers within our market area. Deterioration in local economic conditions could result in declines in asset quality, loan collateral
values, or the demand for our products and services, among other things. In addition, during 2006 to 2008, we originated out-of-market loans, purchased participation loans from other banks, and / or obtained brokered loans brought to us by loan
brokers, which were generally to non-customers for whom we had no pre-existing banking relationship. In connection with our 2009 and 2010 loan portfolio and lending practices reviews, we determined that out-of-market loans were a significant
contributing factor to our increased credit losses and, as such, no longer originate such loans.



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Although our geographic concentration limits us to the economic risks within our market
area, our lack of geographic diversification may make it particularly sensitive to adverse impacts of negative economic conditions that impact our market area.



Maturities and Sensitivities of Loans to Changes in Interest Rates.    The following table summarizes our total
loan portfolio, including mortgage and commercial loans held for sale, by portfolio segment, at December 31, 2010 that, based on contractual terms, were due during the periods noted. Loans having no stated maturity and no stated schedule of
repayment, except for equity lines of credit, are reported as due in one year or less. Equity lines of credit are mortgage loans intended to be long-term real estate consumer products and are reported as due after five years. The table also
summarizes our loan portfolio at December 31, 2010 with regard to fixed-rate and variable-rate maturity or repricing terms due in periods after one year (in thousands).



|                                                                   |  |                            |         |  |                                                                        |  |         |                     |  |  |         |  |  |            |         |  |               |  |         |  |  |  |        | 
|------------------------------------------------------------------ |  | -------------------------- | ------- |  | ---------------------------------------------------------------------- |  | ------- | ------------------- |  |  | ------- |  |  | ---------- | ------- |  | ------------- |  | ------- |  |  |  | ------ | 
|                                                                   |  | Maturity or Repricing Term |         |  | Rate structure for loanswith maturities
orrepricing terms over oneyear | 
|                                                                   |  | Due in oneyear or less     |         |  | Due after oneyear throughfive years                                    |  |         | Due after fiveyears |  |  | Total   |  |  | Fixed-rate |         |  | Variable-rate | 
|Commercial real estate                                             |  | $                          | 239,384 |  |                                                                        |  | 294,632 |                     |  |  | 39,806  |  |  |            | 573,822 |  |               |  | 334,438 |  |  |  |       | 
|Single-family residential                                          |  |                            | 55,380  |  |                                                                        |  | 41,721  |                     |  |  | 86,672  |  |  |            | 183,773 |  |               |  | 104,611 |  |  |  | 23,782 | 
|Commercial and industrial                                          |  |                            | 24,624  |  |                                                                        |  | 21,488  |                     |  |  | 1,700   |  |  |            | 47,812  |  |               |  | 23,188  |  |  |  |       | 
|Consumer                                                           |  |                            | 5,008   |  |                                                                        |  | 41,652  |                     |  |  | 5,992   |  |  |            | 52,652  |  |               |  | 47,644  |  |  |  |       | 
|Other                                                              |  |                            | 3,063   |  |                                                                        |  | 2,088   |                     |  |  | 1,166   |  |  |            | 6,317   |  |               |  | 3,254   |  |  |  |       | 
|                                                                   |  |                            |         |  |                                                                        |  |         |                     |  |  |         |  |  |            |         |  |               |  |         |  |  |  |        | 
|Total loans, including mortgage and commercial loans held for sale |  | $                          | 327,459 |  |                                                                        |  | 401,581 |                     |  |  | 135,336 |  |  |            | 864,376 |  |               |  | 513,135 |  |  |  | 23,782 | 
|                                                                   |  |                            |         |  |                                                                        |  |         |                     |  |  |         |  |  |            |         |  |               |  |         |  |  |  |        | 



Asset
Quality.    Given the negative credit quality trends which began in 2008, accelerated during 2009, and continued into 2010, we have performed extensive analysis of our nonconsumer loan portfolio, with particular focus on
commercial real estate loans. The analyses included internal and external loan reviews that required detailed, written analyses for the loans reviewed and vetting of the risk rating, accrual status, and collateral valuation of the loans by the loan
officers, our senior management team, external consultants, and an external loan review firm. Of particular significance is that these reviews have currently identified 30 specifically identified borrower relationships (43 individual loans) that
have resulted in $70.7 million (63%) of the $112.9 million of net loan charge-offs, writedowns on loans held for sale, and writedowns on foreclosed assets recorded in the past eight quarters. In general, these loans, have one or more of the
following common characteristics:



| |  |  | Individually larger commercial real estate loans originated in 2004 through 2008 that were larger and more complex loans than we historically
originated.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Out-of-market loans, participated loans purchased from other banks, or brokered loans brought to us by loan brokers, which were generally to
non-customers for whom we generally had no pre-existing banking relationship.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Concentrated originations in commercial real estate, including acquisition development and construction loans, by loan officers who did not have the
level of specialized expertise necessary to more effectively underwrite and manage these types of loans.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In general, our entire commercial real estate loan portfolio has been impacted by the challenging economic environment in 2008, 2009, and
2010. However, this pool of loans is the primary contributor to our deteriorated asset quality, charge-offs, and resulting net loss over the past eight quarters. In addition, this pool of loans has exhibited a loss given default much higher than the
remainder of the loan portfolio that is comprised of in-market loans to our ongoing customers that were underwritten by loan officers using our normal credit underwriting standards. Accordingly, as we evaluate the credit quality of the remaining
loan portfolio, we do not currently believe that the higher loss rate incurred on this particular pool of loans is indicative of the loss rate to be incurred on the remainder of the loan portfolio.



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As part of the credit quality plan, to continue to address the impact of the economic
environment on our loan portfolio, we are continuing our detailed review of the loan portfolio and are focused on executing detailed loan workout plans for all of our problem loans led by a team of seasoned commercial lenders and using external loan
workout consulting expertise. It is clear that many of our borrowers are continuing to face financial stress manifesting itself in the following ways:



| |  |  | Cash flows from the underlying properties supporting the loans decreased,
| | - |  | -------------------------------------------------------------------------



| |  |  | Personal cash flows from the borrowers themselves and guarantors under pressure due to illiquid and diminished personal balance sheets resulting from
investing additional personal capital in the projects, and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fair values of real estate related assets declining, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers
are no longer willing to sell the assets at such deep discounts.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We also continue to review our lending policies and procedures and credit administration function. To this end, during 2009 and 2010 we implemented several enhancements as follows:



| |  |  | Construction draws: In 2009, we centralized the oversight and disbursement of construction draws to contractors working for borrowers, and hired a
construction draw manager to review advance requests before funds are advanced to borrowers.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loan Policy: In 2009 and 2010, we amended our loan policy to, among other changes, reduce lending limit approval authorities, prohibit out-of-market
loans to borrowers for which we do not have a previously existing relationship, and prohibit brokered loans.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Credit Administration: In 2009, we hired a new Chief Credit Officer who brings over 25 years of credit administration, loan review, and credit policy
experience to the Company; we reassigned two commercial lenders to credit analysts in the Credit Administration department; and we hired an additional Credit Administration executive.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Special Assets: In 2009 and 2010, we engaged two external workout consultants (who have since completed their engagements); reassigned a commercial
lender; hired two experienced special assets professionals, and we hired a seasoned department leader to manage our Special Assets Department. This department is currently comprised of five people and these internal personnel and external
consultants have been focused exclusively on accelerated resolution of our problem assets.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Training: During 2010, we conducted additional training including external specialists in the areas of problem loan workout and negotiating skills,
analysis of personal financial statements and business tax returns, cash flow analysis, perfecting security interests in collateral, and appraisals.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Delinquent Loans. We determine past due and delinquent status
based on contractual terms. When a borrower fails to make a scheduled loan payment, we attempt to cure the default through several methods including, but not limited to, collection contact and assessment of late fees. If these methods do not result
in the borrower remitting the past due payment, further action may be taken. Interest on loans deemed past due continues to accrue until the loan is placed in nonaccrual status.



Nonperforming Assets. Nonaccrual loans are those loans that
we have determined offer a more than normal risk of future uncollectibility. In most cases, loans are automatically placed in nonaccrual status by the loan system when the loan payment becomes 90 days delinquent and no acceptable arrangement has
been made between us and the borrower. Loans may be manually placed in nonaccrual status if we determine that some factor other than delinquency (such as imminent foreclosure or bankruptcy proceedings) causes us to believe that more than a normal
amount of risk exists with regard to collectability. When the loan is placed in nonaccrual status, accrued interest income is reversed based on the effective date of nonaccrual status. Thereafter, any cash payments received on the nonaccrual loan
are applied as a principal reduction until the entire amortized cost has been recovered. Any additional amounts received are reflected in interest income.



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When the probability of future collectability on a nonaccrual loan declines, we may take
additional collection measures, including commencing foreclosure. Specific steps must be taken when commencing foreclosure action on loans secured by real estate, which takes time based on state-specific legal requirements.



At December 31, 2010, nonperforming assets decreased
$13.5 million (10.8%) from December 31, 2009, which is a total decline of 21.6% from the peak at March 31, 2010 and the third consecutive quarterly decline. However, we continue to have a high risk loan portfolio given the
concentration in commercial real estate and the number of individually large criticized loans.



The following table summarizes nonperforming assets, by class, at the dates indicated (dollars in thousands).



|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------------------------- |  | ------------ | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                        |  | December 31, |          
|                                                        |  | 2010         |           |   | 2009 |   |           | 2008 |  |   | 2007      |   |  | 2006 |          
|Construction, land development and other land loans     |  | $            | 52,528    |   |      | $ | 47,901    |      |  | $ | 15,409    |   |  | $    | 182       |   |  | $ |          |  
|Multifamily residential                                 |  |              | 7,943     |   |      |   | 9,844     |      |  |   | 231       |   |  |      |          |   |  |   |          |  
|Nonfarm nonresidential                                  |  |              | 18,781    |   |      |   | 23,330    |      |  |   | 23,761    |   |  |      | 3,164     |   |  |   | 4,873     |  
|Single-family real estate, revolving, open end loans    |  |              | 998       |   |      |   | 127       |      |  |   | 305       |   |  |      | 143       |   |  |   | 54        |  
|Single-family real estate, closed end, first lien       |  |              | 7,607     |   |      |   | 7,079     |      |  |   | 2,264     |   |  |      | 638       |   |  |   | 1,229     |  
|Single-family real estate, closed end, junior lien      |  |              | 866       |   |      |   | 446       |      |  |   | 57        |   |  |      |          |   |  |   | 115       |  
|Commercial and industrial                               |  |              | 2,197     |   |      |   | 7,475     |      |  |   | 763       |   |  |      | 567       |   |  |   | 549       |  
|Credit cards                                            |  |              | 26        |   |      |   | 372       |      |  |   |          |   |  |      |          |   |  |   |          |  
|All other consumer                                      |  |              | 459       |   |      |   | 312       |      |  |   | 178       |   |  |      | 116       |   |  |   | 179       |  
|Farmland                                                |  |              |          |   |      |   | 50        |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total nonaccrual loans                                  |  |              | 91,405    |   |      |   | 96,936    |      |  |   | 42,968    |   |  |      | 4,810     |   |  |   | 6,999     |  
|Real estate acquired in settlement of loans             |  |              | 19,983    |   |      |   | 27,826    |      |  |   | 6,719     |   |  |      | 7,743     |   |  |   | 600       |  
|Repossessed automobiles acquired in settlement of loans |  |              | 104       |   |      |   | 188       |      |  |   | 564       |   |  |      | 403       |   |  |   | 319       |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total foreclosed assets                                 |  |              | 20,087    |   |      |   | 28,014    |      |  |   | 7,283     |   |  |      | 8,146     |   |  |   | 919       |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total nonperforming assets                              |  | $            | 111,492   |   |      | $ | 124,950   |      |  | $ | 50,251    |   |  | $    | 12,956    |   |  | $ | 7,918     |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Less: Nonaccrual commercial loans held for sale         |  |              | (27,940   | ) |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Adjusted nonperforming assets                           |  | $            | 83,552    |   |      | $ | 124,950   |      |  | $ | 50,251    |   |  | $    | 12,956    |   |  | $ | 7,918     |  
|                                                        |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Loans*                                                  |  | $            | 859,583   |   |      | $ | 1,040,312 |      |  | $ | 1,158,480 |   |  | $    | 1,044,770 |   |  | $ | 945,913   |  
|Total assets                                            |  |              | 1,355,247 |   |      |   | 1,435,763 |      |  |   | 1,368,328 |   |  |      | 1,246,680 |   |  |   | 1,152,701 |  
|Total nonaccrual loans as a percentage of:              |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|loans* and foreclosed assets                            |  |              | 10.39     | % |      |   | 9.07      | %    |  |   | 3.69      | % |  |      | 0.46      | % |  |   | 0.74      | %
|total assets                                            |  |              | 6.74      |   |      |   | 6.75      |      |  |   | 3.14      |   |  |      | 0.39      |   |  |   | 0.61      |  
|Total nonperforming assets as a percentage of:          |  |              |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|loans* and foreclosed assets                            |  |              | 12.67     | % |      |   | 11.70     | %    |  |   | 4.31      | % |  |      | 1.23      | % |  |   | 0.84      | %
|total assets                                            |  |              | 8.23      |   |      |   | 8.70      |      |  |   | 3.67      |   |  |      | 1.04      |   |  |   | 0.69      |  



|* |  | includes gross loans and commercial loans held for sale
|- |  | -------------------------------------------------------



Loans placed in nonaccrual status during 2010 resulted from loans becoming delinquent on contractual payments due to deterioration in the
financial condition of the borrowers or guarantors such that payment in full of principal or interest was not expected due to personal cash flows from the borrowers and guarantors inadequate to service the loans, interest reserves on the loans being
depleted, a decrease in operating cash flows from the underlying properties supporting the loans, or a decline in fair values of the collateral resulting in lower cash proceeds from property sales.



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Twenty-three loans with a balance at December 31, 2010 greater than $1 million
comprised approximately 62% of our nonaccrual loans at December 31, 2010. The following table summarizes the composition of these loans by collateral type (dollars in thousands).



|                                                                      |  |                                    |        |  |                            |  |    |  
|--------------------------------------------------------------------- |  | ---------------------------------- | ------ |  | -------------------------- |  | -- | -
|                                                                      |  | Total nonaccrual loans >$1 million |        |  | % of total nonaccrualloans | 
|Residential/residential lots/golf course development                  |  | $                                  | 39,470 |  |                            |  | 43 | %
|Multifamily residential                                               |  |                                    | 7,400  |  |                            |  | 8  |  
|Real estate for commercial use                                        |  |                                    | 8,700  |  |                            |  | 10 |  
|Marina                                                                |  |                                    | 1,228  |  |                            |  | 1  |  
|                                                                      |  |                                    |        |  |                            |  |    |  
|Total nonaccrual loans > $1 million secured by commercial real estate |  | $                                  | 56,798 |  |                            |  | 62 | %
|                                                                      |  |                                    |        |  |                            |  |    |  



Additionally, four of these
loans (18% based on the principal balance at December 31, 2010) were purchased participations and six of these loans (23% based on the principal balance at December 31, 2010) are out-of-market loans. In 2009, we amended our loan policy to
preclude originating any new loans of these kinds.



While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest income of $4.3 million would
have been reported during the year ended December 31, 2010 had loans classified as nonaccrual during the period performed in accordance with their original terms. As a result, our earnings did not include this interest income.



The following table summarizes the changes in the Foreclosed
real estate portfolio at the dates and for the periods indicated (in thousands). Foreclosed real estate is net of participations sold of $4.6 million (three properties) at December 31, 2010.



|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  
|----------------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                      |  | At and for the years endedDecember 31, |        
|                                                      |  | 2010                                   |         |   | 2009 |   |        | 2008 | 
|Foreclosed real estate, beginning of period           |  | $                                      | 27,826  |   |      | $ | 6,719  |      |  | $ | 7,743  |  
|Plus: New foreclosed real estate                      |  |                                        | 20,423  |   |      |   | 24,628 |      |  |   | 2,778  |  
|Less: Proceeds from sale of foreclosed real estate    |  |                                        | (17,616 | ) |      |   | (689   | )    |  |   | (3,511 | )
|Less: Gain / (loss) on sale of foreclosed real estate |  |                                        | 587     |   |      |   | (72    | )    |  |   | (123   | )
|Less: Provision charged to expense                    |  |                                        | (11,237 | ) |      |   | (2,760 | )    |  |   | (168   | )
|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  
|Foreclosed real estate, end of period                 |  | $                                      | 19,983  |   |      | $ | 27,826 |      |  | $ | 6,719  |  
|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  



The following table summarizes
the Foreclosed real estate portfolio, by FDIC code, at December 31, 2010 (in thousands).



|                                                     |  |   |        | 
|---------------------------------------------------- |  | - | ------ | 
|Construction, land development, and other land loans |  | $ | 6,727  | 
|Single-family residential                            |  |   | 1,807  | 
|Multifamily residential                              |  |   | 1,956  | 
|Nonfarm, nonresidential                              |  |   | 9,493  | 
|                                                     |  |   |        | 
|Total real estate acquired in settlement of loans    |  | $ | 19,983 | 
|                                                     |  |   |        | 



Four individual properties
greater than $1 million comprised approximately 48% of our foreclosed real estate portfolio at December 31, 2010. Of these properties, 37% were retirement center properties, 32% were retail offices, 20% were hotel properties, and 11% were
commercial lots. Additionally, 57% of these properties were participations. Two of the four were the result of out-of-market loans.



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These properties are being actively marketed with the primary objective of liquidating the
collateral at a level which most accurately approximates fair value and allows recovery of as much of the unpaid principal balance as possible upon the sale of the property in a reasonable period of time. As a result, loan charge-offs were recorded
prior to or upon foreclosure to writedown the loans to fair value less estimated costs to sell. For some assets, additional writedowns have been taken based on receipt of updated third party appraisals for which appraised values continue to decline.
Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell although there can be no assurance that the ultimate proceeds from the sale of
these assets will be equal to or greater than the carrying values particularly in the current real estate environment and the continued downward trend in third party appraised values.



During the year ended December 31, 2010, we sold 99 properties with an aggregate net carrying amount of
$17.0 million in total foreclosed real estate sales at a net gain of $587 thousand.



Subsequent to December 31, 2010, four properties with an aggregate net carrying amount of $2.2 million were sold at a loss of $62 thousand. At February 22, 2011, 11 additional properties with an aggregate
net carrying amount of $5.4 million were under contract for sale to close in the first and/or second quarter of 2011.



We are actively addressing the elevated level of nonperforming assets and will continue to be aggressive in working to resolve these
issues as quickly as possible. For problem assets identified, we prepared written workout plans that are borrower specific to determine how best to resolve the loans which could include restructuring the loans, requesting additional collateral,
demanding payment from guarantors, sale of the loans, or foreclosure and sale of the collateral. We are also actively marketing for sale commercial loans held for sale. However, given the nature of the projects related to such loans and the
distressed values within the real estate market, immediate resolution in all cases is not expected. Therefore, it is reasonable to expect that current negative asset quality trends may continue for coming periods when compared to historical periods.
The carrying values of these assets may require additional adjustment for further declines in estimated fair values.



Troubled Debt Restructurings. Troubled debt restructurings are loans which have undergone concessionary adjustments and were restructured
from their original contractual terms due to financial difficulty of the borrower, for example, reduction in the contractual interest rate below that at which the borrower could obtain new credit from another lender. As part of our proactive actions
to resolve problem loans and the resulting determination of our individual loan workout plans, we may restructure loans to assist borrowers facing cash flow challenges in the current economic environment to facilitate ultimate repayment of the loan.
At December 31, 2010, the principal balance of troubled debt restructurings, in gross loans and commercial loans held for sale, totaled $44.9 million, of which loans totaling $17.2 million are classified as commercial loans held for sale.



Historically, we have not split loans into two
legally separate loans. However, at December 31, 2010, we had four loans that had been legally split into separate loans (commonly referred to as an A/B loan structure), with both the A and B loans accounted for as troubled debt restructures.
Restructuring these loans into legally separate loans resulted in charge-offs of $1.5 million of the B loans during 2010. All of the A loans are currently performing in accordance with their terms. The aggregate balances of the A and B loans at
December 31, 2010 were $8.2 million and $11.4 million, respectively.



Twelve individual loans greater than $1 million comprised $35.8 million (80%) of our troubled debt restructurings, including commercial loans held for sale, at December 31, 2010. One of the
loans experienced rate concessions, two experienced term concessions, five experienced rate and term concessions, and three experienced a reduction in required principal paydowns. At December 31, 2010, 11 of the loans totaling $34.3 million are
performing as expected under the new terms.



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A troubled debt restructuring can be removed from this classification in years after the
restructuring if both of the following conditions exist: the restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of the restructuring for a new loan with comparable
risk, and the loan is not impaired based on the terms specified by the restructuring agreement. For the year ended December 31, 2010, no loans were removed from this classification. In the first quarter of 2011, we anticipate that $8.2 million
of these loans will be removed from troubled debt restructuring status as they are performing in accordance with their restructured terms.



Potential Problem Loans. Potential problem loans consist of commercial loans not already classified as nonaccrual for which questions
exist as to the current sound worth and paying capacity of the borrower or of the collateral pledged, if any, have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan, and are characterized by the distinct possibility
that we will sustain some loss of the deficiencies are not corrected. We monitor these loans closely and review performance on a regular basis. As of December 31, 2010, total potential problem loans (loans classified as substandard and
doubtful) totaled $117.1 million, of which $34.9 million were in commercial loans held for sale. Total potential problem loans decreased 20.6% from their peak of $147.5 million at June 30, 2010.



Allowance for Loan Losses.    The
allowance for loan losses represents an amount that we believe will be adequate to absorb probable losses inherent in our loan portfolio as of the balance sheet date. Assessing the adequacy of the allowance for loan losses is a process that
requires considerable judgment. Our judgment in determining the adequacy of the allowance is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and
size of our overall loan portfolio, economic conditions that may impact the overall loan portfolio or an individual borrowers ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and
borrower and collateral specific considerations for loans individually evaluated for impairment.



The allowance for loan losses increased from $24.1 million, or 2.31% of gross loans, at December 31, 2009 to $26.9 million, or 3.39% of gross loans, at December 31, 2010. The increased allowance
and coverage ratio resulted from the overall trends in our asset quality, loan portfolio, and economic factors, some of which offset one another. We believed it was appropriate for the provision for loan losses to cover net charge-offs in 2010 and
incremental specific reserves on new loans individually analyzed for impairment that were added to the list during the year.



The allowance for loan losses at December 31, 2010 decreased $2.4 million from September 30, 2010. The decrease in the allowance
for loan losses resulted primarily from the declining trend in nonaccrual loans, criticized and classified loans, and acquisition, development and construction loans.



The December 31, 2010 allowance for loan losses, and,
therefore indirectly the provision for loan losses for the year ended December 31, 2010, was determined based on the following specific factors, though not intended to be an all inclusive list:



| |  |  | The impact of the ongoing depressed overall economic environment, including within our geographic market,
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | The cumulative impact of the extended duration of this economic deterioration on our borrowers, in particular commercial real estate loans for which we
have a heavy concentration,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The level of real estate development loans, in which the majority of our losses have occurred, although such loans have decreased to 15.9% of the loan
portfolio, including commercial loans held for sale, at December 31, 2010 from 19.8% at December 31, 2009,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The asset quality trends in our loan portfolio, including a high level of nonperforming assets at December 31, 2010, which while still at an
elevated level, decreased for the past three consecutive quarters,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | The trend in our criticized and classified loans, which while still at an elevated level, decreased 11.6% and 8.8% from the previous quarter,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The trend and elevated level of the historical loan loss rates within our loan portfolio,
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | The results of our internal and external loan reviews during 2010, and
| | - |  | ----------------------------------------------------------------------



| |  |  | Our individual impaired loan analysis which identified:
| | - |  | -------------------------------------------------------



| |  |  | Continued stress on borrowers given increasing lack of liquidity and limited bank financing and credit availability, and
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | Continued downward trends in appraised values and market assumptions used to value real estate dependent loans.
| | - |  | ---------------------------------------------------------------------------------------------------------------



The following table summarizes activity within our allowance
for loan losses, by portfolio segment, at the dates and for the periods indicated (dollars in thousands). Loans charged-off and recovered are charged or credited to the allowance for loan losses at the time realized.



|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|---------------------------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | ------- | -
|                                                                                   |  | At and for the years ended December 31, |        
|                                                                                   |  | 2010                                    |         |   | 2009 |   |           | 2008 |  |   | 2007      |   |  | 2006 |          
|Allowance for loan losses, beginning of period                                     |  | $                                       | 24,079  |   |      | $ | 11,000    |      |  | $ | 7,418     |   |  | $    | 8,527     |   |  | $ | 8,431   |  
|Provision for loan losses                                                          |  |                                         | 47,100  |   |      |   | 73,400    |      |  |   | 5,619     |   |  |      | 988       |   |  |   | 1,625   |  
|Less: Allowance reclassified as commercial loans held for sale valuation allowance |  |                                         | 2,358   |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|Less: Allowance reclassified in credit card portfolio sale                         |  |                                         | 452     |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|Loan charged-off                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Commercial real estate                                                             |  |                                         | 33,481  |   |      |   | 49,753    |      |  |   | 198       |   |  |      | 496       |   |  |   | 191     |  
|Single-family residential                                                          |  |                                         | 4,214   |   |      |   | 4,060     |      |  |   | 367       |   |  |      | 371       |   |  |   | 247     |  
|Commercial and industrial                                                          |  |                                         | 3,135   |   |      |   | 4,945     |      |  |   | 430       |   |  |      | 505       |   |  |   | 453     |  
|Consumer                                                                           |  |                                         | 1,483   |   |      |   | 2,033     |      |  |   | 1,174     |   |  |      | 991       |   |  |   | 791     |  
|Other                                                                              |  |                                         | 647     |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Total loans charged-off                                                            |  |                                         | 42,960  |   |      |   | 60,791    |      |  |   | 2,169     |   |  |      | 2,363     |   |  |   | 1,682   |  
|Recoveries                                                                         |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Commercial real estate                                                             |  |                                         | 544     |   |      |   | 111       |      |  |   | 9         |   |  |      | 13        |   |  |   | 6       |  
|Single-family residential                                                          |  |                                         | 98      |   |      |   | 5         |      |  |   | 11        |   |  |      | 39        |   |  |   | 15      |  
|Commercial and industrial                                                          |  |                                         | 154     |   |      |   | 88        |      |  |   | 18        |   |  |      | 54        |   |  |   | 37      |  
|Consumer                                                                           |  |                                         | 729     |   |      |   | 266       |      |  |   | 94        |   |  |      | 160       |   |  |   | 95      |  
|Other                                                                              |  |                                         |        |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |        |  
|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Total loans recovered                                                              |  |                                         | 1,525   |   |      |   | 470       |      |  |   | 132       |   |  |      | 266       |   |  |   | 153     |  
|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Net loans charged-off                                                              |  |                                         | 41,435  |   |      |   | 60,321    |      |  |   | 2,037     |   |  |      | 2,097     |   |  |   | 1,529   |  
|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Allowance for loan losses, end of period                                           |  | $                                       | 26,934  |   |      | $ | 24,079    |      |  | $ | 11,000    |   |  | $    | 7,418     |   |  | $ | 8,527   |  
|                                                                                   |  |                                         |         |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |         |  
|Average gross loans                                                                |  | $                                       | 943,101 |   |      | $ | 1,124,599 |      |  | $ | 1,107,007 |   |  | $    | 986,518   |   |  | $ | 895,062 |  
|Ending gross loans                                                                 |  |                                         | 793,426 |   |      |   | 1,040,312 |      |  |   | 1,158,480 |   |  |      | 1,044,770 |   |  |   | 945,913 |  
|Nonaccrual loans                                                                   |  |                                         | 91,405  |   |      |   | 96,936    |      |  |   | 42,968    |   |  |      | 4,810     |   |  |   | 6,999   |  
|Net loans charged-offs as a percentage of average gross loans                      |  |                                         | 4.39    | % |      |   | 5.36      | %    |  |   | 0.18      | % |  |      | 0.21      | % |  |   | 0.17    | %
|Allowance for loan losses as a percentage of ending gross loans                    |  |                                         | 3.39    |   |      |   | 2.31      |      |  |   | 0.95      |   |  |      | 0.71      |   |  |   | 0.90    |  
|Allowance for loan losses as a percentage of nonaccrual loans                      |  |                                         | 29.47   |   |      |   | 24.84     |      |  |   | 25.60     |   |  |      | 154.22    |   |  |   | 121.83  |  



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In addition to loans charged-off in their entirety in the ordinary course of business,
included within loans charged-off for the year ended December 31, 2010 were $9.9 million in gross loan charge-offs relating to loans individually evaluated for impairment. The determination was made to take partial charge-offs on certain
collateral dependent loans based on the status of the underlying real estate projects or our expectation that these loans would be foreclosed on and we would take possession of the collateral. The loan charge-offs were recorded to writedown the
loans to the fair value of the collateral less estimated costs to sell generally based on fair values from third party appraisals.



We analyze individual loans within the portfolio and make allocations to the allowance for loan losses based on each individual
loans specific factors and other circumstances that impact the collectability of the loan. The population of loans evaluated to be potential impaired loans includes all troubled debt restructures and all loans with interest reserves, as
well as significant individual loans classified as doubtful or on nonaccrual status. At December 31, 2010, we had two loans totaling $3.3 million with Bank funded interest reserves. Based on their performance, these loans were not considered
impaired.



In situations where a loan is
determined to be impaired (primarily because it is probable that all principal and interest due according to the terms of the loan agreement will not be collected as scheduled), the loan is excluded from the general reserve calculation described
below and is evaluated individually for impairment. The impairment analysis is based on the determination of the most probable source of repayment which is typically liquidation of the underlying collateral but may also include discounted
future cash flows or, in rare cases, the market value of the loan itself. At December 31, 2010, $79.1 million of our loans evaluated individually for impairment, including commercial loans held for sale, were valued based on collateral value,
$23.9 million were valued based on discounted future cash flows, $3.4 million were valued based on a loans observable market price, and $1.3 million were based on bid prices for contracted loan sales expected to close in the first quarter of
2011.



Generally, for larger impaired loans valued
based on the value of the collateral, current appraisals performed by approved third party appraisers are the basis for estimating the current fair value of the collateral. However, in situations where a current appraisal is not available, we
use the best available information (including recent appraisals for similar properties, communications with qualified real estate professionals, information contained in reputable trade publications, and other observable market data) to estimate the
current fair value. The estimated costs to sell the property, if not already included in the appraisal, are then deducted from the appraised value to arrive at the net realizable value of the loan used to calculate the loans specific
reserve.



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The following table summarizes the composition of and information relative to impaired
loans, by class, at December 31, 2010 (in thousands).



|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|------------------------------------------------------- |  | ------------------ | ------ |  | ----------------------------- | - | ------ | ---------------- |  | - | ------------------ |  |  | ---------------------- | ------ |  | ------------------ | - | ------ | ---------------------- |  | - | ---------------- |  |  | - | ------- |  |  | - | ----- | 
|                                                        |  | Gross Loans        |        |  | Commercial LoansHeld for Sale |   |        | Total Loans      | 
|                                                        |  | RecordedInvestment |        |  | UnpaidPrincipalBalance        |   |        | RelatedAllowance |  |   | RecordedInvestment |  |  | UnpaidPrincipalBalance |        |  | RecordedInvestment |   |        | UnpaidPrincipalBalance |  |   | RelatedAllowance | 
|With no related allowance recorded:                     |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 29,183 |  |                               | $ | 39,953 |                  |  |   |                    |  |  | $                      | 11,123 |  |                    | $ | 25,303 |                        |  | $ | 40,306           |  |  | $ | 65,256  |  |  |   |       | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        | 7,943  |  |                    |   | 14,010 |                        |  |   | 7,943            |  |  |   | 14,010  |  |  |   |       | 
|Nonfarm nonresidential                                  |  |                    | 11,504 |  |                               |   | 17,099 |                  |  |   |                    |  |  |                        | 19,674 |  |                    |   | 30,367 |                        |  |   | 31,178           |  |  |   | 47,466  |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 40,687 |  |                               |   | 57,052 |                  |  |   |                    |  |  |                        | 38,740 |  |                    |   | 69,680 |                        |  |   | 79,427           |  |  |   | 126,732 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|Single-family real estate, closed end, first lien       |  |                    | 2,567  |  |                               |   | 6,233  |                  |  |   |                    |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 3,162            |  |  |   | 7,607   |  |  |   |       | 
|Single-family real estate, closed end, junior lien      |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 2,567  |  |                               |   | 6,233  |                  |  |   |                    |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 3,162            |  |  |   | 7,607   |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 117    |  |                               |   | 117    |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   | 117              |  |  |   | 117     |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans with no related allowance recorded |  | $                  | 43,371 |  |                               | $ | 63,402 |                  |  |   |                    |  |  | $                      | 39,335 |  |                    | $ | 71,054 |                        |  | $ | 82,706           |  |  | $ | 134,456 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|With an allowance recorded:                             |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 11,164 |  |                               | $ | 17,527 |                  |  | $ | 3,103              |  |  |                        |        |  |                    |   |        |                        |  | $ | 11,164           |  |  | $ | 17,527  |  |  | $ | 3,103 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 10,936 |  |                               |   | 10,936 |                  |  |   | 2,273              |  |  |                        |        |  |                    |   |        |                        |  |   | 10,936           |  |  |   | 10,936  |  |  |   | 2,273 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 22,100 |  |                               |   | 28,463 |                  |  |   | 5,376              |  |  |                        |        |  |                    |   |        |                        |  |   | 22,100           |  |  |   | 28,463  |  |  |   | 5,376 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 1,300  |  |                               |   | 1,300  |                  |  |   | 94                 |  |  |                        |        |  |                    |   |        |                        |  |   | 1,300            |  |  |   | 1,300   |  |  |   | 94    | 
|Single-family real estate, closed end, junior lien      |  |                    | 165    |  |                               |   | 165    |                  |  |   | 57                 |  |  |                        |        |  |                    |   |        |                        |  |   | 165              |  |  |   | 165     |  |  |   | 57    | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 1,465  |  |                               |   | 1,465  |                  |  |   | 151                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,465            |  |  |   | 1,465   |  |  |   | 151   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 1,381  |  |                               |   | 1,450  |                  |  |   | 819                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,381            |  |  |   | 1,450   |  |  |   | 819   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans with an allowance recorded         |  | $                  | 24,946 |  |                               | $ | 31,378 |                  |  | $ | 6,346              |  |  |                        |        |  |                    |   |        |                        |  | $ | 24,946           |  |  | $ | 31,378  |  |  | $ | 6,346 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total:                                                  |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 40,347 |  |                               | $ | 57,480 |                  |  | $ | 3,103              |  |  | $                      | 11,123 |  |                    | $ | 25,303 |                        |  | $ | 51,470           |  |  | $ | 82,783  |  |  | $ | 3,103 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        | 7,943  |  |                    |   | 14,010 |                        |  |   | 7,943            |  |  |   | 14,010  |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 22,440 |  |                               |   | 28,035 |                  |  |   | 2,273              |  |  |                        | 19,674 |  |                    |   | 30,367 |                        |  |   | 42,114           |  |  |   | 58,402  |  |  |   | 2,273 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 62,787 |  |                               |   | 85,515 |                  |  |   | 5,376              |  |  |                        | 38,740 |  |                    |   | 69,680 |                        |  |   | 101,527          |  |  |   | 155,195 |  |  |   | 5,376 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 3,867  |  |                               |   | 7,533  |                  |  |   | 94                 |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 4,462            |  |  |   | 8,907   |  |  |   | 94    | 
|Single-family real estate, closed end, junior lien      |  |                    | 165    |  |                               |   | 165    |                  |  |   | 57                 |  |  |                        |       |  |                    |   |       |                        |  |   | 165              |  |  |   | 165     |  |  |   | 57    | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 4,032  |  |                               |   | 7,698  |                  |  |   | 151                |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 4,627            |  |  |   | 9,072   |  |  |   | 151   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 1,498  |  |                               |   | 1,567  |                  |  |   | 819                |  |  |                        |       |  |                    |   |       |                        |  |   | 1,498            |  |  |   | 1,567   |  |  |   | 819   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans                                    |  | $                  | 68,317 |  |                               | $ | 94,780 |                  |  | $ | 6,346              |  |  | $                      | 39,335 |  |                    | $ | 71,054 |                        |  | $ | 107,652          |  |  | $ | 165,834 |  |  | $ | 6,346 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 



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Interest income recognized on impaired loans during the year ended December 31, 2010
was $1.5 million. The average balance of total impaired loans was $105.7 million for the same period.



At December 31, 2009, the balance of impaired loans was $96.8 million. Of that balance, $11.3 million of the impaired loans had a
related allowance for loan losses of $5.3 million. The average balance of impaired loans was $82.5 million and $22.6 million for the years ended December 31, 2009 and 2008, respectively.



We calculate our general allowance by applying our historical loss factors to each sector of the loan
portfolio. For consistency of comparison on a quarterly basis, we utilize a five-year look-back period when computing historical loss rates. However, given the increase in charge-offs beginning in 2009, we also utilized a three-year look-back period
in 2010 for computing historical loss rates as another reference point in determining the allowance for loan losses.



We adjust these historical loss percentages for qualitative environmental factors derived from macroeconomic indicators and other
factors. Qualitative factors we considered in the determination of the December 31, 2010 allowance for loan losses include pervasive factors that generally impact borrowers across the loan portfolio (such as unemployment and consumer price
index) and factors that have specific implications to particular loan portfolios (such as residential home sales or commercial development). Factors evaluated may include changes in delinquent, nonaccrual and troubled debt restructured loan trends,
trends in risk ratings and net loans charged-off, concentrations of credit, competition and legal and regulatory requirements, trends in the nature and volume of the loan portfolio, national and local economic and business conditions, collateral
valuations, the experience and depth of lending management, lending policies and procedures, underwriting standards and practices, the quality of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other
external factors. The general reserve calculated using the historical loss rates and qualitative factors is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.



The following table summarizes the allocation of the allowance
for loan losses, by portfolio segment, at December 31, 2010 (in thousands).



|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|----------------------------------------------------------------------- |  | --------------------- | ------- |  | ------------------------ | - | ------- | ------------------------ |  | - | -------- |  |  | ----- | ------ |  | ----- | - | ----- |  |  | - | ------- | 
|                                                                        |  | CommercialReal Estate |         |  | Single-familyResidential |   |         | Commercial andIndustrial |  |   | Consumer |  |  | Other |        |  | Total |  
|Allowance for loan losses:                                              |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, beginning of period                          |  | $                     | 13,369  |  |                          | $ | 3,683   |                          |  | $ | 4,853    |  |  | $     | 2,173  |  |       | $ | 1     |  |  | $ | 24,079  | 
|Provision for loan losses                                               |  |                       | 40,899  |  |                          |   | 4,500   |                          |  |   | 620      |  |  |       | 408    |  |       |   | 673   |  |  |   | 47,100  | 
|Less: Allowance reclassified to loans held for sale valuation allowance |  |                       | 2,352   |  |                          |   | 6       |                          |  |   |         |  |  |       |       |  |       |   |      |  |  |   | 2,358   | 
|Less: Allowance associated with credit card portfolio sale              |  |                       |        |  |                          |   |        |                          |  |   |         |  |  |       | 452    |  |       |   |      |  |  |   | 452     | 
|Loan charge-offs                                                        |  |                       | 33,481  |  |                          |   | 4,214   |                          |  |   | 3,135    |  |  |       | 1,483  |  |       |   | 647   |  |  |   | 42,960  | 
|Loan recoveries                                                         |  |                       | 544     |  |                          |   | 98      |                          |  |   | 154      |  |  |       | 729    |  |       |   |      |  |  |   | 1,525   | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Net loans charged-off                                                   |  |                       | 32,937  |  |                          |   | 4,116   |                          |  |   | 2,981    |  |  |       | 754    |  |       |   | 647   |  |  |   | 41,435  | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, end of period                                |  | $                     | 18,979  |  |                          | $ | 4,061   |                          |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Individually evaluated for impairment                                   |  | $                     | 5,376   |  |                          | $ | 151     |                          |  | $ | 819      |  |  | $     |       |  |       | $ |      |  |  | $ | 6,346   | 
|Collectively evaluated for impairment                                   |  |                       | 13,603  |  |                          |   | 3,910   |                          |  |   | 1,673    |  |  |       | 1,375  |  |       |   | 27    |  |  |   | 20,588  | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, end of period                                |  | $                     | 18,979  |  |                          | $ | 4,061   |                          |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|                                                                        |  |                       |         |  |                          |  
|Gross loans, end of period:                                             |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Individually evaluated for impairment                                   |  | $                     | 62,787  |  |                          | $ | 4,032   |                          |  | $ | 1,498    |  |  | $     |       |  |       | $ |      |  |  | $ | 68,317  | 
|Collectively evaluated for impairment                                   |  |                       | 445,810 |  |                          |   | 174,016 |                          |  |   | 46,314   |  |  |       | 52,652 |  |       |   | 6,317 |  |  |   | 725,109 | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Total gross loans                                                       |  | $                     | 508,597 |  |                          | $ | 178,048 |                          |  | $ | 47,812   |  |  | $     | 52,652 |  |       | $ | 6,317 |  |  | $ | 793,426 | 
|                                                                        |  |                       |         |  |                          |   |         |                          |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 



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Portions of the allowance for loan losses may be allocated for specific loans or portfolio
segments. However, the entire allowance for loan losses is available for any loan that, in our judgment, should be charged-off. While we utilize the best judgment and information available to it, the ultimate adequacy of the allowance for loan
losses depends on a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications.



In addition to our portfolio review process, various
regulatory agencies periodically review our allowance for loan losses. These agencies may require us to recognize additions to the allowance for loan losses based on their judgments and information available to them at the time of their
examinations. While we use available information to recognize inherent losses on loans, future adjustments to the allowance for loan losses may be necessary based on changes in economic conditions and other factors and the impact of such changes and
other factors on our borrowers.



We believe that
the allowance for loan losses at December 31, 2010 is appropriate and adequate to cover probable inherent losses in the loan portfolio. However, underlying assumptions may be impacted in future periods by changes in economic conditions, the
impact of regulatory examinations, and the discovery of information with respect to borrowers which was not known to us at the time of the issuance of our Consolidated Financial Statements. Therefore, our assumptions may or may not prove valid.
Thus, there can be no assurance that loan losses in future periods, including potential incremental losses resulting from the sale of the commercial loans held for sale, will not exceed the current allowance for loan losses amount or that future
increases in the allowance for loan losses will not be required. Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require
significant future additions to the allowance for loan losses, thus adversely impacting our business, financial condition, results of operations, and cash flows.



Commercial Loans Held for Sale Valuation
Allowance.    At December 31, 2010, commercial loans held for sale are carried at the lower of cost or fair value, and reflect a valuation allowance of $2.3 million recorded against the loans held for sale resulting in a
net carrying amount in the Consolidated Balance Sheets of $66.2 million. A valuation allowance is recorded against the loans held for sale for the excess of the recorded investment in the loan and the fair value less estimated selling costs.



In September 2010, we decided to market for sale
commercial loans totaling $90.9 million at September 30, 2010, and we are evaluating the bids received on a loan by loan basis. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking
industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year end. In many cases,
we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in
commercial real estate as required by the Consent Order.



During the fourth quarter of 2010, we entered into contracts to sell loans with a gross book value of $13.9 million, of which $10.4 million closed in the fourth quarter. During the fourth quarter of 2010,
we transferred $6.0 million of commercial loans held for sale back to loans held for investment, as our intentions with respect to these loans had changed. We are continuing our efforts to sell the remaining loans held for sale.



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The following table summarizes activity within commercial loans held for sale and the
related valuation allowance, at the dates and for the periods indicated (in thousands).



|                                                                 |  |                                                            |        |  |                                                     |   |       | 
|---------------------------------------------------------------- |  | ---------------------------------------------------------- | ------ |  | --------------------------------------------------- | - | ----- | 
|                                                                 |  | Commercial loans heldfor sale, prior tovaluation allowance |        |  | Valuation allowanceon commercialloans held for sale |  
|Beginning balance at December 31, 2009                           |  | $                                                          |       |  |                                                     | $ |      | 
|Additions:                                                       |  |                                                            |        |  |                                                     |   |       | 
|Loans held for investment transferred to loans held for sale     |  |                                                            | 90,922 |  |                                                     |   | 2,358 | 
|Additional valuation requirements for ending loans held for sale |  |                                                            |       |  |                                                     |   | 1,198 | 
|                                                                 |  |                                                            |        |  |                                                     |   |       | 
|Total additions                                                  |  |                                                            | 90,922 |  |                                                     |   | 3,556 | 
|                                                                 |  |                                                            |        |  |                                                     |   |       | 
|Reductions:                                                      |  |                                                            |        |  |                                                     |   |       | 
|Loans held for sale sold                                         |  |                                                            | 10,402 |  |                                                     |   | 1,186 | 
|Net transfers out                                                |  |                                                            | 5,665  |  |                                                     |   | 36    | 
|Direct writedowns on loans held for sale                         |  |                                                            | 6,364  |  |                                                     |   |      | 
|                                                                 |  |                                                            |        |  |                                                     |   |       | 
|Total reductions                                                 |  |                                                            | 22,431 |  |                                                     |   | 1,222 | 
|                                                                 |  |                                                            |        |  |                                                     |   |       | 
|Ending balance at December 31, 2010                              |  | $                                                          | 68,491 |  |                                                     | $ | 2,334 | 
|                                                                 |  |                                                            |        |  |                                                     |   |       | 



Premises and equipment, net



Premises and equipment, net decreased by
$1.5 million (5.1%) during year ended December 31, 2010. As part of our earnings plan to improve our overall financial performance, we eliminated in 2010 all bank-owned automobiles provided to officers. Bank automobiles with a net book
value of $270 thousand were sold at a loss of $21 thousand during 2010.



In June 2010, we sold one vacant bank-owned branch with a net book value of $46 thousand at a gain of $14 thousand. At December 31, 2010, another vacant branch facility with a net book value of $235
thousand is under contract for sale and included in Other assets in the Consolidated Balance Sheets.



Goodwill



In the third quarter 2010, we recorded a goodwill impairment charge of $3.7 million. Goodwill resulted from past business combinations
from 1988 through 1999. We perform our annual impairment testing as of June 30 each year. However, due to the overall adverse economic environment and the negative impact on the banking industry as a whole, including the impact to the Company
resulting in net losses and a decline in market capitalization based on our common stock price, we also performed impairment tests of our goodwill quarterly in 2010.



Our common stock is not listed on any national securities
exchange or quoted on the OTC Bulletin Board. Our common stock is, however, quoted on the Pink Sheets under the symbol PLMT.PK. Although our common stock is quoted on the Pink Sheets, there is currently only a limited public trading
market of our common stock. Private trading of our common stock also has been limited and has typically been conducted through the Private Trading System on our website. In addition, buyers and sellers may privately negotiate transactions in our
common stock. Because there is not an established market for our common stock, we may not be aware of all prices at which our common stock has been traded. Accordingly, we normally determine the value of our common stock based on the last five
trades of the stock facilitated by the Company through the Private Trading System on our website.



While there were trades in our common stock in the first and second quarters of 2010 through the Private Trading System, there were not any trades through the Private Trading System during the three month
period ended September 30, 2010. The Private Placement was consummated on October 7, 2010 pursuant to which the



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Company issued 39,975,980 million shares of common stock at $2.60 per share. This per share issue price was negotiated by the Company at arms length with the investors and was
supported by a fairness opinion from the investment banking firm engaged by the Companys Board of Directors, including a comparison to common stock prices as a percentage of book value for publicly traded banks with similar asset quality and
financial condition of the Company, and in comparison to recent merger and acquisition transactions. Accordingly, we believe it was appropriate to utilize the $2.60 issue price in our goodwill impairment evaluation at September 30, 2010.



The first step of the goodwill impairment
evaluation was performed by comparing the fair value of our reporting unit with its carrying amount, including goodwill. Since the carrying amount of the reporting unit exceeded its fair value, the second step of the goodwill impairment test was
performed to measure the amount of impairment loss. The second step of the goodwill impairment test compared the implied fair value of our reporting unit goodwill with the carrying amount of that goodwill. Since the carrying amount of reporting unit
goodwill exceeded the implied fair value of that goodwill, an impairment loss was recognized in an amount equal to that excess. The evaluation at September 30, 2010 indicated that the carrying value of the Companys goodwill exceeded
the fair value and resulted in a third quarter noncash charge of $3.7 million, eliminating the goodwill as an asset on the Companys Consolidated Balance Sheets. This charge had no effect on the liquidity, regulatory capital, or daily
operations of the Company and was recorded as a component of noninterest expense on the Consolidated Statement of Income (Loss).



No impairment loss was recognized during 2009.



Deferred Tax Asset



As of December 31, 2010, prior to any valuation allowance, gross deferred tax assets totaling $25.9 million and gross deferred tax
liabilities totaling $5.4 million were recorded in the Companys Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the previous three years, limitations on
future utilization of various deferred tax assets under the Internal Revenue Code, and available tax planning strategies, we recorded a valuation allowance against the net deferred tax asset in the amount of $20.5 million through a charge against
income tax expense (benefit) at December 31, 2010. At December 31, 2009, net deferred tax assets totaled $5.8 million and were supported by an available net operating loss carryback against federal income taxes previously paid. No
valuation allowance was recorded at December 31, 2009.



The Private Placement that was consummated on October 7, 2010 is considered to be a change in control under the Internal Revenue Code. Accordingly, with the assistance of third party specialists we
were required to determine the fair value of the Company and our assets for the purpose of evaluating any potential limitation or deferral of our ability to carry forward pre-acquisition net operating losses and to determine the amount of net
unrealized built-in losses as of October 7, 2010, which also limits the amount of net operating losses that may be used in the future. As a result of the valuations and tax analysis, we currently estimate that future utilization of net
operating loss carry forwards and built-in losses of $46 million generated prior to October 7, 2010 will be limited to $1.1 million per year.



Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it
requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at December 31, 2010, the net operating losses
are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to utilize some of the net operating losses for income
tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and therefore how much of the valuation allowance that may be
reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.



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Deposit Activities



Traditional deposit accounts have historically been the primary source of funds for the Company and a
competitive strength of our Company. Traditional deposit accounts also provide a customer base for the sale of additional financial products and services and fee income through service charges. We set targets for growth in deposit accounts annually
in an effort to increase the number of products per banking relationship. Deposits are attractive sources of funding because of their stability and generally low cost as compared with other funding sources.



The following table summarizes our composition of deposits at
the dates indicated (dollars in thousands).



|                                                 |  |              |           |  |           |  |       |       |  |   |           |  |  |       |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|------------------------------------------------ |  | ------------ | --------- |  | --------- |  | ----- | ----- |  | - | --------- |  |  | ----- | ----- | - | --------- | - | --------- | ----- |  |  | --------- | - |  | ----- | --------- |  | --------- |  | ----- | - |  | - | ------- |  |  |  | ----- | -
|                                                 |  | December 31, |          
|                                                 |  | 2010         |           |  | 2009      |  |       | 2008  |  |   |           |  |  | 2007  |       |   |           |   |           | 2006  |  |  |           |  
|                                                 |  | Total        |           |  | % oftotal |  |       | Total |  |   | % oftotal |  |  | Total |       |   | % oftotal |   |           | Total |  |  | % oftotal |   |  | Total |           |  | % oftotal | 
|Noninterest-bearing transaction deposit accounts |  | $            | 141,281   |  |           |  | 12.0  | %     |  | $ | 142,609   |  |  |       | 11.7  | % |           | $ | 134,465   |       |  |  | 12.6      | % |  | $     | 135,920   |  |           |  | 12.8  | % |  | $ | 134,229 |  |  |  | 13.5  | %
|Interest-bearing transaction deposit accounts    |  |              | 292,827   |  |           |  | 25.0  |       |  |   | 307,258   |  |  |       | 25.3  |   |           |   | 364,315   |       |  |  | 34.0      |   |  |       | 387,248   |  |           |  | 36.6  |   |  |   | 313,613 |  |  |  | 31.5  |  
|                                                 |  |              |           |  |           |  |       |       |  |   |           |  |  |       |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|Transaction deposit accounts                     |  |              | 434,108   |  |           |  | 37.0  |       |  |   | 449,867   |  |  |       | 37.0  |   |           |   | 498,780   |       |  |  | 46.6      |   |  |       | 523,168   |  |           |  | 49.4  |   |  |   | 447,842 |  |  |  | 45.0  |  
|Money market deposit accounts                    |  |              | 143,143   |  |           |  | 12.2  |       |  |   | 119,082   |  |  |       | 9.8   |   |           |   | 93,746    |       |  |  | 8.7       |   |  |       | 118,681   |  |           |  | 11.2  |   |  |   | 124,874 |  |  |  | 12.6  |  
|Savings deposit accounts                         |  |              | 49,472    |  |           |  | 4.2   |       |  |   | 40,335    |  |  |       | 3.3   |   |           |   | 36,623    |       |  |  | 3.4       |   |  |       | 34,895    |  |           |  | 3.3   |   |  |   | 41,887  |  |  |  | 4.2   |  
|Time deposit accounts                            |  |              | 546,639   |  |           |  | 46.6  |       |  |   | 605,630   |  |  |       | 49.9  |   |           |   | 442,347   |       |  |  | 41.3      |   |  |       | 382,859   |  |           |  | 36.1  |   |  |   | 379,584 |  |  |  | 38.2  |  
|                                                 |  |              |           |  |           |  |       |       |  |   |           |  |  |       |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  
|Total deposits                                   |  | $            | 1,173,362 |  |           |  | 100.0 | %     |  | $ | 1,214,914 |  |  |       | 100.0 | % |           | $ | 1,071,496 |       |  |  | 100.0     | % |  | $     | 1,059,603 |  |           |  | 100.0 | % |  | $ | 994,187 |  |  |  | 100.0 | %
|                                                 |  |              |           |  |           |  |       |       |  |   |           |  |  |       |       |   |           |   |           |       |  |  |           |   |  |       |           |  |           |  |       |   |  |   |         |  |  |  |       |  



In March 2010, we introduced a
new checking account, MyPal checking, and a new savings account, Smart Savings. These accounts combine traditional banking features and nonbanking features and are expected to be a source of both additional deposits and noninterest income resulting
primarily from service charges or debit card transactions.



The MyPal checking account includes a monthly fee of $5, which is reduced by $0.50 each time an account holder uses their debit card. Thus, ten debit card transactions per month results in no monthly fee
to the account holder. However, the Company earns a per transaction fee from the merchant each time the debit cards are used. In addition, the MyPal checking account includes a competitive interest rate, free checks, free identity theft protection
and safety deposit rental for a period of time, and comes with a membership rewards program that provides purchase discounts to the account holders for items such as airfare, car rental and hotel, and every day savings at a wide variety of national
and local retailers and entertainment companies.



The Smart Savings account can be linked to any of our checking accounts and results in $1 being transferred from the account holders
checking account to the Smart Saving account each time the account holder uses their debit card. The Company initially matched each $1 transfer with $1 for the first six months. Effective October 1, 2010, the match was reduced to $0.10 per each
$1 transfer. The maximum match is $250 per year. The Smart Savings account is also interest-bearing.



We also evaluated the profitability of all of our pre-existing checking accounts and in October 2010 upgraded a large number of
unprofitable checking accounts to the MyPal account. We are also revising our existing fees (some increases and some decreases) and eliminating existing fees or implementing new fees based on our analysis of our fee structure in relation to our
costs and competitor fees, with various implementation dates generally between October 1, 2010 and March 31, 2011.



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The Dodd-Frank Act, which was signed into law on July 21, 2010, calls for new limits on
interchange transaction fees that banks receive from merchants via card networks like Visa, Inc. and MasterCard, Inc. when a customer uses a debit card. In December 2010, the Federal Reserve issued a proposal to implement a provision in the
Dodd-Frank Act that requires the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does
not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates. The results of
this proposed legislation may impact our interchange income from debit card transactions in the future.



During the first and second quarters of 2010, we conducted targeted deposit growth and retention campaigns related to maturing
certificates of deposit and to attract new deposits. The CD campaigns included CDs with various maturities ranging from 6 months to 60 months, as well as 15, 20, and 36 month step-up add-on CDs that allow holders to reset their interest rate up to
one, two and three times, respectively, over the life of the CD and to add to the CDs over their lives. These CD campaigns ended on June 30, 2010. From January 1, 2010 through June 30, 2010, these campaigns resulted in the retention
of existing CDs and generation of new CDs totaling $258.1 million. However, in the second half of 2010, we did not aggressively pursue retention of maturing CDs given our excess cash and to reduce our net deposit funding cost. At December 31,
2010, CDs decreased $59.0 million from December 31, 2009. In general, this CD runoff was expected as part of our balance sheet management efforts to attract and retain lower priced transaction deposit accounts and shrink our higher priced
deposit base given the decline in the loan portfolio and is expected to continue in the first quarter 2011.



At December 31, 2010, traditional deposit accounts as a percentage of liabilities were 94.5% compared with 89.3% at December 31,
2009. Interest-bearing deposits decreased $40.2 million during the year ended December 31, 2010, primarily due to higher priced time deposit accounts not being retained at maturity as part of our balance sheet management efforts.
Noninterest-bearing deposits decreased $1.3 million during the same period. Traditional deposit accounts continue to be our primary source of funding, and, as part of our liquidity plan, we are proactively pursuing deposit retention initiatives with
our deposit customers. We are also pursuing strategies to increase our transaction deposit accounts as a proportion of our total deposits.



The Dodd-Frank Act also permanently raises the current standard maximum deposit insurance amount to $250,000. The standard maximum
insurance amount of $100,000 had been temporarily raised to $250,000 until December 31, 2013. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category. In addition, the FDIC
provides unlimited deposit insurance coverage for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. We elected to voluntarily participate in the program
through December 31, 2010. Throughout 2010, participating institutions paid fees of 15 to 25 basis points (annualized), depending on the Risk Category assigned to the institution, on the balance of each covered account in excess of $250
thousand. Coverage under the program was in addition to and separate from the basic coverage available under the FDICs general deposit insurance rules. We believe participation in the program enhanced our ability to retain customer deposits.
As a result of the Dodd-Frank Act, the voluntary TAGP program will end on December 31, 2010, and all institutions will be required to provide full deposit insurance on noninterest-bearing transaction accounts until December 31, 2012. There
will not be a separate assessment for this as there was for institutions participating in the TAGP program.



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The table set forth below summarizes the average balances of interest-bearing deposits by
type and the weighted average rates paid thereon for the periods indicated (dollars in thousands).



|                                |  |                                  |           |  |                 |   |        |                          |  |  |                |   |  |                 |           |  |                          |   |        |                |  |  |                 |   |  |                          |         |  |  |   |        |  |  |  |      |  
|------------------------------- |  | -------------------------------- | --------- |  | --------------- | - | ------ | ------------------------ |  |  | -------------- | - |  | --------------- | --------- |  | ------------------------ | - | ------ | -------------- |  |  | --------------- | - |  | ------------------------ | ------- |  |  | - | ------ |  |  |  | ---- | -
|                                |  | For the years ended December 31, |          
|                                |  | 2010                             |           |  | 2009            |   |        | 2008                     | 
|                                |  | Averagebalance                   |           |  | Interestexpense |   |        | Weightedaveragerate paid |  |  | Averagebalance |   |  | Interestexpense |           |  | Weightedaveragerate paid |   |        | Averagebalance |  |  | Interestexpense |   |  | Weightedaveragerate paid |        
|Transaction deposit accounts    |  | $                                | 292,696   |  |                 | $ | 248    |                          |  |  | 0.08           | % |  | $               | 323,613   |  |                          | $ | 526    |                |  |  | 0.16            | % |  | $                        | 374,382 |  |  | $ | 4,966  |  |  |  | 1.33 | %
|Money market deposit accounts   |  |                                  | 137,955   |  |                 |   | 622    |                          |  |  | 0.45           |   |  |                 | 108,566   |  |                          |   | 602    |                |  |  | 0.55            |   |  |                          | 105,834 |  |  |   | 1,922  |  |  |  | 1.82 |  
|Savings deposit accounts        |  |                                  | 46,112    |  |                 |   | 124    |                          |  |  | 0.27           |   |  |                 | 40,871    |  |                          |   | 132    |                |  |  | 0.32            |   |  |                          | 37,692  |  |  |   | 129    |  |  |  | 0.34 |  
|Time deposit accounts           |  |                                  | 552,854   |  |                 |   | 12,566 |                          |  |  | 2.27           |   |  |                 | 578,026   |  |                          |   | 18,251 |                |  |  | 3.16            |   |  |                          | 400,516 |  |  |   | 16,677 |  |  |  | 4.16 |  
|                                |  |                                  |           |  |                 |   |        |                          |  |  |                |   |  |                 |           |  |                          |   |        |                |  |  |                 |   |  |                          |         |  |  |   |        |  |  |  |      |  
|Total interest-bearing deposits |  | $                                | 1,029,617 |  |                 | $ | 13,560 |                          |  |  | 1.32           | % |  | $               | 1,051,076 |  |                          | $ | 19,511 |                |  |  | 1.86            | % |  | $                        | 918,424 |  |  | $ | 23,694 |  |  |  | 2.58 | %
|                                |  |                                  |           |  |                 |   |        |                          |  |  |                |   |  |                 |           |  |                          |   |        |                |  |  |                 |   |  |                          |         |  |  |   |        |  |  |  |      |  



Jumbo Time Deposit
Accounts.    Jumbo time deposit accounts are accounts with balances totaling $100,000 or greater at the date indicated. Jumbo time deposit accounts totaled 22.7% of total interest-bearing liabilities at
December 31, 2010. The following table summarizes our jumbo time deposit accounts by maturity at December 31, 2010 (in thousands).



|                                      |  |   |         | 
|------------------------------------- |  | - | ------- | 
|Three months or less                  |  | $ | 44,092  | 
|Over three months through six months  |  |   | 17,994  | 
|Over six months through twelve months |  |   | 90,171  | 
|                                      |  |   |         | 
|Twelve months or less                 |  |   | 152,257 | 
|Over twelve months                    |  |   | 94,912  | 
|                                      |  |   |         | 
|Total jumbo time deposit accounts     |  | $ | 247,169 | 
|                                      |  |   |         | 



Jumbo time deposit accounts
totaled $263.7 million at December 31, 2009. We believe our balance sheet management efforts to attract and retain lower priced transaction deposit accounts and shrink our higher priced deposit base contributed to the decrease in jumbo time
deposit accounts.



Borrowing Activities



Borrowings as a percentage of total
liabilities decreased from 10.0% at December 31, 2009 to 4.5% at December 31, 2010. The decrease was due to less reliance on such borrowed funding sources as liquidity was provided through deposit growth and cash retention of proceeds from
loan payments and maturing securities. We also utilized excess cash balances in December 2010 to prepay $61.0 million of FHLB advances.



The following table summarizes our borrowings composition at the dates indicated (dollars in thousands).



|                             |  |                   |        |  |                   |  |       |       |  |   |           |  |  |  |       |  
|---------------------------- |  | ----------------- | ------ |  | ----------------- |  | ----- | ----- |  | - | --------- |  |  |  | ----- | -
|                             |  | December 31, 2010 |        |  | December 31, 2009 | 
|                             |  | Total             |        |  | % oftotal         |  |       | Total |  |   | % oftotal | 
|Retail repurchase agreements |  | $                 | 20,720 |  |                   |  | 37.2  | %     |  | $ | 15,545    |  |  |  | 11.5  | %
|Commercial paper             |  |                   |       |  |                   |  |      |       |  |   | 19,061    |  |  |  | 14.0  |  
|FHLB advances                |  |                   | 35,000 |  |                   |  | 62.8  |       |  |   | 101,000   |  |  |  | 74.5  |  
|                             |  |                   |        |  |                   |  |       |       |  |   |           |  |  |  |       |  
|Total borrowed funds         |  | $                 | 55,720 |  |                   |  | 100.0 | %     |  | $ | 135,606   |  |  |  | 100.0 | %
|                             |  |                   |        |  |                   |  |       |       |  |   |           |  |  |  |       |  



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The following table provides further detail with respect to our borrowings composition at
the dates and for the periods indicated (dollars in thousands).



|                                                                     |  |                                        |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                     |  | At and for the years endedDecember 31, |        
|                                                                     |  | 2010                                   |         |   | 2009 |   |         | 2008 | 
|Retail repurchase agreements                                         |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      | 20,720  |   |      | $ | 15,545  |      |  | $ | 16,357  |  
|Average amount outstanding during year                               |  |                                        | 22,809  |   |      |   | 23,227  |      |  |   | 18,063  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 26,106  |   |      |   | 29,461  |      |  |   | 21,817  |  
|Rate paid at year-end*                                               |  |                                        | 0.25    | % |      |   | 0.25    | %    |  |   | 0.25    | %
|Weighted average rate paid during the year                           |  |                                        | 0.25    |   |      |   | 0.25    |      |  |   | 1.37    |  
|                                                                     |  |                                        |        
|Commercial paper                                                     |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      |        |   |      | $ | 19,061  |      |  | $ | 27,955  |  
|Average amount outstanding during year                               |  |                                        | 8,435   |   |      |   | 24,085  |      |  |   | 32,415  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 18,948  |   |      |   | 27,041  |      |  |   | 37,487  |  
|Rate paid at year-end*                                               |  |                                        |        | % |      |   | 0.25    | %    |  |   | 0.25    | %
|Weighted average rate paid during the year                           |  |                                        | 0.25    |   |      |   | 0.25    |      |  |   | 1.11    |  
|                                                                     |  |                                        |        
|Other short-term borrowingslines of credit from correspondent banks |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      |        |   |      | $ |        |      |  | $ | 35,785  |  
|Average amount outstanding during year                               |  |                                        | 1       |   |      |   | 5,335   |      |  |   | 13,240  |  
|Maximum amount outstanding at any month-end                          |  |                                        |        |   |      |   | 17,295  |      |  |   | 38,171  |  
|Rate paid at year-end                                                |  |                                        |        | % |      |   |        | %    |  |   | 0.68    | %
|Weighted average rate paid during the year                           |  |                                        |        |   |      |   | 0.62    |      |  |   | 2.27    |  
|                                                                     |  |                                        |        
|FHLB borrowings                                                      |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      | 35,000  |   |      | $ | 101,000 |      |  | $ | 96,000  |  
|Average amount outstanding during year                               |  |                                        | 95,231  |   |      |   | 78,166  |      |  |   | 76,718  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 101,000 |   |      |   | 170,000 |      |  |   | 111,000 |  
|Rate paid at year-end                                                |  |                                        | 2.99    | % |      |   | 2.01    | %    |  |   | 2.02    | %
|Weighted average rate paid during the year                           |  |                                        | 1.79    |   |      |   | 2.27    |      |  |   | 2.61    |  



|* |  | Rates paid are tiered based on level of deposit. Rate presented represents the average rate for all tiers offered at year-end.
|- |  | ------------------------------------------------------------------------------------------------------------------------------



Retail Repurchase
Agreements.    We offer retail repurchase agreements as an alternative investment tool to conventional savings deposits. The investor buys an interest in a pool of U.S. government or agency securities. Funds are swept
daily between the customer and the Bank. Retail repurchase agreements are securities transactions, not insured deposits.



Commercial Paper.    Through June 30, 2010, we offered commercial paper as an alternative investment tool
for our commercial customers. Through a master note arrangement between the Company and the Bank, Palmetto Master Notes were issued as an alternative investment for commercial sweep accounts. These master notes were unsecured but backed by the full
faith and credit of the Company. The commercial paper was issued only in conjunction with deposits in the Banks automated sweep accounts.



Effective July 1, 2010, as part of our efforts to provide enhanced services to our customers, we terminated the commercial paper
program, and all commercial paper accounts were converted to a new money market sweep account. The money market sweep account is an FDIC insured deposit and includes interest paid on excess balances and automatic transfers between various customer
accounts.



Wholesale
Funding.    Wholesale funding options include lines of credit from correspondent banks, FHLB advances, and the Federal Reserve Discount Window. Such funding provides us with the ability to access the



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type of funding needed at the time and amount needed at market rates. This provides us with the flexibility to tailor borrowings to our specific needs. Interest rates on such borrowings vary from
time to time in response to general economic conditions.



Correspondent Bank Line of Credit.    At December 31, 2010, we had access to a line of credit from a correspondent bank in the amount of $5 million. From August 24,
2009 to October 31, 2010, this line of credit was secured by U.S. Treasury and federal agency securities. Effective November 1, 2010 we were no longer required to pledge collateral for this line of credit.



The following table summarizes our line of credit funding
utilization and availability at the dates indicated (in thousands).



|                                                          |  |              |       |  |      |   |       | 
|--------------------------------------------------------- |  | ------------ | ----- |  | ---- | - | ----- | 
|                                                          |  | December 31, |      
|                                                          |  | 2010         |       |  | 2009 |  
|Correspondent bank line of credit accomodations           |  | $            | 5,000 |  |      | $ | 5,000 | 
|Utilized correspondent bank line of credit accomodations  |  |              |      |  |      |   |      | 
|                                                          |  |              |       |  |      |   |       | 
|Available correspondent bank line of credit accomodations |  | $            | 5,000 |  |      | $ | 5,000 | 
|                                                          |  |              |       |  |      |   |       | 



This correspondent bank line of
credit funding source may be canceled at any time at the correspondent banks discretion.



FHLB Borrowings.    We pledge investment securities and loans to collateralize FHLB advances and letters of credit. Additionally, we may pledge cash and cash equivalents. The
amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages, as calculated by the FHLB.



The following table summarizes FHLB borrowed funds
utilization and availability at the dates indicated (in thousands).



|                                                                                                             |  |                  |         |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | ---------------- | ------- | - | ---------------- | - | -------- | -
|                                                                                                             |  | December 31,2010 |         |   | December 31,2009 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $                | 92,464  |   |                  | $ | 162,014  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |                  | 46,275  |   |                  |   | 26,791   |  
|Advances and letters of credit                                                                               |  |                  |         |   |                  |   |          |  
|FHLB advances                                                                                                |  |                  | (35,000 | ) |                  |   | (101,000 | )
|Letters of credit                                                                                            |  |                  | (50,000 | ) |                  |   | (50,000  | )
|Excess / (deficiency)                                                                                        |  |                  | 53,303  |   |                  |   | 55       |  



The following table summarizes FHLB borrowings at December 31, 2010 (dollars in thousands). Our outstanding FHLB advances do not have
embedded call options.



|                  |  |   |          |   |  |   |          |       |  |   |        |  
|----------------- |  | - | -------- | - |  | - | -------- | ----- |  | - | ------ | -
|                  |  |   |          |   |  |   |          | Total | 
|Borrowing balance |  | $ | 30,000   |   |  | $ | 5,000    |       |  | $ | 35,000 |  
|Interest rate     |  |   | 2.89     | % |  |   | 3.61     | %     |  |   | 2.99   | %
|Maturity date     |  |   | 3/7/2011 |   |  |   | 4/2/2013 |       |  |   |        |  



In January 2010, we
were notified by the FHLB that we could only rollover existing advances as they matured and that incremental borrowings would not be allowed; however, in December 2010 we were notified by the FHLB that our borrowing capacity had been restored up to
10% of total assets.



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Any FHLB advance with a fixed interest rate is subject to a prepayment fee in the event of
full or partial repayment prior to maturity or the expiration of any interim interest rate period. In December 2010, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing cost, we prepaid
$61.0 million of FHLB advances. In January 2011, we also prepaid FHLB advances of $30.0 million.



Federal Reserve Discount Window.    We have established a borrowing relationship with the Federal Reserve through its Discount Window. Through the Discount Window, primary
credit is available to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. Our maximum maturity for potential borrowings is
overnight. Although we have not drawn on this availability since established in 2009 or during 2010, any potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues.
Further, the Federal Reserve has the discretion to deny approval of borrowing requests.



Convertible Debt.    In March 2010, the Company issued unsecured convertible promissory notes in an aggregate principal amount of $380 thousand to members of the Board of
Directors. The notes bore interest at 10% per year payable quarterly, had a stated maturity of March 31, 2015, were prepayable by the Company at any time at the discretion of the Board of Directors, and were mandatorily convertible into
stock of the Company at the same terms and conditions as other investors that participate in the Companys next stock offering. The proceeds from the issuance of the notes were contributed to the Bank as a capital contribution. Upon the
consummation of the Private Placement on October 7, 2010, the outstanding convertible promissory notes were converted into shares of the Companys common stock at the same price per share as the common stock issued in the Private
Placement, and the accrued interest was paid on October 7, 2010.



Capital



At December 31, 2010, as a result of the consummation of the Private Placement on October 7, 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds as well
as the minimum capital ratios established in the Consent Order.



The following table summarizes capital key performance indicators at the dates and for the periods indicated (dollars in thousands, except per share data).



|                                                               |  |                                         |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                               |  | At and for the years ended December 31, |        
|                                                               |  | 2010                                    |         |   | 2009 |   |         | 2008 | 
|Total shareholders equity                                     |  | $                                       | 113,899 |   |      | $ | 75,015  |      |  | $ | 115,776 |  
|Average shareholders equity                                   |  |                                         | 87,463  |   |      |   | 106,906 |      |  |   | 116,222 |  
|Shareholders equity as a percentage of assets                 |  |                                         | 8.40    | % |      |   | 5.22    | %    |  |   | 8.46    | %
|Average shareholders equity as a percentage of average assets |  |                                         | 6.25    |   |      |   | 7.48    |      |  |   | 8.79    |  
|Cash dividends per common share                                |  | $                                       |        |   |      | $ | 0.06    |      |  | $ | 0.80    |  
|Dividend payout ratio                                          |  |                                         | n/a     | % |      |   | n/a     | %    |  |   | 37.89   | %



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The following table summarizes activity impacting shareholders equity for the period
indicated (in thousands).



|                                                                                               |  |                                            |         |  
|---------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | -
|                                                                                               |  | At and for the yearended December 31, 2010 |        
|Total shareholders equity, beginning of period                                                |  | $                                          | 75,015  |  
|Additions to shareholders equity during period                                                |  |                                            |         |  
|Change in accumulated other comprehensive loss due to investment securities available for sale |  |                                            | 958     |  
|Common stock issued pursuant to Private Placement, net of issuance costs                       |  |                                            | 95,980  |  
|Common stock issued pursuant to Follow-On offering                                             |  |                                            | 2,018   |  
|Common stock issued upon conversion of convertible debt                                        |  |                                            | 380     |  
|Common stock issued pursuant to restricted stock plan                                          |  |                                            | 297     |  
|Compensation expense related to stock option plan                                              |  |                                            | 30      |  
|                                                                                               |  |                                            |         |  
|Total additions to shareholders equity during period                                          |  |                                            | 99,663  |  
|Reductions in shareholders equity during period                                               |  |                                            |         |  
|Net loss                                                                                       |  |                                            | (60,202 | )
|Change in accumulated other comprehensive loss due to defined benefit pension plan             |  |                                            | (577    | )
|                                                                                               |  |                                            |         |  
|Total reductions in shareholders equity during period                                         |  |                                            | (60,779 | )
|                                                                                               |  |                                            |         |  
|Total shareholders equity, end of period                                                      |  | $                                          | 113,899 |  
|                                                                                               |  |                                            |         |  



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Accumulated Other Comprehensive Loss.    The following table
summarizes the components of accumulated other comprehensive loss, net of tax impact, at the dates and for the periods indicated (in thousands).



|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|---------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                   |  | For the years ended December 31, |        
|                                                                                   |  | 2010                             |         |   | 2009 |   |         | 2008 | 
|Net Unrealized (Losses) Gains on Investment Securities Available for Sale          |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, beginning of year                                                         |  | $                                | 306     |   |      | $ | (1,621  | )    |  | $ | (252   | )
|Other comprehensive income (loss):                                                 |  |                                  |         |   |      |   |         |      |  |   |        |  
|Unrealized holding gains (losses) arising during the period                        |  |                                  | (64     | ) |      |   | 3,211   |      |  |   | (2,201 | )
|Income tax (expense) benefit                                                       |  |                                  | 24      |   |      |   | (1,216  | )    |  |   | 832    |  
|Less: Reclassification adjustment for (gains) losses included in net (loss) income |  |                                  | 1,608   |   |      |   | (104    | )    |  |   |       |  
|Income tax expense (benefit)                                                       |  |                                  | (610    | ) |      |   | 36      |      |  |   |       |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  |                                  | 958     |   |      |   | 1,927   |      |  |   | (1,369 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, end of year                                                               |  |                                  | 1,264   |   |      |   | 306     |      |  |   | (1,621 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net Unrealized (Losses) Gains on Impact of Defined Benefit Pension Plan            |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, beginning of year                                                         |  |                                  | (7,266  | ) |      |   | (4,496  | )    |  |   | (2,486 | )
|Other comprehensive loss:                                                          |  |                                  |         |   |      |   |         |      |  |   |        |  
|Impact of FASB ASC 715                                                             |  |                                  | (887    | ) |      |   | (4,261  | )    |  |   | (3,092 | )
|Income tax benefit                                                                 |  |                                  | 310     |   |      |   | 1,491   |      |  |   | 1,082  |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  |                                  | (577    | ) |      |   | (2,770  | )    |  |   | (2,010 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, end of year                                                               |  |                                  | (7,843  | ) |      |   | (7,266  | )    |  |   | (4,496 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  | $                                | (6,579  | ) |      | $ | (6,960  | )    |  | $ | (6,117 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Total other comprehensive income (loss), end of year                               |  | $                                | 381     |   |      | $ | (843    | )    |  | $ | (3,379 | )
|Net (loss) income                                                                  |  |                                  | (60,202 | ) |      |   | (40,085 | )    |  |   | 13,599 |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Comprehensive (loss) income                                                        |  | $                                | (59,821 | ) |      | $ | (40,928 | )    |  | $ | 10,220 |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  



Dividends,    The Company and the Bank are subject to regulatory policies and requirements relating to the
payment of dividends. In an effort to retain capital during this period of economic uncertainty, the Board of Directors reduced the quarterly dividend for the first quarter of 2009 and has not declared or paid a quarterly common stock dividend since
that date. The Board of Directors believes that suspension of the dividend was prudent to protect our capital base. In addition, given the Banks recent losses and the restrictions imposed by the Consent Order with the Supervisory Authorities,
we are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to seek regulatory approval prior to paying dividends and to maintain adequate capital above regulatory minimums. Our Board of
Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be reinstated, and at what level, because they are dependent on our financial condition,
results of operations, and / or cash flows, as well as capital and dividend regulations from the FDIC and others.



Basel III.    Internationally, both the Basel Committee and the Financial Stability Board (established in April
2009 by the G-20 Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital
standards and liquidity buffers within the banking system through Basel III. On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements
(raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by
January 2019. The U.S. federal banking agencies support this agreement. In December 2010, the Basel Committee issued the Basel III



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rules text that outlines the details and time-lines of global regulatory standards on bank capital adequacy and liquidity. According to the Basel Committee, the Framework sets out higher and
better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two
global liquidity standards.



Private
Placement.    On May 25, 2010 (and as amended on June 8, 2010 and September 22, 2010), the Company entered into the definitive investment agreements with institutional investors, pursuant to which on
October 7, 2010 the investors purchased $103.9 million of shares of the Companys common stock at $2.60 per share. As a result, the Companys and the Banks capital adequacy ratios now exceed the minimum capital adequacy ratios
to be categorized as well capitalized and those required by the Consent Order for the Bank.



In addition, the investors have preemptive rights with respect to public or private offerings of the Companys common stock (or
rights to purchase, or securities convertible into or exercisable for, common stock) during a 24-month period after the closing of the Private Placement to enable the investors to maintain their percentage interests of the Companys common
stock beneficially owned, subject to certain exceptions, including an exception that permits the Company to conduct a common stock offering following the closing of the Private Placement of up to $10 million directed to the Companys
shareholders as of the close of business on October 6, 2010. On December 6, 2010, a registration statement was declared effective by the SEC for the offering of up to 3,846,153 shares of our common stock at $2.60. These shareholders had
until January 3, 2011 to purchase shares of the Companys common stock. At December 31, 2010, we had issued 776,123 shares of common stock for proceeds of $2.0 million, and in January 2011 we issued an additional 453,906 shares for
proceeds of $1.2 million.



Under the terms of the
Private Placement, the institutional investors who participated in the Private Placement had the right to purchase any unsubscribed shares from the follow-on offering to the legacy shareholders. As a result, in the first quarter 2011, we issued to
these institutional investors 2,616,124 shares of common stock at $2.60 per share for net proceeds of $6.8 million, resulting in the $10 million offering being fully subscribed. The net proceeds of the offerings were contributed to the Bank as an
additional capital contribution.



In connection
with the Private Placement, we evaluated the appropriate accounting for the transaction by analyzing investor ownership, independence, risk, solicitation and collaboration considerations. Based on our analysis of these factors, we concluded that the
Private Placement transaction resulted in a recapitalization of the Companys ownership for which push-down accounting was not required.



Regulatory Capital and Other Requirements.    The Company and the Bank are required to meet regulatory capital
requirements that include several measures of capital. Under regulatory capital requirements, accumulated other comprehensive income (loss) amounts do not increase or decrease regulatory capital and are not included in the calculation of risk-based
capital and leverage ratios.



As previously
described, in March 2010, the Company issued unsecured convertible promissory notes in an aggregate principal amount of $380 thousand. The proceeds from this issuance, along with other cash of the Company, were contributed to the Bank as a capital
contribution. Upon the consummation of the Private Placement, the principal balances of the outstanding convertible promissory notes were converted into shares of the Companys common stock at the same price per share as the common stock issued
in the Private Placement, and the accrued interest was paid on October 7, 2010.



Due to the Consent Order we may not accept brokered deposits unless a waiver is granted by the FDIC. Although we currently do not utilize brokered deposits as a funding source, if we were to seek to begin
using such funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we would normally be



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restricted from offering an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on their website. However, on April 1, 2010, we were
notified by the FDIC that they had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, we are able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in our
geographic areas. The FDIC has informed us that this high-rate determination is also effective for 2011.



In addition, as a result of the Private Placement, as of October 7, 2010 the Companys and the Banks capital adequacy
ratios exceed the minimum capital adequacy ratios to be categorized as well capitalized and also met the requirements of the Consent Order.



The balance of the net deferred income tax asset at December 31, 2010 represented tax assets and liabilities arising from temporary
differences between the financial reporting and income tax bases of various items as of that date. As of December 31, 2010, we evaluated whether it was more likely than not that the net deferred tax asset could be supported as realizable, given
the financial results for the year and change in control resulting from the Private Placement that was consummated on October 7,2010. Based on this evaluation, as described in more detail in Financial ConditionDeferred Tax Asset, we
recorded a valuation allowance for financial reporting purposes at December 31, 2010. Additionally, for regulatory capital purposes, deferred tax assets are limited to the assets which can be realized through (i) carryback to prior years
or (ii) taxable income in the next twelve months. At December 31, 2010, all of our net deferred tax asset was excluded from Tier 1 and total capital based on these criteria. We will continue to evaluate the realizability of our deferred
tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. The evaluation may result in the inclusion of some of the deferred tax asset in regulatory capital in future periods.



See Item 8. Financial Statements and Supplementary Data,
Note 21, Regulatory Capital Requirements and Dividend Restrictions, for disclosures regarding the Companys and the Banks actual and required regulatory capital requirements and ratios.



Since December 31, 2010, no conditions or events have
occurred of which we are aware, that have resulted in a material change in the Companys or the Banks regulatory capital category other than as reported in this Annual Report on Form 10-K.



Equity.    We have authorized
common stock and preferred stock of 75 million and 2.5 million shares, respectively. In the Private Placement, 39,975,980 shares of common stock were issued on October 7, 2010, 1,230,029 shares were issued in connection with the
follow-on offering to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional investors in the Private Placement in the first quarter 2011, resulting in remaining authorized but unissued common shares of
50,513,722 at February 22, 2011.



Government Financing.    We did not participate in the U.S. Treasurys Capital Purchase Program offered in
2008 based on our evaluation of the merits of the program at that time.



On September 27, 2010, the U.S. President signed into law the Small Business Jobs Act of 2010. The SBLF, which was enacted as part of the Act, a $30 billion fund that encourages lending to small
businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. On December 21, 2010, the U.S. Treasury published the application form, term sheet and their guidance for participation in the SBLF. Under
the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1 capital for regulatory purposes and rank senior to a participating
institutions common stock. The application deadline for participating in the SBLF is March 31, 2011. Based on the program criteria, we do not plan to participate in the SBLF.



With respect to any other potential government assistance programs in the future, we will evaluate the merits
of the programs, including the terms of the financing, the Companys capital position, the cost to the Company of alternative capital, and the Companys strategy for the use of additional capital, to determine whether it is prudent to
participate.



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Private Trading System.    On June 26, 2009, we implemented
a Private Trading System on our website (www.palmettobank.com). The Private Trading System is a passive mechanism created to assist buyers and sellers in facilitating trades in our common stock. On June 30, 2009, the Company mailed a
letter and related materials to shareholders regarding the Private Trading System and elected to furnish this information as an exhibit to a Current Report on Form 8-K filed with the SEC on July 2, 2009 which can be accessed through the
SECs website (www.sec.gov).



One of the
requirements of the Private Placement is that the Company will use its reasonable best efforts to list the shares of our common stock on NASDAQ or another national securities exchange within nine months of the closing date of the Private Placement
on October 7, 2010. While we intend to list our common stock on NASDAQ, we are currently evaluating the listing requirements, and no assurances can be provided at this time that we will meet such listing requirements.



Board of Directors and
Governance.    During 2009 and 2010, as part of our ongoing self-assessment process, management and the Board of Directors focused on their governance roles and processes to improve the risk management oversight of the
Company, refine the roles and responsibilities of the Board of Directors and Board committees, and to support an overall healthy corporate culture. In 2010, the Board performed a self-assessment facilitated by an external consultant including
comparisons to best practices from recognized authorities such as the Business Roundtable, CalPERS, and the national stock exchanges. In 2009 and 2010, the Board also reviewed the Companys Articles of Incorporation and Bylaws and Committee
charters and updated them to fit the current and future size, structure, and business activities of the Company. Also, during 2009 and 2010, Committees of the Board determined annual Committee objectives and management refined its performance
evaluation process with a more detailed focus on roles and responsibilities and related accountabilities.



As a condition of the Private Placement, the Company appointed three designees of the investors to the Companys Board of Directors
effective October 12, 2010, and these designees have also been appointed to the Board of Directors of the Bank. Based on terms of the Private Placement the Board of Directors of the Company was reduced to 11 directors, including the three new
investor designees, immediately following the consummation of the Private Placement. The changes in the Boards of Directors were reported on a Current Report on Form 8-K filed with the SEC on October 18, 2010.



Derivative Activities



We are required to recognize all
derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for
which the derivative is held and whether the derivative qualifies for hedge accounting.



We originate certain residential loans with the intention of selling these loans. Between the time that we enter into an interest rate lock commitment to originate a residential loan with a potential
borrower and the time the closed loan is sold, we are subject to variability in market prices related to these commitments. We also enter into forward sale agreements of to be issued loans. The commitments to originate residential loans
and forward sales commitments are freestanding derivative instruments and are recorded on the Consolidated Balance Sheets at fair value. They do not qualify for hedge accounting treatment. Fair value adjustments are recorded within Mortgage-banking
in the Consolidated Statements of Income (Loss).



At December 31, 2010, commitments to originate conforming loans totaled $12.2 million. At December 31, 2010, these derivative
loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $103 thousand and negative fair values, included with Other liabilities in the Consolidated Balance Sheets, totaling $40 thousand.
At December 31, 2009, commitments to originate conforming loans totaled $7.0 million. At December 31, 2009, these derivative loan commitments had positive



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fair values, included within Other assets in the Consolidated Balance Sheets, totaling $52 thousand, and negative fair values, included within Other liabilities in the Consolidated Balance
Sheets, totaling $11 thousand. The net change in derivative loan commitment fair values during the years ended December 31, 2010 and 2009, resulted in net derivative loan commitment income of $22 thousand and $41 thousand, respectively.



Forward sales commitments totaled $19.6 million
at December 31, 2010. At December 31, 2010, forward sales commitments had positive fair values, included with Other assets in the Consolidated Balance Sheets, totaling $175 thousand and negative fair values, included within Other
liabilities in the Consolidated Balance Sheets, totaling $96 thousand. At December 31, 2009, forward sales commitments totaled $10.0 million. At December 31, 2009, these forward sales commitments had positive fair values, included within
Other assets in the Consolidated Balance Sheets, totaling $92 thousand, and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $1 thousand. The net change in forward sales commitment fair values
during the years ended December 31, 2010 and 2009 resulted in a loss of $12 thousand and income of $91 thousand, respectively.



Liquidity



General



Liquidity measures our ability to meet current and future
cash flow needs as they become due. The liquidity of a financial institution reflects its ability to accommodate possible outflows in deposit accounts, meet loan requests and commitments, maintain reserve requirements, pay operating expenses,
provide funds for dividends and debt service, manage operations on an ongoing basis, capitalize on new business opportunities, and take advantage of interest rate market opportunities. The ability of a financial institution to meet its current
financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining a level of liquid funds through proactive
balance sheet management.



Asset liquidity is
provided by liquid assets which are readily convertible into cash, are pledgeable or which will mature in the near future. Our liquid assets may include cash, interest-bearing deposits in banks, investment securities available for sale, and federal
funds sold. Liability liquidity is provided by access to funding sources, which include deposits and borrowed funds. We may also issue equity securities although our common and preferred stock are not listed on a national exchange or quoted on the
OTC Bulletin Board. Each of the Companys sources of liquidity is subject to various factors beyond our control.



Liquidity resources and balances at December 31, 2010, contained herein, are an accurate depiction of our activity during the period
and, except as noted, have not materially changed to date.



In June 2009, we implemented a forward-looking liquidity plan and increased our liquidity monitoring. The liquidity plan includes, among other things:



| |  |  | Implementing proactive customer deposit retention initiatives specific to large deposit customers and our deposit customers in general.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Executing targeted deposit growth and retention campaigns which resulted in retained and new certificates of deposit through June 30, 2010. Since
June 30, 2010, our deposits have remained stable through our normal growth and retention efforts, and therefore we have not utilized any special campaigns. In addition, given our cash position, in the fourth quarter 2010 and continuing into the
first quarter 2011, we are not pursuing special CD campaigns and have reduced our deposit pricing to allow our higher priced CDs to roll off as they mature.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB and Federal Reserve borrowings.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Accelerating the filing of our 2009 income tax refund claims resulting in refunds received totaling $20.9 million, all of which were received during
the three month period ended March 31, 2010, reduced by $661 thousand as a result of the filing of an amended 2009 federal income tax return in June 2010.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Planned filing of a 2008 income tax refund claim in early 2011for the carryback of net operating losses generated in 2010. The carryback of these
losses is expected to result in the refund of $7.4 million of income taxes previously paid for the 2008 tax year. The refund is expected to be received in 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in
other earning assets. Maintaining this cash balance has reduced our interest income by $4.7 million for the year ended December 31, 2010 when compared with investing these funds at the average yield of 2.75% on our investment securities, since
we are retaining a higher level of cash instead of reinvesting this cash in higher yielding assets. Following the consummation of our Private Placement on October 7, 2010, we have redeployed, through February 22, 2011, $96.0 million of
this cash into investment securities and prepaid $91 million of FHLB advances which were scheduled to mature in January through April 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



These measures resulted in an overall improved liquidity position at December 31, 2010 when compared with that of December 31,
2009.



Cash Flow Needs



In the normal course of business, we enter into various
transactions, some of which, in accordance with accounting principles generally accepted in the U.S., are not recorded in our Consolidated Balance Sheets. These transactions may involve, to varying degrees, elements of credit risk and interest rate
risk in excess of the amounts recognized in the Consolidated Balance Sheets, if any.



Lending Commitments and Standby Letters of Credit.    Unused lending commitments to customers are not recorded in our Consolidated Balance Sheets until funds are advanced,
except for those associated with mortgage loans held for sale as described in Financial ConditionDerivative Activities. For commercial customers, lending commitments generally take the form of unused revolving credit arrangements to finance
customers working capital requirements. For retail customers, lending commitments are generally unused lines of credit secured by residential property. At December 31, 2010, unused lending availability totaled $111.0 million.



Standby letters of credit are issued for customers in
connection with contracts between the customers and third parties. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The maximum potential amount of undiscounted future payments
related to letters of credit at December 31, 2009 was $2.7 million compared with $4.6 million at December 31, 2009.



Our lending commitments and standby letters of credit do not meet the criteria to be accounted for at fair value since our commitment
letters contained material adverse change clauses. Accordingly, we account for these instruments in a manner similar to our loans.



We use the same credit policies in making and monitoring commitments as used for loan underwriting. Therefore, in general the methodology
to determine the reserve for unfunded commitments is inherently similar to that used to determine the general reserve component of the allowance for loan losses. However, commitments have fixed expiration dates and most of our commitments to extend
credit have adverse change clauses that allow the Bank to cancel the commitments based on various factors, including deterioration in the creditworthiness of the borrower. Accordingly, many of our loan commitments are expected to expire without
being drawn upon and therefore the total commitment amounts do not necessarily represent potential credit exposure. The credit reserve for unfunded commitments at December 31, 2010 was $99 thousand and is recorded in Other liabilities in the
Consolidated Balance Sheets.



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Derivatives.    See Derivative Activities, included
elsewhere in this item, for discussion regarding the Companys off-balance sheet arrangements and commitments related to our derivative loan commitments and freestanding derivatives.



Dividend Obligations.    The holders of the Companys common stock are entitled
to receive dividends, when and if declared by the Companys Board of Directors, out of funds legally available for such dividends. The Company is a legal entity separate and distinct from the Bank and depends on the payment of dividends from
the Bank. The Company and the Bank are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory
authorities are authorized to determine under certain circumstances that the payment of dividends by a bank holding company or a bank would be an unsafe or unsound practice and to prohibit payment of those dividends. The appropriate federal
regulatory authorities have indicated that banking organizations should generally pay dividends only out of current income. In addition, as a South Carolina chartered bank, the Bank is subject to legal limitations on the amount of dividends it is
permitted to pay.



In an effort to retain capital
during this period of economic uncertainty, the Board of Directors reduced the quarterly dividend for the first quarter of 2009. For the three month period ended March 31, 2009, cash dividends were declared by the Board of Directors and paid
totaling $389 thousand, or $0.06 per common share. These dividends equate to a dividend payout ratio of 19.51% for the quarter ended March 31, 2009. The Board of Directors suspended the quarterly common stock dividend since the first quarter of
2009. The Board of Directors believes that suspension of the dividend was prudent to protect our capital base. In addition, payment of a dividend on our common stock requires prior notification to and non-objection from the applicable banking
regulators. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be reinstated, and at what level, because they are dependent on our
financial condition, results of operations, and / or cash flows, as well as capital and dividend regulations from the FDIC and others.



For the year ended December 31, 2008, cash dividends were declared by the Companys Board of Directors and paid totaling $5.2
million, or $0.80 per common share, respectively. These dividends equate to a dividend payout ratios of 37.89% for the same period. The Companys dividend payout ratio calculates the percentage of income paid to shareholders in the form of
dividends.



Long-Term Contractual
Obligations.    In addition to the contractual commitments and arrangements previously described, the Company enters into other contractual obligations in the ordinary course of business. The following table summarizes these
contractual obligations at December 31, 2010 (in thousands) except obligations for employee benefit plans as these obligations are paid from separately identified assets. See Item 8. Financial Statements and Supplementary Data, Note 14,
Employee Benefit Plans, for discussion regarding this employee benefit plan.



|                                          |  |                   |         |  |                            |   |         |                             |  |   |                |  |  |       |        |  |  |   |         | 
|----------------------------------------- |  | ----------------- | ------- |  | -------------------------- | - | ------- | --------------------------- |  | - | -------------- |  |  | ----- | ------ |  |  | - | ------- | 
|Other contractual obligations             |  | Less thanone year |         |  | Over onethrough threeyears |   |         | Over threethroughfive years |  |   | Over fiveyears |  |  | Total |       
|Real property operating lease obligations |  | $                 | 1,867   |  |                            | $ | 3,358   |                             |  | $ | 3,118          |  |  | $     | 12,740 |  |  | $ | 21,083  | 
|Time deposit accounts                     |  |                   | 367,673 |  |                            |   | 175,131 |                             |  |   | 3,801          |  |  |       | 34     |  |  |   | 546,639 | 
|FHLB advances                             |  |                   | 30,000  |  |                            |   | 5,000   |                             |  |   |               |  |  |       |       |  |  |   | 35,000  | 
|                                          |  |                   |         |  |                            |   |         |                             |  |   |                |  |  |       |        |  |  |   |         | 
|Total other contractual obligations       |  | $                 | 399,540 |  |                            | $ | 183,489 |                             |  | $ | 6,919          |  |  | $     | 12,774 |  |  | $ | 602,722 | 
|                                          |  |                   |         |  |                            |   |         |                             |  |   |                |  |  |       |        |  |  |   |         | 



In January 2011, we prepaid
$30.0 million of FHLB advances due in 2011.



Obligations under noncancelable real property operating lease agreements noted above are payable over several years with the longest
obligation expiring in 2029. Option periods that the Company has not yet exercised are not included in the preceding table.



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Real property operating lease obligations summarized in the preceding table:



| |  |  | Are net of payments to be received under a sublease agreement with a third party with regard to the Companys previous Blackstock Road banking
office for which we are contracted under a lease agreement as Lessee. This lease is scheduled to expire in February 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Include obligations with regard to one banking office that was consolidated during 2008 that is leased by the Company and currently vacant. Management
is considering options with regard to this leased location.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Do not include periodic increases in lease payments for the Rock Hill operating building lease and operating lease for additional office space. Lease
payment increases are subject to consumer price index changes. We do not believe that future minimum lease payments relative to these locations will significantly differ from current obligations at December 31, 2010. Therefore, current lease
obligations have been used to determine the operating lease obligations in the preceding table. Obligations under these operating lease agreements are payable over several years with the building lease expiring in 2015 and the additional office
space lease expiring in 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Do not include the parking leases in downtown Greenville which are paid month-to-month.
| | - |  | ---------------------------------------------------------------------------------------



We relocated our corporate headquarters to downtown
Greenville, South Carolina during March 2009 into a leased facility.



The Company enters into agreements with third parties with respect to the leasing, servicing, and maintenance of equipment. However, because we believe that these agreements are immaterial when considered
individually, or in the aggregate, with regard to our Consolidated Financial Statements, we have not included such agreements in the preceding contractual obligations table. Therefore, we believe that noncompliance with terms of such agreements
would not have a material impact on our business, financial condition, results of operations, and cash flows. Furthermore, as most such commitments are entered into for a 12-month period with option extensions, long-term obligations beyond 2011
cannot be reasonably estimated at this time.



Short-Term Contractual and Noncontractual Obligations.    In conjunction with our annual budgeting process,
capital expenditures are approved for the coming year. During the budgeting process for 2011, the Board of Directors approved $2.4 million in capital expenditures related to technology and facilities. Generally, purchase obligations are not made in
advance of such purchases, although to obtain discounted pricing we may enter into such arrangements. In addition, we anticipate that expenditures will be required during 2011 that could not have been expected and, therefore, were not approved in
the budgeting process. Funds to fulfill both budgeted and nonbudgeted commitments will come from our operational cash flows.



Although we expect to make capital expenditures in years subsequent to 2011, capital expenditures are reviewed on an annual basis.
Therefore, we have not yet estimated such capital expenditure obligations for years subsequent to 2011.



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Earnings Review



Overview



PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Income (Loss)

(dollars in thousands, except per share data)



|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|--------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ----------------------- | - | --------- | ---- |  | - | -------------- | - |  | --------------- | ------- | - |  |  | ------ | --
|                                                                |  | For the years ended December 31, |            |   | 2010 to 2009 comparison |  
|                                                                |  | 2010                             |            |   | 2009                    |   |           | 2008 |  |   | Dollarvariance |   |  | Percentvariance |        
|Interest income                                                 |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Interest earned on cash and cash equivalents                    |  | $                                | 498        |   |                         | $ | 215       |      |  | $ | 106            |   |  | $               | 283     |   |  |  | 131.6  | % 
|Dividends received on FHLB stock                                |  |                                  | 23         |   |                         |   | 19        |      |  |   | 189            |   |  |                 | 4       |   |  |  | 21.1   |   
|Interest earned on investment securities available for sale     |  |                                  | 3,725      |   |                         |   | 5,667     |      |  |   | 6,010          |   |  |                 | (1,942  | ) |  |  | (34.3  | ) 
|Interest and fees earned on loans                               |  |                                  | 52,381     |   |                         |   | 60,309    |      |  |   | 71,940         |   |  |                 | (7,928  | ) |  |  | (13.1  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Total interest income                                           |  |                                  | 56,627     |   |                         |   | 66,210    |      |  |   | 78,245         |   |  |                 | (9,583  | ) |  |  | (14.5  | ) 
|Interest expense                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Interest paid on deposits                                       |  |                                  | 13,560     |   |                         |   | 19,511    |      |  |   | 23,694         |   |  |                 | (5,951  | ) |  |  | (30.5  | ) 
|Interest paid on retail repurchase agreements                   |  |                                  | 57         |   |                         |   | 58        |      |  |   | 247            |   |  |                 | (1      | ) |  |  | (1.7   | ) 
|Interest paid on commercial paper                               |  |                                  | 21         |   |                         |   | 60        |      |  |   | 359            |   |  |                 | (39     | ) |  |  | (65.0  | ) 
|Interest paid on other short-term borrowings                    |  |                                  |           |   |                         |   | 33        |      |  |   | 301            |   |  |                 | (33     | ) |  |  | (100.0 | ) 
|Interest paid on FHLB borrowings                                |  |                                  | 1,708      |   |                         |   | 1,777     |      |  |   | 2,005          |   |  |                 | (69     | ) |  |  | (3.9   | ) 
|Interest paid on long-term borrowings                           |  |                                  | 20         |   |                         |   |          |      |  |   |               |   |  |                 | 20      |   |  |  | 100.0  |   
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Total interest expense                                          |  |                                  | 15,366     |   |                         |   | 21,439    |      |  |   | 26,606         |   |  |                 | (6,073  | ) |  |  | (28.3  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Net interest income                                             |  |                                  | 41,261     |   |                         |   | 44,771    |      |  |   | 51,639         |   |  |                 | (3,510  | ) |  |  | (7.8   | ) 
|Provision for loan losses                                       |  |                                  | 47,100     |   |                         |   | 73,400    |      |  |   | 5,619          |   |  |                 | (26,300 | ) |  |  | (35.8  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Net interest income (expense) after provision for loan losses   |  |                                  | (5,839     | ) |                         |   | (28,629   | )    |  |   | 46,020         |   |  |                 | 22,790  |   |  |  | (79.6  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Noninterest income                                              |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Service charges on deposit accounts, net                        |  |                                  | 7,543      |   |                         |   | 8,275     |      |  |   | 8,596          |   |  |                 | (732    | ) |  |  | (8.8   | ) 
|Fees for trust and investment management and brokerage services |  |                                  | 2,597      |   |                         |   | 2,275     |      |  |   | 2,996          |   |  |                 | 322     |   |  |  | 14.2   |   
|Mortgage-banking                                                |  |                                  | 1,794      |   |                         |   | 1,903     |      |  |   | 1,264          |   |  |                 | (109    | ) |  |  | (5.7   | ) 
|Automatic teller machine                                        |  |                                  | 1,300      |   |                         |   | 1,389     |      |  |   | 1,234          |   |  |                 | (89     | ) |  |  | (6.4   | ) 
|Merchant services                                               |  |                                  | 937        |   |                         |   | 1,079     |      |  |   | 1,129          |   |  |                 | (142    | ) |  |  | (13.2  | ) 
|Bankcard services                                               |  |                                  | 1,793      |   |                         |   | 658       |      |  |   | 724            |   |  |                 | 1,135   |   |  |  | 172.5  |   
|Investment securities gains                                     |  |                                  | 10         |   |                         |   | 2         |      |  |   | 1              |   |  |                 | 8       |   |  |  | 400.0  |   
|Other                                                           |  |                                  | 1,627      |   |                         |   | 1,850     |      |  |   | 2,073          |   |  |                 | (223    | ) |  |  | (12.1  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Total noninterest income                                        |  |                                  | 17,601     |   |                         |   | 17,431    |      |  |   | 18,017         |   |  |                 | (170    | ) |  |  | (1.0   | ) 
|Noninterest expense                                             |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Salaries and other personnel                                    |  |                                  | 24,677     |   |                         |   | 24,463    |      |  |   | 23,774         |   |  |                 | 214     |   |  |  | 0.9    |   
|Occupancy                                                       |  |                                  | 4,778      |   |                         |   | 4,293     |      |  |   | 3,293          |   |  |                 | 485     |   |  |  | 11.3   |   
|Furniture and equipment                                         |  |                                  | 3,841      |   |                         |   | 3,407     |      |  |   | 3,823          |   |  |                 | 434     |   |  |  | 12.7   |   
|Loss (gain) on disposition of premises and equipment            |  |                                  | 37         |   |                         |   | 81        |      |  |   | (2             | ) |  |                 | (44     | ) |  |  | (54.3  | ) 
|Professional services                                           |  |                                  | 2,507      |   |                         |   | 1,709     |      |  |   | 942            |   |  |                 | 798     |   |  |  | 46.7   |   
|FDIC deposit insurance assessment                               |  |                                  | 4,487      |   |                         |   | 3,261     |      |  |   | 786            |   |  |                 | 1,226   |   |  |  | 37.6   |   
|Marketing                                                       |  |                                  | 1,407      |   |                         |   | 1,114     |      |  |   | 1,576          |   |  |                 | 293     |   |  |  | 26.3   |   
|Foreclosed real estate writedowns and expenses                  |  |                                  | 11,656     |   |                         |   | 3,233     |      |  |   | 516            |   |  |                 | 8,423   |   |  |  | 260.5  |   
|Goodwill impairment                                             |  |                                  | 3,691      |   |                         |   |          |      |  |   |               |   |  |                 | 3,691   |   |  |  | 100.0  |   
|Loss on commercial loans held for sale                          |  |                                  | 7,562      |   |                         |   |          |      |  |   |               |   |  |                 | 7,562   |   |  |  | 100.0  |   
|Other                                                           |  |                                  | 8,663      |   |                         |   | 9,454     |      |  |   | 8,266          |   |  |                 | (791    | ) |  |  | (8.4   | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Total noninterest expense                                       |  |                                  | 73,306     |   |                         |   | 51,015    |      |  |   | 42,974         |   |  |                 | 22,291  |   |  |  | 43.7   |   
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Net income (loss) before provision (benefit) for income taxes   |  |                                  | (61,544    | ) |                         |   | (62,213   | )    |  |   | 21,063         |   |  |                 | 669     |   |  |  | (1.1   | ) 
|                                                                |  |                                  |            |   |                        
|Provision (benefit) for income taxes                            |  |                                  | (1,342     | ) |                         |   | (22,128   | )    |  |   | 7,464          |   |  |                 | 20,786  |   |  |  | (93.9  | ) 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Net income (loss)                                               |  | $                                | (60,202    | ) |                         | $ | (40,085   | )    |  | $ | 13,599         |   |  | $               | (20,117 | ) |  |  | 50.2   | % 
|                                                                |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|                                                                |  |                                  |            |   |                        
|Common and per share data                                       |  |                                  |            |   |                         |   |           |      |  |   |                |   |  |                 |         |   |  |  |        |   
|Net income (loss)basic                                         |  | $                                | (3.78      | ) |                         | $ | (6.21     | )    |  | $ | 2.11           |   |  | $               | 2.43    |   |  |  | (39.1  | )%
|Net income (loss)diluted                                       |  |                                  | (3.78      | ) |                         |   | (6.21     | )    |  |   | 2.09           |   |  | $               | 2.43    |   |  |  | (39.1  | ) 
|Cash dividends                                                  |  |                                  |           |   |                         |   | 0.06      |      |  |   | 0.80           |   |  | $               | (0.06   | ) |  |  | (100.0 | ) 
|Book value                                                      |  |                                  | 2.40       |   |                         |   | 11.55     |      |  |   | 17.96          |   |  | $               | (9.15   | ) |  |  | (79.2  | ) 
|                                                                |  |                                  |            |   |                        
|Weighted average common shares outstandingbasic                |  |                                  | 15,913,000 |   |                         |   | 6,449,754 |      |  |   | 6,438,071      |   |  |                 |         |   |  |  |        |   
|Weighted average common shares outstandingdiluted              |  |                                  | 15,913,000 |   |                         |   | 6,449,754 |      |  |   | 6,519,849      |   |  |                 |         |   |  |  |        |   



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Summary



Historically, our earnings were driven primarily by a high
net interest margin which allowed for a higher expense base related primarily to personnel and facilities. However, given the narrowing of our net interest margin due to the reduction of 500 to 525 basis points in interest rates by the Federal
Reserve in 2007 and 2008, we have become much more focused on increasing our noninterest income and managing expenses. In addition, we are realigning our lending focus to originate higher yielding loan portfolio segments with lower historical loss
rates. To accelerate efforts to improve our earnings, we also engaged external strategic consulting firms in 2010 which specialize in assessment of banking products and services, revenue enhancements, and efficiency reviews.



One of the components of our Strategic Project Plan is an
earnings plan that is focused on earnings improvement through a combination of revenue increases and expense reductions. In summary, to date:



| |  |  | With respect to net interest income, we have implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain
criteria. At December 31, 2010, loans aggregating $214.6 million had interest rate floors, of which $196.1 million had floors greater than or equal to 5%. In June and July 2010, we began loan specials intended to generate additional loan volume
for residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest rates,
during 2010 we borrowed longer-term advances from the FHLB and extended maturities on certain CD specials to lock in the current low interest rates. In December 2010 and January 2011, we used excess cash earning 0.25 basis points to prepay $91.0
million of FHLB advances bearing interest at an average rate of 1.58%.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regarding noninterest income, we are evaluating other noninterest sources of income. For example, in March 2010, we introduced a new checking account,
MyPal checking, and a new savings account, Smart Savings, both of which provide noninterest income resulting from service charges or debit card transactions. We evaluated the profitability of all of our pre-existing checking accounts and in October
2010 upgraded a large number of unprofitable checking accounts to the MyPal account. We also revised our existing fees and implemented new fees, with various implementation dates generally between October 1, 2010 and March 31, 2011.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regarding noninterest expenses, we identified specific noninterest expense reductions realized in 2009 and 2010 and are continuing to review other
expense areas for additional reductions. These expense reductions have been and will be partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming
assets.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We continue to critically evaluate each of our businesses to determine their contribution to our financial performance and their relative risk / return
relationship. Based on the evaluation to date, we sold two product lines during 2010. In March 2010, we sold our merchant services product line and entered into a referral and services agreement with Global Direct which resulted in a net gain of
$587 thousand. Similarly, in December 2010 we sold our credit card portfolio and entered into a joint marketing agreement with Elan Financial Services, Inc., resulting in a net gain of $1.2 million.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We are continuing our keen focus on improving credit quality
and earnings. Overall, with the completion of the Private Placement in October 2010, we are in the process of repositioning the balance sheet as part of our balance sheet management efforts to utilize our excess cash more effectively to improve our
net interest margin. This includes investing in higher yielding investment securities until loan growth resumes, as well as paying down higher priced funding such as FHLB advances and maturing CDs. We are also continuing to adapt our organizational
structure to fit the current and future size and scope of our business activities and operations. Such efforts include hiring management personnel with specialized industry experience, more specifically delineating our businesses, and preparing
go to market strategies with relevant products and services and marketing plans by business.



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Net Interest Income



General.    Net interest income is the difference between interest income earned on
interest-earning assets, primarily loans and investment securities, and interest expense paid on interest-bearing deposits and other interest-bearing liabilities. This measure represents the largest component of income for us. The net interest
margin measures how effectively we manage the difference between the interest income earned on interest-earning assets and the interest expense paid for funds to support those assets. Changes in interest rates earned on interest-earning assets and
interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities base, the ratio of interest-earning assets to interest-bearing liabilities, and the management of interest rate
sensitivity factor into fluctuations within net interest income.



During the second half of 2008 and continuing in 2009 and 2010, the financial markets experienced significant volatility resulting from the continued fallout of subprime lending and the global liquidity
crisis. A multitude of government initiatives along with interest rate cuts by the Federal Reserve have been designed to improve liquidity for the distressed financial markets and stabilize the banking system. The relationship between declining
interest-earning asset yields and more slowly declining interest-bearing liability costs has caused, and may continue to cause, net interest margin compression. Net interest margin compression may also continue to be impacted by continued
deterioration of assets resulting in further interest income adjustments.



Net interest income totaled $41.3 million for the year ended December 31, 2010 compared with $44.8 million for the year ended December 31, 2009. Overall, interest income in 2010 was negatively
impacted by the following:



| |  |  | Reduction in interest rates by the Federal Reserve by 500 to 525 basis points throughout 2007 and 2008. In response, taking into consideration the
yields earned and rates paid, we have refined the type of loan and deposit products we prefer to pursue and are exercising more discipline in our loan and deposit interest rate levels. We have also implemented interest rate floors on loans. At
December 31, 2010, loans aggregating $214.6 million had interest rate floors, of which $196.1 million had floors greater than or equal to 5%.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Higher level of loans placed in nonaccrual status during the period; foregone interest on nonaccrual loans for the year ended December 31, 2010
totaled $4.3 million.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in other earning assets.
Maintaining this cash balance has reduced our interest income by $4.7 million for the year ended December 31, 2010 when compared with investing these funds at the average yield of 2.75% on our investment securities, since we are retaining a
higher level of cash instead of reinvesting this cash in higher yielding assets. Given the consummation of our Private Placement on October 7, 2010, we have begun redeploying this cash balance into investment securities and also prepaid $91
million of FHLB advances in December 2010 and January 2011 scheduled to mature in January through April 2011.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reduction of $246.9 million in the loan portfolio, including the net transfer of $82.9 million commercial real estate loans to the held for sale
portfolio in 2010.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



Average
Balance Sheets and Net Interest Income/Margin Analysis.    The following table summarizes our average balance sheets and net interest income / margin analysis for the periods indicated (dollars in thousands). Our interest
yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities,
respectively. The following table does not include a tax-equivalent adjustment to net interest income for interest-earning assets earning tax-exempt income to a comparable yield on a taxable basis.



103



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|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|-------------------------------------------------------- |  | -------------------------------- | --------- | - | -------------- | - | ------ | ---------- |  |  | -------------- | - |  | -------------- | --------- | - | ---------- | - | ------ | -------------- |  |  | -------------- | - |  | ---------- | --------- | - |  | - | ------ |  |  |  | ---- | -
|                                                         |  | For the years ended December 31, |          
|                                                         |  | 2010                             |           |   | 2009           |   |        | 2008       | 
|                                                         |  | Averagebalance                   |           |   | Income/expense |   |        | Yield/rate |  |  | Averagebalance |   |  | Income/expense |           |   | Yield/rate |   |        | Averagebalance |  |  | Income/expense |   |  | Yield/rate |          
|Assets                                                   |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Interest-earnings assets                                 |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Cash and cash equivalents                                |  | $                                | 215,482   |   |                | $ | 498    |            |  |  | 0.23           | % |  | $              | 96,546    |   |            | $ | 215    |                |  |  | 0.22           | % |  | $          | 9,365     |   |  | $ | 106    |  |  |  | 1.13 | %
|FHLB stock                                               |  |                                  | 6,908     |   |                |   | 23     |            |  |  | 0.33           |   |  |                | 6,363     |   |            |   | 19     |                |  |  | 0.30           |   |  |            | 5,640     |   |  |   | 189    |  |  |  | 3.35 |  
|Investment securities available for sale, taxable (1)    |  |                                  | 91,338    |   |                |   | 2,251  |            |  |  | 2.46           |   |  |                | 70,693    |   |            |   | 4,027  |                |  |  | 5.70           |   |  |            | 71,778    |   |  |   | 4,204  |  |  |  | 5.86 |  
|Investment securities available for sale, nontaxable (1) |  |                                  | 44,041    |   |                |   | 1,474  |            |  |  | 3.35           |   |  |                | 48,545    |   |            |   | 1,640  |                |  |  | 3.38           |   |  |            | 51,773    |   |  |   | 1,806  |  |  |  | 3.49 |  
|Loans (2)                                                |  |                                  | 967,882   |   |                |   | 52,381 |            |  |  | 5.41           |   |  |                | 1,130,809 |   |            |   | 60,309 |                |  |  | 5.33           |   |  |            | 1,111,436 |   |  |   | 71,940 |  |  |  | 6.47 |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total interest-earning assets                            |  |                                  | 1,325,651 |   |                |   | 56,627 |            |  |  | 4.27           |   |  |                | 1,352,956 |   |            |   | 66,210 |                |  |  | 4.89           |   |  |            | 1,249,992 |   |  |   | 78,245 |  |  |  | 6.26 |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Noninterest-earning assets                               |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Cash and cash equivalents                                |  |                                  | 11,438    |   |                |   |        |            |  |  |                |   |  |                | 23,022    |   |            |   |        |                |  |  |                |   |  |            | 25,915    |   |  |   |        |  |  |  |      |  
|Allowance for loan losses                                |  |                                  | (25,818   | ) |                |   |        |            |  |  |                |   |  |                | (16,831   | ) |            |   |        |                |  |  |                |   |  |            | (7,611    | ) |  |   |        |  |  |  |      |  
|Premises and equipment, net                              |  |                                  | 29,217    |   |                |   |        |            |  |  |                |   |  |                | 28,931    |   |            |   |        |                |  |  |                |   |  |            | 24,704    |   |  |   |        |  |  |  |      |  
|Goodwill                                                 |  |                                  | 2,749     |   |                |   |        |            |  |  |                |   |  |                | 3,688     |   |            |   |        |                |  |  |                |   |  |            | 3,688     |   |  |   |        |  |  |  |      |  
|Accrued interest receivable                              |  |                                  | 4,223     |   |                |   |        |            |  |  |                |   |  |                | 4,934     |   |            |   |        |                |  |  |                |   |  |            | 6,012     |   |  |   |        |  |  |  |      |  
|Real estate acquired in settlement of loans              |  |                                  | 25,952    |   |                |   |        |            |  |  |                |   |  |                | 14,887    |   |            |   |        |                |  |  |                |   |  |            | 7,563     |   |  |   |        |  |  |  |      |  
|Income tax refund receivable                             |  |                                  | 7,231     |   |                |   |        |            |  |  |                |   |  |                | 57        |   |            |   |        |                |  |  |                |   |  |            |          |   |  |   |        |  |  |  |      |  
|Deferred tax asset, net                                  |  |                                  | 8,761     |   |                |   |        |            |  |  |                |   |  |                | 7,677     |   |            |   |        |                |  |  |                |   |  |            |          |   |  |   |        |  |  |  |      |  
|Other                                                    |  |                                  | 10,188    |   |                |   |        |            |  |  |                |   |  |                | 9,402     |   |            |   |        |                |  |  |                |   |  |            | 11,460    |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total noninterest-earning assets                         |  |                                  | 73,941    |   |                |   |        |            |  |  |                |   |  |                | 75,767    |   |            |   |        |                |  |  |                |   |  |            | 71,731    |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total assets                                             |  | $                                | 1,399,592 |   |                |   |        |            |  |  |                |   |  | $              | 1,428,723 |   |            |   |        |                |  |  |                |   |  | $          | 1,321,723 |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Liabilities and Shareholders Equity                     |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Liabilities                                              |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Interest-bearing liabilities                             |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Transaction deposit accounts                             |  | $                                | 292,696   |   |                | $ | 248    |            |  |  | 0.08           | % |  | $              | 323,613   |   |            | $ | 526    |                |  |  | 0.16           | % |  | $          | 374,382   |   |  | $ | 4,966  |  |  |  | 1.33 | %
|Money market deposit accounts                            |  |                                  | 137,955   |   |                |   | 622    |            |  |  | 0.45           |   |  |                | 108,566   |   |            |   | 602    |                |  |  | 0.55           |   |  |            | 105,834   |   |  |   | 1,922  |  |  |  | 1.82 |  
|Savings deposit accounts                                 |  |                                  | 46,112    |   |                |   | 124    |            |  |  | 0.27           |   |  |                | 40,871    |   |            |   | 132    |                |  |  | 0.32           |   |  |            | 37,692    |   |  |   | 129    |  |  |  | 0.34 |  
|Time deposit accounts                                    |  |                                  | 552,854   |   |                |   | 12,566 |            |  |  | 2.27           |   |  |                | 578,026   |   |            |   | 18,251 |                |  |  | 3.16           |   |  |            | 400,516   |   |  |   | 16,677 |  |  |  | 4.16 |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total interest-bearing deposits                          |  |                                  | 1,029,617 |   |                |   | 13,560 |            |  |  | 1.32           |   |  |                | 1,051,076 |   |            |   | 19,511 |                |  |  | 1.86           |   |  |            | 918,424   |   |  |   | 23,694 |  |  |  | 2.58 |  
|Retail repurchase agreements                             |  |                                  | 22,809    |   |                |   | 57     |            |  |  | 0.25           |   |  |                | 23,227    |   |            |   | 58     |                |  |  | 0.25           |   |  |            | 18,063    |   |  |   | 247    |  |  |  | 1.37 |  
|Commercial paper (Master notes)                          |  |                                  | 8,435     |   |                |   | 21     |            |  |  | 0.25           |   |  |                | 24,085    |   |            |   | 60     |                |  |  | 0.25           |   |  |            | 32,415    |   |  |   | 359    |  |  |  | 1.11 |  
|Other short-term borrowings                              |  |                                  | 1         |   |                |   |       |            |  |  |               |   |  |                | 5,335     |   |            |   | 33     |                |  |  | 0.62           |   |  |            | 13,240    |   |  |   | 301    |  |  |  | 2.27 |  
|FHLB borrowings                                          |  |                                  | 95,231    |   |                |   | 1,708  |            |  |  | 1.79           |   |  |                | 78,166    |   |            |   | 1,777  |                |  |  | 2.27           |   |  |            | 76,718    |   |  |   | 2,005  |  |  |  | 2.61 |  
|Convertible debt                                         |  |                                  | 199       |   |                |   | 20     |            |  |  | 10.06          |   |  |                |          |   |            |   |       |                |  |  |               |   |  |            |          |   |  |   |       |  |  |  |     |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total interest-bearing liabilities                       |  |                                  | 1,156,292 |   |                |   | 15,366 |            |  |  | 1.33           |   |  |                | 1,181,889 |   |            |   | 21,439 |                |  |  | 1.81           |   |  |            | 1,058,860 |   |  |   | 26,606 |  |  |  | 2.51 |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Noninterest-bearing deposits                             |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Noninterest-bearing deposits                             |  |                                  | 143,974   |   |                |   |        |            |  |  |                |   |  |                | 134,138   |   |            |   |        |                |  |  |                |   |  |            | 138,373   |   |  |   |        |  |  |  |      |  
|Accrued interest payable                                 |  |                                  | 1,588     |   |                |   |        |            |  |  |                |   |  |                | 2,209     |   |            |   |        |                |  |  |                |   |  |            | 2,301     |   |  |   |        |  |  |  |      |  
|Other                                                    |  |                                  | 10,275    |   |                |   |        |            |  |  |                |   |  |                | 3,581     |   |            |   |        |                |  |  |                |   |  |            | 5,967     |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total noninterest-bearing liabilities                    |  |                                  | 155,837   |   |                |   |        |            |  |  |                |   |  |                | 139,928   |   |            |   |        |                |  |  |                |   |  |            | 146,641   |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total liabilities                                        |  |                                  | 1,312,129 |   |                |   |        |            |  |  |                |   |  |                | 1,321,817 |   |            |   |        |                |  |  |                |   |  |            | 1,205,501 |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Shareholders equity                                     |  |                                  | 87,463    |   |                |   |        |            |  |  |                |   |  |                | 106,906   |   |            |   |        |                |  |  |                |   |  |            | 116,222   |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|Total liabilities and shareholders equity               |  | $                                | 1,399,592 |   |                |   |        |            |  |  |                |   |  | $              | 1,428,723 |   |            |   |        |                |  |  |                |   |  | $          | 1,321,723 |   |  |   |        |  |  |  |      |  
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  
|NET INTEREST INCOME/NET YIELD ON INTEREST-EARNING ASSETS |  |                                  |           |   |                | $ | 41,261 |            |  |  | 3.11           | % |  |                |           |   |            | $ | 44,771 |                |  |  | 3.31           | % |  |            |           |   |  | $ | 51,639 |  |  |  | 4.13 | %
|                                                         |  |                                  |           |   |                |   |        |            |  |  |                |   |  |                |           |   |            |   |        |                |  |  |                |   |  |            |           |   |  |   |        |  |  |  |      |  



|(1) |  | The average balances for investment securities include the applicable unrealized gain or loss recorded for available for sale securities.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Calculated including mortgage and commercial loans held for sale, excluding the allowance for loan losses. Nonaccrual loans are included in average balances for yield
computations. The impact of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis. All loans and deposits are domestic.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Federal Reserve Rate Influences.    The Federal Reserve
influences the general market rates of interest earned on interest-earning assets and interest paid on interest-bearing liabilities. However, there have been no changes by the Federal Reserve with regard to the federal funds interest rate from
December 31, 2008 through December 31, 2010.



Rate/Volume Analysis.    The following rate/volume analysis summarizes the dollar amount of changes in interest income and interest expense attributable to changes in volume and
the amount attributable to changes in rate when comparing the periods indicated (in thousands). The impact of the combination of rate and volume change has been divided proportionately between the rate change and volume change.



|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|---------------------------------------- |  | -------------------------------------------------------------------------------- | ------ | - | ------------- | - | ------ | ----------- |  | - | ------ | -
|                                         |  | For the year endedDecember 31,
2010 comparedwith the year endedDecember 31, 2009 |       
|                                         |  | Change involume                                                                  |        |   | Changein rate |   |        | Totalchange | 
|Assets                                   |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Interest-earnings assets                 |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Cash and cash equivalents                |  | $                                                                                | 275    |   |               | $ | 8      |             |  | $ | 283    |  
|FHLB stock                               |  |                                                                                  | 2      |   |               |   | 2      |             |  |   | 4      |  
|Investment securities available for sale |  |                                                                                  | 920    |   |               |   | (2,862 | )           |  |   | (1,942 | )
|Loans                                    |  |                                                                                  | (8,832 | ) |               |   | 904    |             |  |   | (7,928 | )
|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Total interest income                    |  | $                                                                                | (7,635 | ) |               | $ | (1,948 | )           |  | $ | (9,583 | )
|Liabilities and Shareholders Equity     |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Interest-bearing liabilities             |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Transaction deposit accounts             |  | $                                                                                | (46    | ) |               | $ | (232   | )           |  | $ | (278   | )
|Money market deposit accounts            |  |                                                                                  | 65     |   |               |   | (45    | )           |  |   | 20     |  
|Savings deposit accounts                 |  |                                                                                  | 27     |   |               |   | (35    | )           |  |   | (8     | )
|Time deposit accounts                    |  |                                                                                  | (765   | ) |               |   | (4,920 | )           |  |   | (5,685 | )
|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Total interest paid on deposits          |  |                                                                                  | (719   | ) |               |   | (5,232 | )           |  |   | (5,951 | )
|                                         |  |                                                                                  |       
|Retail repurchase agreements             |  |                                                                                  | (1     | ) |               |   |       |             |  |   | (1     | )
|Commercial paper                         |  |                                                                                  | (39    | ) |               |   |       |             |  |   | (39    | )
|Other short-term borrowings              |  |                                                                                  | (16    | ) |               |   | (17    | )           |  |   | (33    | )
|FHLB borrowings                          |  |                                                                                  | (2,059 | ) |               |   | 1,990  |             |  |   | (69    | )
|Convertible debt                         |  |                                                                                  | 20     |   |               |   |       |             |  |   | 20     |  
|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Total interest expense                   |  | $                                                                                | (2,814 | ) |               | $ | (3,259 | )           |  | $ | (6,073 | )
|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  
|Net interest income                      |  | $                                                                                | (4,821 | ) |               | $ | 1,311  |             |  | $ | (3,510 | )
|                                         |  |                                                                                  |        |   |               |   |        |             |  |   |        |  



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Absent the significant impact of nonaccrual loans during 2010, the change in loans due
to volume and the change due to rate for the year ended December 31, 2010 compared with the year ended December 31, 2009 was ($10.6) million and $2.7 million, respectively.



|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|---------------------------------------- |  | -------------------------------------------------------------------------------- | ------ | - | ------------- | - | ------- | ----------- |  | - | ------- | -
|                                         |  | For the year endedDecember 31,
2009 comparedwith the year endedDecember 31, 2008 |       
|                                         |  | Change involume                                                                  |        |   | Change inrate |   |         | Totalchange | 
|Assets                                   |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Interest-earnings assets                 |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Cash and cash equivalents                |  | $                                                                                | 119    |   |               | $ | (10     | )           |  | $ | 109     |  
|FHLB stock                               |  |                                                                                  | 28     |   |               |   | (198    | )           |  |   | (170    | )
|Investment securities available for sale |  |                                                                                  | (207   | ) |               |   | (136    | )           |  |   | (343    | )
|Loans                                    |  |                                                                                  | 1,278  |   |               |   | (12,909 | )           |  |   | (11,631 | )
|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Total interest income                    |  | $                                                                                | 1,218  |   |               | $ | (13,253 | )           |  | $ | (12,035 | )
|Liabilities and Shareholders Equity     |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Interest-bearing liabilities             |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Transaction deposit accounts             |  | $                                                                                | (594   | ) |               | $ | (3,846  | )           |  | $ | (4,440  | )
|Money market deposit accounts            |  |                                                                                  | 51     |   |               |   | (1,371  | )           |  |   | (1,320  | )
|Savings deposit accounts                 |  |                                                                                  | 8      |   |               |   | (5      | )           |  |   | 3       |  
|Time deposit accounts                    |  |                                                                                  | 3,462  |   |               |   | (1,888  | )           |  |   | 1,574   |  
|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Total interest paid on deposits          |  |                                                                                  | 2,927  |   |               |   | (7,110  | )           |  |   | (4,183  | )
|                                         |  |                                                                                  |       
|Retail repurchase agreements             |  |                                                                                  | 102    |   |               |   | (291    | )           |  |   | (189    | )
|Commercial paper                         |  |                                                                                  | (74    | ) |               |   | (225    | )           |  |   | (299    | )
|Other short-term borrowings              |  |                                                                                  | (121   | ) |               |   | (147    | )           |  |   | (268    | )
|FHLB borrowings                          |  |                                                                                  | 39     |   |               |   | (267    | )           |  |   | (228    | )
|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Total interest expense                   |  | $                                                                                | 2,873  |   |               | $ | (8,040  | )           |  | $ | (5,167  | )
|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  
|Net interest income                      |  | $                                                                                | (1,655 | ) |               | $ | (5,213  | )           |  | $ | (6,868  | )
|                                         |  |                                                                                  |        |   |               |   |         |             |  |   |         |  



Absent the significant impact of
nonaccrual loans during 2009, the change in loans due to volume and the change due to rate for the year ended December 31, 2009 compared with the year ended December 31, 2008 was ($3.0) million and ($8.6) million,
respectively.



Provision for Loan Losses



Provision for loan losses decreased from
$73.4 million during the year ended December 31, 2009 to $47.1 million for the year ended December 31, 2010. The decrease was due primarily to declining charge-offs during 2010. See also Financial ConditionLending Activities,
included elsewhere in this item, for discussion regarding our accounting policies related to, factors impacting, and methodology for analyzing the adequacy of our allowance for loan losses and, therefore, our provision for loan losses.



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Noninterest Income



General.    The following table summarizes the components of noninterest income for
the periods indicated (in thousands).



|                                                                |  |                                 |        |  |      |   |        |      |  |   |        | 
|--------------------------------------------------------------- |  | ------------------------------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | 
|                                                                |  | For the years
endedDecember 31, |       
|                                                                |  | 2010                            |        |  | 2009 |   |        | 2008 | 
|Service charges on deposit accounts, net                        |  | $                               | 7,543  |  |      | $ | 8,275  |      |  | $ | 8,596  | 
|Fees for trust and investment management and brokerage services |  |                                 | 2,597  |  |      |   | 2,275  |      |  |   | 2,996  | 
|Mortgage-banking                                                |  |                                 | 1,794  |  |      |   | 1,903  |      |  |   | 1,264  | 
|Automatic teller machine                                        |  |                                 | 1,300  |  |      |   | 1,389  |      |  |   | 1,234  | 
|Merchant services                                               |  |                                 | 937    |  |      |   | 1,079  |      |  |   | 1,129  | 
|Bankcard services                                               |  |                                 | 1,793  |  |      |   | 658    |      |  |   | 724    | 
|Investments securities gains                                    |  |                                 | 10     |  |      |   | 2      |      |  |   | 1      | 
|Other                                                           |  |                                 | 1,627  |  |      |   | 1,850  |      |  |   | 2,073  | 
|                                                                |  |                                 |        |  |      |   |        |      |  |   |        | 
|Total noninterest income                                        |  | $                               | 17,601 |  |      | $ | 17,431 |      |  | $ | 18,017 | 
|                                                                |  |                                 |        |  |      |   |        |      |  |   |        | 



Service Charges on Deposit
Accounts, Net.    Net service charges on deposit accounts comprise a significant component of noninterest income totaling 1.7% of average transaction deposit accounts for the year ended December 31, 2010 compared with
1.8% of average transaction deposit accounts for the year ended December 31, 2009. The decrease in service charges on deposit accounts is attributed to a decrease in overdraft fees resulting from a $100 free overdraft limit included with the
new MyPal account that we began offering in March 2010, a change in customer behavior from their increased awareness of overdraft fees such that the number of transactions that would otherwise result in overdrafts has been reduced, and the customers
with historical overdraft transactions who did not opt-in to overdraft protection in accordance with Regulation E.



In response to competition to retain deposits, institutions in the financial services industry have increasingly been providing services
for free in an effort to lure deposits away from competitors and retain existing balances. Services that were initially developed as fee income opportunities, such as Internet banking and bill payment service, are now provided to customers free of
charge. Consequently, opportunities to earn additional income from service charges for such services have been more limited. In addition, recent focus on the level of deposit service charges within the banking industry by the media and the U.S.
Government may result in future legislation limiting the amount and type of services charges within the banking industry.



The November 2009 amendment to Regulation E of the Electronic Fund Transfer Act, which was effective July 1, 2010 for new customers
and August 15, 2010 for existing customers, prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions unless a consumer consents to the overdraft service
for those types of transactions. Some industry experts estimated that the impact of the change from Regulation E would result in a reduction of 30% to 40% of such overdraft fees. To continue to have overdraft services available to those customers
who desired to have this service, we were proactive in encouraging our deposit customers to opt-in to overdraft protection; however, not all of our customers who have previously utilized overdraft features have opted-in to overdraft protection. In
addition, in December 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would
result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community
banks, which could be pressured by the marketplace to lower their own interchange rates. We are still evaluating the guidance and at this time we do not yet know if the guidance and the implementation of Regulation E will result in a sustained
reduction in our services charges.



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Fees for Trust and Investment Management and Brokerage
Services.    The following table summarizes the composition of fees for trust and investment management and brokerage services for the periods indicated (in thousands).



|                                                                      |  |                                 |       |  |      |   |       |      |  |   |       | 
|--------------------------------------------------------------------- |  | ------------------------------- | ----- |  | ---- | - | ----- | ---- |  | - | ----- | 
|                                                                      |  | For the years endedDecember 31, |      
|                                                                      |  | 2010                            |       |  | 2009 |   |       | 2008 | 
|Fees for trust and investment management services                     |  | $                               | 1,967 |  |      | $ | 1,764 |      |  | $ | 2,311 | 
|Fees for brokerage services                                           |  |                                 | 630   |  |      |   | 511   |      |  |   | 685   | 
|                                                                      |  |                                 |       |  |      |   |       |      |  |   |       | 
|Total fees for trust and investment management and brokerage services |  | $                               | 2,597 |  |      | $ | 2,275 |      |  | $ | 2,996 | 
|                                                                      |  |                                 |       |  |      |   |       |      |  |   |       | 



Fees for trust and investment
management and brokerage services for 2010 increased $322 thousand (14.2%) to $2.6 million from $2.3 million for 2009, primarily as a result of the overall increase in the average market values of securities held in trust accounts upon which
trust fees are calculated. Fees for brokerage services are primarily transaction-based. As such, the increase in these fees was primarily due to the increase in brokerage transaction activity over the periods presented.



In October 2010, we refined our organizational structure and
designated one of our most senior members of executive management with the role of expanding the Banks existing trust, investments and insurance division into a comprehensive wealth management business. We believe providing broader wealth
management services to our customers, including private banking and investment management, is critical to obtaining market growth. We will be evaluating our overall strategy, platform and resources over the next few months, and expect the expansion
into wealth management to occur in 2011.



Mortgage-Banking.    Most of the residential mortgage loans that we originate are sold in the secondary market.
Normally we retain the servicing rights to maintain the customer relationships related to servicing the loans. Mortgage loans serviced for the benefit of others amounted to $423.6 million and $426.6 million at December 31, 2010 and
December 31, 2009, respectively, and are not included in our Consolidated Balance Sheets.



The following table summarizes the components of mortgage-banking income for the periods indicated (dollars in thousands).



|                                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ------ | ---- |  | - | ----- | -
|                                                                                                     |  | For the years endedDecember 31, |      
|                                                                                                     |  | 2010                            |       |   | 2009 |   |        | 2008 | 
|Mortgage-servicing fees                                                                              |  | $                               | 1,069 |   |      | $ | 978    |      |  | $ | 904   |  
|Gain on sale of mortgage loans held for sale                                                         |  |                                 | 1,256 |   |      |   | 1,728  |      |  |   | 994   |  
|Mortgage-servicing rights portfolio amortization and impairment                                      |  |                                 | (798  | ) |      |   | (1,271 | )    |  |   | (881  | )
|Derivative loan commitment income                                                                    |  |                                 | 22    |   |      |   | 41     |      |  |   |      |  
|Forward sales commitment income (loss)                                                               |  |                                 | (12   | ) |      |   | 91     |      |  |   |      |  
|Other                                                                                                |  |                                 | 257   |   |      |   | 336    |      |  |   | 247   |  
|                                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  
|Total mortgage-banking income                                                                        |  | $                               | 1,794 |   |      | $ | 1,903  |      |  | $ | 1,264 |  
|                                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  
|Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others |  |                                 | 0.25  | % |      |   | 0.24   | %    |  |   | 0.25  | %



Mortgage-banking income decreased $109 thousand (5.7%) from December 31, 2009 to December 31, 2010. Gains on sales of mortgage loans declined approximately $472 thousand (27.3%) while
the expense associated with amortization and impairment of mortgage-servicing rights decreased $473 thousand (37.2%) from the year ended December 31, 2009 to the year ended December 31, 2010. During 2007 and 2008,



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the Federal Reserve decreased rates by 500 to 525 basis points. During 2009, this decline in interest rates resulted in an increase in new loan volume and existing loan prepayments and,
therefore, increased gains on sales and amortization within the mortgage-servicing rights portfolio. Loan sales and loan prepayments were significantly lower in 2010 both because many of those borrowers who were able to refinance had already done so
and because mortgage rates increased during the fourth quarter 2010. Offsetting this change, derivative loan commitment income and forward sales commitment income decreased $122 thousand over the same periods. Derivative loan commitment income and
forward sales commitment income fluctuates based on the change in interest rates between the time we entered into the commitment to originate / sell the loans and the valuation date. In January 2011, we began a review of our mortgage origination and
servicing business with the assistance of a third party consultant to identify opportunities to improve the profitability of this business.



Automatic Teller Machine.    Automatic teller machine income decreased $89 thousand (6.4%) from
December 31, 2009 to December 31, 2010. The decrease was consistent with a decrease of one automatic teller machine in 2010 and our revised deposit product related fees implemented throughout 2010.



Merchant Services.    Merchant
services income decreased $142 thousand (13.2%) from December 31, 2009 to December 31, 2010. As previously described in the Executive Summary of 2010 Financial Results, Strategic Project Plan, we are critically evaluating each of our
product lines to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation to date, on March 31, 2010 we sold this product line and entered into a referral and services
agreement with Global Direct related to our merchant services business which resulted in a gross payment to the Company of $786 thousand, which is included in Merchant services income in the amount of $587 thousand, net of transaction fees, for the
year ended December 31, 2010. Under the agreement, Global Direct will provide services including merchant sales through a dedicated sales person, marketing and advertising within our geographic footprint, credit review and approval and
activating new merchant accounts, equipment sales and customer service, transaction authorization service, risk mitigation services, and compliance with applicable laws and card association and payment network rules. Under the terms of the
agreement, we now receive referral income when we refer customers that are accepted by Global Direct and a percentage of the ongoing revenues related to merchant services accounts sold to Global Direct.



Bankcard Services.    In
connection with our on-going strategic review of our business, we sold our credit card portfolio and entered into a joint marketing agreement in December 2010 with Elan Financial Services, Inc., resulting in a net gain of $1.2 million, included
within this financial statement item. We also entered into an interim servicing agreement to cover the period through the date the accounts are transferred to the third partys system, a period expected not to exceed eight months. In connection
with the interim servicing agreement, we will receive a set servicing fee per active account per month for providing servicing related functions such as payment processing, collections, customer service and billing. Based on the structure of the
interim servicing agreement, the servicing fee to be received is considered adequate compensation for the services to be performed and, therefore, no servicing asset or liability was recognized in connection with the sale.



Other.    Other noninterest income
decreased $223 thousand (12.1%) from the year ended December 31, 2009 to December 31, 2010. The decrease was primarily due to the cost of new deposit product incentives which are recorded as an offset to the associated fee income
within this financial statement line item.



Noninterest Expense



General.    The earnings component of our Strategic Project Plan includes keen focus on expense management. As
part of our earnings plan to improve our overall financial performance, we identified specific noninterest expense reductions realized in 2009 and 2010 and are continuing to review other expense areas for additional reductions. Examples include:



| |  |  | Freezing most employee salaries effective May 1, 2009 and eliminating the remaining officer cash incentive plan awards under the corporate
incentive plan for 2009
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Reducing our Saturday banking hours from 2:00 p.m. to noon in September 2009 and converting some branch office hours on Saturdays to drive thru only in
October 2010
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing marketing expenses and corporate contributions to not-for-profit organizations
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Reducing officer perquisites, including elimination in 2010 of all bank-owned automobiles, reduction in coverage for annual physical examinations,
elimination in 2010 of Company paid life insurance premiums for certain officers, and termination of officer participation in the Supplemental Executive Retirement Plan.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



With the assistance from a third party consulting firm, we also reviewed our Retail Banking network in March
through June 2010 and are implementing process improvements and other recommendations that we believe will result in reduced expenses. In September 2010 through January 2011, with assistance from the same consulting firm, we performed a
comprehensive review of our lending process that we believe will similarly result in efficiency improvements and cost savings. Savings have also been realized resulting from more fully leveraging existing technology, implementing more advanced
technology, and other process improvements. These expense reductions are partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming assets. We
continue to review other expense areas for additional reduction opportunities.



The following table summarizes the components of noninterest expense for the periods indicated (in thousands).



|                                                     |  |                                  |        |  |      |   |        |      |  |   |        |  
|---------------------------------------------------- |  | -------------------------------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | -
|                                                     |  | For the years ended December 31, |       
|                                                     |  | 2010                             |        |  | 2009 |   |        | 2008 | 
|Salaries and other personnel                         |  | $                                | 24,677 |  |      | $ | 24,463 |      |  | $ | 23,774 |  
|Occupancy                                            |  |                                  | 4,778  |  |      |   | 4,293  |      |  |   | 3,293  |  
|Furniture and equipment                              |  |                                  | 3,841  |  |      |   | 3,407  |      |  |   | 3,823  |  
|Loss (gain) on disposition of premises and equipment |  |                                  | 37     |  |      |   | 81     |      |  |   | (2     | )
|Professional services                                |  |                                  | 2,507  |  |      |   | 1,709  |      |  |   | 942    |  
|FDIC deposit insurance assessment                    |  |                                  | 4,487  |  |      |   | 3,261  |      |  |   | 786    |  
|Marketing                                            |  |                                  | 1,407  |  |      |   | 1,114  |      |  |   | 1,576  |  
|Foreclosed real estate writedowns and expenses       |  |                                  | 11,656 |  |      |   | 3,233  |      |  |   | 516    |  
|Goodwill impairment                                  |  |                                  | 3,691  |  |      |   |       |      |  |   |       |  
|Loss on commercial loans held for sale               |  |                                  | 7,562  |  |      |   |       |      |  |   |       |  
|Other                                                |  |                                  | 8,663  |  |      |   | 9,454  |      |  |   | 8,266  |  
|                                                     |  |                                  |        |  |      |   |        |      |  |   |        |  
|Total noninterest expense                            |  | $                                | 73,306 |  |      | $ | 51,015 |      |  | $ | 42,974 |  
|                                                     |  |                                  |        |  |      |   |        |      |  |   |        |  



Salaries and Other
Personnel.    Salaries and personnel expense increased $214 thousand (0.9%) for the year ended December 31, 2010 as compared to the same period of 2009 as declines in salaries expense were more than offset by increases
in contract labor, incentives and employee benefit costs. In connection with the execution of our strategic plan, we are evaluating the proper alignment of roles and responsibilities within the Company and working to ensure our overall compensation
structure remains competitive with the industry as we continue to compete for talent.



Occupancy.    Occupancy expense increased $485 thousand (11.3%) for the year ended December 31, 2010 over 2009, primarily as a result of the impact of the new
corporate headquarters. Occupancy expense for the year ended December 31, 2010 included twelve monthly payments under the lease agreement for the new headquarters and only nine and one-half monthly payments for the year ended December 31,
2009. This increase was offset by the impact of expenses associated with banking offices previously consolidated or relocated that have not yet been subleased or sold no longer being recorded within this financial statement line item but rather
being recorded as a branch closure expense within Other noninterest expense in the Consolidated Statements of Income (Loss).



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Furniture and Equipment.    Furniture and equipment expense
increased $434 thousand (12.7%) for the year ended December 31, 2010 over 2009. Furniture and equipment depreciation and capital lease amortization, included within this line item, increased $355 thousand over the same periods primarily
due to a new capitalized lease in December 2009.



Professional Services.    Professional services expense increased $798 thousand (46.7%) for the year ended
December 31, 2010 over 2009 due to increased use of consultant services to assist with strategic business reviews and process improvement engagements, an increase in tax services related to the Private Placement, legal fees related to the
Consent Order, and loan advisory firm fees associated with the marketing of commercial loans held for sale.



FDIC Deposit Insurance Assessment.    FDIC insurance premiums increased $1.2 million (37.6%) for the year ended
December 31, 2010 compared to the same period of 2009. For the year ended December 31, 2010, the FDICs general assessment rates increased compared to 2009. The increase in the general assessment was the result of our voluntary
participation in the FDICs Transaction Account Guarantee Program and our capital classification being below well-capitalized. During the second quarter of 2009, we accrued an incremental $680 thousand of increased FDIC premiums due to the
industry-wide special assessment by the FDIC to bolster the FDIC insurance fund. The FDIC imposed a 5 basis point special assessment on assets less tier 1 capital with a cap of 10-basis points times deposits.



In February 2011, the FDIC approved two rules that amend the
deposit insurance assessment regulations. The first rule changes the assessment base from one based on domestic deposits to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus
average tangible equity. The second rule changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act. Since the new base would be much larger than the current base, the FDIC
will lower assessment rates, which achieves the FDICs goal of not significantly altering the total amount of revenue collected from the industry. Risk categories and debt ratings will be eliminated from the assessment calculation for large
banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial institution will continue to be defined as an insured depository institution with at least $10
billion in assets. Both changes in the assessment system will be effective as of April 1, 2011 and will be payable at the end of September.



With the consummation of the Private Placement on October 7, 2010 and the resulting change in the Banks capital classification
to well-capitalized, as well as the changes to the deposit insurance assessment regulations, we project that our FDIC insurance premiums will be reduced by approximately $1.8 million in 2011, based on our 2011 budgeted level of deposits and assets.



Marketing.    Marketing expense increased $293 thousand (26.3%) from the year ended December 31, 2009
to the same period of 2010, primarily due to promotional efforts related to our new MyPal checking and Smart Savings deposit accounts introduced in March 2010 and increased marketing related to mortgage and small business. In 2009, a concerted
effort was made to reduce discretionary expenditures.



Foreclosed Real Estate Writedowns and Expenses.    Foreclosed real estate writedowns and expenses increased $8.4 million for the year ended December 31, 2010 in comparison
with the same period of 2009. Based on currently available valuation information primarily from third party appraisals, the carrying value of these assets is written down to their fair value less estimated selling costs. Writedowns on seven such
properties resulted in a provision charged to expense of $7.0 million (61.9% of total writedowns). The continued high level of writedowns is due to receipts of contracts for sale and updated appraisals which continued to show declining values based
on lack of property sales activity. The continued high level of expenses is due to payment of legal fees, taxes, insurance, utilities, property management company fees, and other carrying costs on our elevated level of foreclosed properties.



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Goodwill Impairment.    Goodwill impairment of $3.7 million was
recognized during the year ended December 31, 2010. As described in Part I., Item 7. Financial Condition, Goodwill, we performed an impairment test of our goodwill quarterly in 2010. The September 30, 2010 evaluation indicated that
the carrying value of the Companys goodwill exceeded the fair value and resulted in a noncash charge of $3.7 million, eliminating the entire balance of the goodwill on the Companys Consolidated Balance Sheets. This charge had no
effect on the liquidity, regulatory capital, or daily operations of the Company.



Loss on Loans Held for Sale.    In September 2010, we decided to market for sale commercial loans totaling $90.9 million at September 30, 2010 and we are evaluating the
bids received on a loan by loan basis. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets.
We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year end. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the
strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order.



During the fourth quarter of 2010, we sold five loans,
representing two relationships, with a gross book value of $10.4 million for an aggregate loss of $3.5 million. At December 31, 2010, we had commercial loans held for sale aggregating $66.2 million, of which $2.0 million were under contract for
sale and expected to close in the first quarter 2011. Writedowns of $1.1 million were recorded in the fourth quarter 2010 to reduce the value of these loans to the contract value less estimated costs to sell.



Other.    Other noninterest
expense decreased $791 thousand (8.4%) during the year ended December 31, 2010 over 2009. Included in this financial statement line item are the following:



| |  |  | Credit-related costs and expenses associated with the execution of the Strategic Project Plan and problem loan resolution consulting assistance.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Branch closure expense associated with banking offices previously consolidated or relocated that have not yet been subleased or sold. Two operating
leases with total monthly payments of approximately $9 thousand expired during 2010 and will result in a reduction in branch facilities expense going forward.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2010, a vacant bank-owned branch facility was placed under contract. Based on the contract price, we recorded a writedown of $24 thousand
for the year ended December 31, 2010.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2010, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing cost, we prepaid
$61.0 million of FHLB advances resulting in a prepayment penalty of $33 thousand for the year ended December 31, 2010.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Provision (Benefit) for Income Taxes



As a result of a charge against income tax provision (benefit) to record a valuation allowance of $20.5 million against our gross deferred
tax asset as of December 31, 2010, our income tax benefit of $1.3 million for the year ended December 31, 2010 was significantly less than the normal expectation using a 35% federal income tax rate applied to the net loss for the year
before income taxes. During the year ended December 31, 2009, we recognized an income tax benefit of $22.1 million, and during the year ended December 31, 2008, we recognized an income tax expense of $7.5 million. Our effective tax rates
were 2.2%, 35.6%, and 35.4% for the years ended December 31, 2010, 2009, and 2008, respectively. The 2010 benefit is related to our ability to utilize operating losses as a carryback to offset income taxes paid in 2008.



As of December 31, 2010, prior to any valuation
allowance, net deferred tax assets totaling $20.5 million were recorded in the Companys Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the previous three
years, net operating loss carry forward limitations as discussed below and available tax planning strategies, we recorded a valuation allowance against



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the net deferred tax asset at December 31, 2010. The Private Placement that was consummated on October 7, 2010 is considered to be a change in control under the Internal Revenue Service
rules. Accordingly, with the assistance of third party specialists we were required to determine the fair value of the Company and our assets for the purpose of evaluating any potential limitation or deferral of our ability to carry forward
pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses as of October 7, 2010, which also limits the amount of net operating losses that may be used in the future. As a result of the valuations and tax
analysis, we currently estimate that future utilization of net operating loss carry forwards and built-in losses of $46 million generated prior to October 7, 2010 will be limited to $1.1 million per year.



Analysis of our ability to realize deferred tax assets
requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for
financial reporting purposes at December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the
future, we will be able to utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able
to utilize and therefore how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.



Recently Issued / Adopted
Authoritative Pronouncements



See
Item 8. Financial Statements and Supplementary Data, Note 1, Summary of Significant Accounting Policies, for a discussion regarding recently issued and recently adopted authoritative pronouncements and their expected impact on our business,
financial condition, results of operations, and cash flows.



Impact of Inflation and Changing Prices



The Consolidated Financial Statements contained in Item 8 of this document and related data have been prepared in accordance with
GAAP which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time because of inflation.



Unlike most industrial companies, virtually all of the assets
and liabilities of a financial institution are monetary. As a result, interest rates have a more significant impact on a financial institutions performance than the impact of general levels of inflation. Interest rates do not
necessarily move in the same direction or in the same magnitude as the price of goods and services since such prices are impacted by inflation. We are committed to continuing to actively manage the gap between our interest-sensitive assets and
interest-sensitive liabilities.



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ITEM 7A.QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Market risk refers to the risk of loss arising from adverse changes in interest rates, foreign exchange rates, commodity prices, and other
relevant market rates and prices such as equity prices. Due to the nature of our operations, we are primarily exposed to interest rate risk and liquidity risk. To a lesser degree we are also exposed to equity risk as variability in equity values
impacts the amount of our trust income and the funded status of our retirement plan, which was frozen in 2007.



Interest rate risk within our Consolidated Balance Sheets consists of reprice, option, and basis risks. Reprice risk results from
differences in the maturity, or repricing, of asset and liability portfolios. Option risk arises from embedded options present in many financial instruments, such as loan prepayment options, deposit early withdrawal options, and interest
rate options. These options allow customers opportunities to benefit when market interest rates change, which typically results in higher expense or lower income for us. Basis risk refers to the potential for changes in the underlying relationship
between market rates and indices, which subsequently result in a narrowing of the profit spread on an interest-earning asset or interest-bearing liability. Basis risk is also present in administered rate liabilities, such as savings accounts,
negotiable order of withdrawal accounts, and money market accounts with respect to which historical pricing relationships to market rates may change due to the level or directional change in market interest rates.



We seek to avoid fluctuations in our net interest margin and
to maximize net interest income within acceptable levels of risk through periods of changing interest rates. Accordingly, our Asset / Liability Committee (ALCO) and the Board of Directors monitor our interest rate sensitivity and
liquidity on an ongoing basis. The Board of Directors and ALCO oversee market risk management and establish risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its impact on net interest income and capital.
ALCO uses a variety of measures to gain a comprehensive view of the magnitude of interest rate risk, the distribution of risk, the level of risk over time, and the exposure to changes in certain interest rate relationships.



We utilize a simulation model as the primary quantitative
tool in measuring the amount of interest rate risk associated with changing market rates. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates over the coming
12 month period. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing, and the repricing and maturity characteristics of the existing and projected Consolidated Balance Sheets. Other interest rate related
risks, such as prepayment, basis, and option risk, are also considered in the model.



ALCO continuously monitors and manages the volume of interest sensitive assets and interest sensitive liabilities. Interest-sensitive assets and liabilities are those that reprice or mature within a given
timeframe. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective and mitigate potential market risk, management develops and implements investment, lending,
funding and pricing strategies.



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As of December 31, 2010, the following table summarizes the forecasted impact on net
interest income using a base case scenario given upward and downward movements in interest rates of 100, 200 and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates.
Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the
issuance of the Consolidated Financial Statements. Therefore, managements assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not
cause actual occurrences to differ from underlying assumptions.



|                           |  |                                                   |       |   
|-------------------------- |  | ------------------------------------------------- | ----- | --
|Interest rate scenario (1) |  | Percentage change in netinterest income from base |      
|Up 300 basis points        |  |                                                   | (5.08 | )%
|Up 200 basis points        |  |                                                   | (3.51 | ) 
|Up 100 basis points        |  |                                                   | (1.40 | ) 
|Base                       |  |                                                   |       |   
|Down 100 basis points      |  |                                                   | 1.76  |   
|Down 200 basis points      |  |                                                   | 2.04  |   
|Down 300 basis points      |  |                                                   | 1.77  |   



|(1) |  | The rising and falling 100, 200 and 300 basis point interest rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



There are material limitations with
the model presented above, which include, but are not limited to:



| |  |  | It presents the balance sheet in a static position. When assets and liabilities mature or reprice, they do not necessarily keep the same
characteristics.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The computation of prospective impacts of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as
indicative of actual results.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The computations do not contemplate any additional actions we could undertake in response to changes in interest rates.
| | - |  | -----------------------------------------------------------------------------------------------------------------------



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ITEM 8.FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA



MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING



Management of Palmetto Bancshares, Inc. is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 as amended (the Exchange Act). The Companys internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Companys internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that in reasonable detail, accurately and fairly reflect the transactions and disposition of the Companys assets; (2) provide
reasonable assurance that transactions are recorded as necessary to permit the preparation of the financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only
in accordance with the authorizations of the Companys management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets
that could have a material impact on the financial statements.



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject
to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.



Management conducted an evaluation of the effectiveness of the internal control over financial reporting based on the framework in
Internal ControlIntegrated Framework promulgated by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation under the COSO criteria, management concluded that the internal
control over financial reporting was effective as of December 31, 2010.



The effectiveness of the internal control structure over financial reporting as of December 31, 2010 has been audited by Elliott Davis, LLC, an independent registered public accounting firm, as
stated in their report included in this Annual Report on Form 10-K, which expresses an unqualified opinion on the effectiveness of the Companys internal control over financial reporting as of December 31, 2010.



|                                                  |  |                                                  
|------------------------------------------------- |  | -------------------------------------------------
|LOGO                                              |  | LOGO                                             
|Samuel L. Erwin                                   |  | Roy D. Jones                                     
|Chief Executive Officer
Palmetto Bancshares, Inc. |  | Chief Financial Officer
Palmetto Bancshares, Inc.



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Shareholders

Palmetto Bancshares, Inc.

Greenville, South
Carolina



We have audited the accompanying
consolidated balance sheets of Palmetto Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income (loss), changes in shareholders equity and comprehensive
income (loss) and cash flows for each of the three years in the period ended December 31, 2010. 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 the standards of the Public
Company Accounting Oversight Board (United States). 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, 2010
and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.



We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the Companys internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2011 expressed an unqualified opinion on the effectiveness of Palmetto Bancshares, Inc. and Subsidiarys internal control over financial
reporting.



/s/
Elliott Davis LLC



Greenville,
South Carolina

February 28, 2011





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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Shareholders

Palmetto Bancshares, Inc.

Greenville, South Carolina



We have audited the internal control over financial reporting of Palmetto Bancshares, Inc. and Subsidiary (the Company) as of
December 31, 2010, based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Companys management is
responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A companys internal control over financial reporting is
a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys
internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject
to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





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In our opinion, the Company maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2010, based on the COSO criteria.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2010 and 2009 and
the related consolidated statements of income (loss), changes in shareholders equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010 and our report dated February 28, 2011
expressed an unqualified opinion thereon.



/s/ Elliott Davis LLC



Greenville, South Carolina

February 28, 2011



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Consolidated Balance Sheets

(dollars in thousands, except per share data)



|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                                                                                                                                                     |  | December 31,2010 |           |   | December 31,2009 |  
|Assets                                                                                                                                                                                                                                                                                               |  |                  |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                                                                                                                                                            |  |                  |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                                                                                                                                                              |  | $                | 223,017   |   |                  | $ | 188,084   |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total cash and cash equivalents                                                                                                                                                                                                                                                                      |  |                  | 223,017   |   |                  |   | 188,084   |  
|FHLB stock, at cost                                                                                                                                                                                                                                                                                  |  |                  | 6,785     |   |                  |   | 7,010     |  
|Investment securities available for sale, at fair value                                                                                                                                                                                                                                              |  |                  | 218,775   |   |                  |   | 119,986   |  
|Mortgage loans held for sale                                                                                                                                                                                                                                                                         |  |                  | 4,793     |   |                  |   | 3,884     |  
|Commercial loans held for sale                                                                                                                                                                                                                                                                       |  |                  | 66,157    |   |                  |   |          |  
|Loans, gross                                                                                                                                                                                                                                                                                         |  |                  | 793,426   |   |                  |   | 1,040,312 |  
|Less: allowance for loan losses                                                                                                                                                                                                                                                                      |  |                  | (26,934   | ) |                  |   | (24,079   | )
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Loans, net                                                                                                                                                                                                                                                                                           |  |                  | 766,492   |   |                  |   | 1,016,233 |  
|Premises and equipment, net                                                                                                                                                                                                                                                                          |  |                  | 28,109    |   |                  |   | 29,605    |  
|Goodwill                                                                                                                                                                                                                                                                                             |  |                  |          |   |                  |   | 3,691     |  
|Accrued interest receivable                                                                                                                                                                                                                                                                          |  |                  | 4,702     |   |                  |   | 4,322     |  
|Foreclosed real estate                                                                                                                                                                                                                                                                               |  |                  | 19,983    |   |                  |   | 27,826    |  
|Income tax refund receivable                                                                                                                                                                                                                                                                         |  |                  | 7,436     |   |                  |   | 20,869    |  
|Deferred tax asset, net                                                                                                                                                                                                                                                                              |  |                  |          |   |                  |   | 5,799     |  
|Other                                                                                                                                                                                                                                                                                                |  |                  | 8,998     |   |                  |   | 8,454     |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total assets                                                                                                                                                                                                                                                                                         |  | $                | 1,355,247 |   |                  | $ | 1,435,763 |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Liabilities and shareholders equity                                                                                                                                                                                                                                                                 |  |                  |           |   |                  |   |           |  
|Liabilities                                                                                                                                                                                                                                                                                          |  |                  |           |   |                  |   |           |  
|Deposits                                                                                                                                                                                                                                                                                             |  |                  |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                                                                                                                                                                                  |  | $                | 141,281   |   |                  | $ | 142,609   |  
|Interest-bearing                                                                                                                                                                                                                                                                                     |  |                  | 1,032,081 |   |                  |   | 1,072,305 |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total deposits                                                                                                                                                                                                                                                                                       |  |                  | 1,173,362 |   |                  |   | 1,214,914 |  
|Retail repurchase agreements                                                                                                                                                                                                                                                                         |  |                  | 20,720    |   |                  |   | 15,545    |  
|Commercial paper (Master notes)                                                                                                                                                                                                                                                                      |  |                  |          |   |                  |   | 19,061    |  
|FHLB borrowings                                                                                                                                                                                                                                                                                      |  |                  | 35,000    |   |                  |   | 101,000   |  
|Accrued interest payable                                                                                                                                                                                                                                                                             |  |                  | 1,187     |   |                  |   | 2,020     |  
|Other                                                                                                                                                                                                                                                                                                |  |                  | 11,079    |   |                  |   | 8,208     |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                                                                                                                                                    |  |                  | 1,241,348 |   |                  |   | 1,360,748 |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Shareholders equity                                                                                                                                                                                                                                                                                 |  |                  |           |   |                  |   |           |  
|Preferred stock-par value $0.01 per share; authorized 2,500,000 at December 31, 2010 and December 31, 2009; none issued
and outstanding at December 31, 2010 and December 31, 2009                                                                                                                   |  |                  |          |   |                  |   |          |  
|Common stockpar value $0.01 per share at December 31, 2010, $5.00 per share at December 31, 2009; authorized
75,000,000 shares at December 31, 2010, 25,000,000 at December 31, 2009; 47,409,078 issued and outstanding at December 31, 2010, 6,495,130 issued and outstanding at December 31, 2009 |  |                  | 474       |   |                  |   | 32,282    |  
|Capital surplus                                                                                                                                                                                                                                                                                      |  |                  | 133,112   |   |                  |   | 2,599     |  
|Retained earnings (deficit)                                                                                                                                                                                                                                                                          |  |                  | (13,108   | ) |                  |   | 47,094    |  
|Accumulated other comprehensive loss, net of tax                                                                                                                                                                                                                                                     |  |                  | (6,579    | ) |                  |   | (6,960    | )
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                                                                                                                                                           |  |                  | 113,899   |   |                  |   | 75,015    |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  
|Total liabilities and shareholders equity                                                                                                                                                                                                                                                           |  | $                | 1,355,247 |   |                  | $ | 1,435,763 |  
|                                                                                                                                                                                                                                                                                                     |  |                  |           |   |                  |   |           |  



See Notes to Consolidated
Financial Statements



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Income (Loss)

(in thousands, except per share data)



|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|--------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                |  | For the years ended December 31, |           
|                                                                |  | 2010                             |            |   | 2009 |   |           | 2008 | 
|Interest income                                                 |  |                                  |            |   |      |   |           |      |  |   |           |  
|Interest earned on cash and cash equivalents                    |  | $                                | 498        |   |      | $ | 215       |      |  | $ | 106       |  
|Dividends received on FHLB stock                                |  |                                  | 23         |   |      |   | 19        |      |  |   | 189       |  
|Interest earned on investment securities available for sale     |  |                                  |            |   |      |   |           |      |  |   |           |  
|U.S. Treasury and federal agencies (taxable)                    |  |                                  | 57         |   |      |   | 8         |      |  |   | 235       |  
|State and municipal (nontaxable)                                |  |                                  | 1,474      |   |      |   | 1,640     |      |  |   | 1,806     |  
|Collateralized mortgage obligations (taxable)                   |  |                                  | 1,518      |   |      |   | 3,069     |      |  |   | 2,877     |  
|Other mortgage-backed (taxable)                                 |  |                                  | 676        |   |      |   | 950       |      |  |   | 1,092     |  
|Interest and fees earned on loans                               |  |                                  | 52,381     |   |      |   | 60,309    |      |  |   | 71,940    |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Total interest income                                           |  |                                  | 56,627     |   |      |   | 66,210    |      |  |   | 78,245    |  
|Interest expense                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Interest paid on deposits                                       |  |                                  | 13,560     |   |      |   | 19,511    |      |  |   | 23,694    |  
|Interest paid on retail repurchase agreements                   |  |                                  | 57         |   |      |   | 58        |      |  |   | 247       |  
|Interest paid on commercial paper                               |  |                                  | 21         |   |      |   | 60        |      |  |   | 359       |  
|Interest paid on other short-term borrowings                    |  |                                  |           |   |      |   | 33        |      |  |   | 301       |  
|Interest paid on FHLB borrowings                                |  |                                  | 1,708      |   |      |   | 1,777     |      |  |   | 2,005     |  
|Other                                                           |  |                                  | 20         |   |      |   |          |      |  |   |          |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Total interest expense                                          |  |                                  | 15,366     |   |      |   | 21,439    |      |  |   | 26,606    |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Net interest income                                             |  |                                  | 41,261     |   |      |   | 44,771    |      |  |   | 51,639    |  
|Provision for loan losses                                       |  |                                  | 47,100     |   |      |   | 73,400    |      |  |   | 5,619     |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Net interest income (expense) after provision for loan losses   |  |                                  | (5,839     | ) |      |   | (28,629   | )    |  |   | 46,020    |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Noninterest income                                              |  |                                  |            |   |      |   |           |      |  |   |           |  
|Service charges on deposit accounts, net                        |  |                                  | 7,543      |   |      |   | 8,275     |      |  |   | 8,596     |  
|Fees for trust and investment management and brokerage services |  |                                  | 2,597      |   |      |   | 2,275     |      |  |   | 2,996     |  
|Mortgage-banking                                                |  |                                  | 1,794      |   |      |   | 1,903     |      |  |   | 1,264     |  
|Automatic teller machine                                        |  |                                  | 1,300      |   |      |   | 1,389     |      |  |   | 1,234     |  
|Merchant services                                               |  |                                  | 937        |   |      |   | 1,079     |      |  |   | 1,129     |  
|Bankcard services                                               |  |                                  | 1,793      |   |      |   | 658       |      |  |   | 724       |  
|Investment securities gains                                     |  |                                  | 10         |   |      |   | 2         |      |  |   | 1         |  
|Other                                                           |  |                                  | 1,627      |   |      |   | 1,850     |      |  |   | 2,073     |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Total noninterest income                                        |  |                                  | 17,601     |   |      |   | 17,431    |      |  |   | 18,017    |  
|Noninterest expense                                             |  |                                  |            |   |      |   |           |      |  |   |           |  
|Salaries and other personnel                                    |  |                                  | 24,677     |   |      |   | 24,463    |      |  |   | 23,774    |  
|Occupancy                                                       |  |                                  | 4,778      |   |      |   | 4,293     |      |  |   | 3,293     |  
|Furniture and equipment                                         |  |                                  | 3,841      |   |      |   | 3,407     |      |  |   | 3,823     |  
|Loss (gain) on disposition of premises and equipment            |  |                                  | 37         |   |      |   | 81        |      |  |   | (2        | )
|Professional services                                           |  |                                  | 2,507      |   |      |   | 1,709     |      |  |   | 942       |  
|FDIC deposit insurance assessment                               |  |                                  | 4,487      |   |      |   | 3,261     |      |  |   | 786       |  
|Marketing                                                       |  |                                  | 1,407      |   |      |   | 1,114     |      |  |   | 1,576     |  
|Foreclosed real estate writedowns and expenses                  |  |                                  | 11,656     |   |      |   | 3,233     |      |  |   | 516       |  
|Goodwill impairment                                             |  |                                  | 3,691      |   |      |   |          |      |  |   |          |  
|Loss on commercial loans held for sale                          |  |                                  | 7,562      |   |      |   |          |      |  |   |          |  
|Other                                                           |  |                                  | 8,663      |   |      |   | 9,454     |      |  |   | 8,266     |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Total noninterest expense                                       |  |                                  | 73,306     |   |      |   | 51,015    |      |  |   | 42,974    |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Net income (loss) before provision (benefit) for income taxes   |  |                                  | (61,544    | ) |      |   | (62,213   | )    |  |   | 21,063    |  
|Provision (benefit) for income taxes                            |  |                                  | (1,342     | ) |      |   | (22,128   | )    |  |   | 7,464     |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|Net income (loss)                                               |  | $                                | (60,202    | ) |      | $ | (40,085   | )    |  | $ | 13,599    |  
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           |  
|                                                                |  |                                  |           
|Common and per share data                                       |  |                                  |            |   |      |   |           |      |  |   |           |  
|Net income (loss)basic                                         |  |                                  | (3.78      | ) |      |   | (6.21     | )    |  |   | 2.11      |  
|Net income (loss)diluted                                       |  |                                  | (3.78      | ) |      |   | (6.21     | )    |  |   | 2.09      |  
|Cash dividends                                                  |  |                                  |           |   |      |   | 0.06      |      |  |   | 0.80      |  
|Book value                                                      |  |                                  | 2.40       |   |      |   | 11.55     |      |  |   | 17.96     |  
|                                                                |  |                                  |           
|Weighted average common shares outstandingbasic                |  |                                  | 15,913,000 |   |      |   | 6,449,754 |      |  |   | 6,438,071 |  
|Weighted average common shares outstandingdiluted              |  |                                  | 15,913,000 |   |      |   | 6,449,754 |      |  |   | 6,519,849 |  



See Notes to Consolidated Financial Statements



121



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##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Consolidated Statements of Changes in Shareholders
Equity and Comprehensive Income (Loss)

(dollars in thousands, except per share data)



|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | -------------------- | ---------- |  | ----------- | - | ------- | -------------- |  | - | ------------------------- | - |  | ---------------------------------------------- | ------- | - | ----- | - | ------ | - |  | - | ------- | -
|                                                                                               |  | Shares ofcommonstock |            |  | Commonstock |   |         | Capitalsurplus |  |   | Retainedearnings(deficit) |   |  | Accumulatedothercomprehensiveincome(loss), net |         |   | Total |  
|Balance at December 31, 2007                                                                   |  |                      | 6,421,765  |  |             | $ | 32,109  |                |  | $ | 1,664                     |   |  | $                                              | 79,221  |   |       | $ | (2,738 | ) |  | $ | 110,256 |  
|                                                                                               |  |                      |            |  |             |  
|Net income                                                                                     |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | 13,599  |   |       |   |        |   |  |   | 13,599  |  
|Other comprehensive income (loss), net of tax                                                  |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Investment securities available for sale                                                       |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $832                     |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (1,368 | ) |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $0                    |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (1     | ) |  |   |         |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Net unrealized loss on investment securities available for sale                                |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | (1,369  | )
|Defined benefit pension plan                                                                   |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Impact of FASB ASC 715, net of tax impact of $1,082                                            |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (2,010 | ) |  |   | (2,010  | )
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|                                                                                               |  |                      |            |  |             |  
|Comprehensive income                                                                           |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | 10,220  |  
|Cumulative effect of adoption of new accounting standard (see Note 14)                         |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | (99     | ) |       |   |        |   |  |   | (99     | )
|Cash dividend declared and paid ($0.80 per share)                                              |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | (5,153  | ) |       |   |        |   |  |   | (5,153  | )
|Compensation expense related to stock option plan                                              |  |                      |            |  |             |   |         |                |  |   | 94                        |   |  |                                                |         |   |       |   |        |   |  |   | 94      |  
|Excess tax benefit from equity-based awards                                                    |  |                      |            |  |             |   |         |                |  |   | 78                        |   |  |                                                |         |   |       |   |        |   |  |   | 78      |  
|Common stock issued pursuant to stock option plan                                              |  |                      | 24,325     |  |             |   | 121     |                |  |   | 259                       |   |  |                                                |         |   |       |   |        |   |  |   | 380     |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Balance at December 31, 2008                                                                   |  |                      | 6,446,090  |  |             | $ | 32,230  |                |  | $ | 2,095                     |   |  | $                                              | 87,568  |   |       | $ | (6,117 | ) |  | $ | 115,776 |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Net loss                                                                                       |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | (40,085 | ) |       |   |        |   |  |   | (40,085 | )
|Other comprehensive loss, net of tax                                                           |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Investment securities available for sale                                                       |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $1,179                   |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | 1,928  |   |  |   |         |  
|Reclassification adjustment included in net loss, net of tax impact of $1                      |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (1     | ) |  |   |         |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Net unrealized gain on investment securities available for sale                                |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | 1,927   |  
|Defined benefit pension plan                                                                   |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Impact of FASB ASC 715, net of tax impact of $1,491                                            |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (2,770 | ) |  |   | (2,770  | )
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Comprehensive loss                                                                             |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | (40,928 | )
|Cash dividend declared and paid ($0.06 per share)                                              |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | (389    | ) |       |   |        |   |  |   | (389    | )
|Compensation expense related to stock option plan                                              |  |                      |            |  |             |   |         |                |  |   | 64                        |   |  |                                                |         |   |       |   |        |   |  |   | 64      |  
|Excess tax benefit from equity-based awards                                                    |  |                      |            |  |             |   |         |                |  |   | 133                       |   |  |                                                |         |   |       |   |        |   |  |   | 133     |  
|Common stock issued pursuant to stock option plan                                              |  |                      | 4,000      |  |             |   | 20      |                |  |   | 86                        |   |  |                                                |         |   |       |   |        |   |  |   | 106     |  
|Common stock issued pursuant to restricted stock plan                                          |  |                      | 45,040     |  |             |   | 32      |                |  |   | 221                       |   |  |                                                |         |   |       |   |        |   |  |   | 253     |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Balance at December 31, 2009                                                                   |  |                      | 6,495,130  |  |             | $ | 32,282  |                |  | $ | 2,599                     |   |  | $                                              | 47,094  |   |       | $ | (6,960 | ) |  | $ | 75,015  |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Net loss                                                                                       |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                | (60,202 | ) |       |   |        |   |  |   | (60,202 | )
|Other comprehensive loss, net of tax                                                           |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Investment securities available for sale                                                       |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Change in unrealized position during the period, net of tax impact of $590                     |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | 964    |   |  |   |         |  
|Reclassification adjustment included in net income, net of tax impact of $4                    |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (6     | ) |  |   |         |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Net unrealized gain on investment securities available for sale                                |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | 958     |  
|Defined benefit pension plan                                                                   |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Impact of FASB ASC 715, net of tax impact of $310                                              |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   | (577   | ) |  |   | (577    | )
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Comprehensive loss                                                                             |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   | (59,821 | )
|Compensation expense related to stock option plan                                              |  |                      |            |  |             |   |         |                |  |   | 30                        |   |  |                                                |         |   |       |   |        |   |  |   | 30      |  
|Par Value Adjustment, as of August 6, 2010                                                     |  |                      |           |  |             |   | (32,410 | )              |  |   | 32,410                    |   |  |                                                |         |   |       |   |        |   |  |   |        |  
|Common stock issued pursuant to restricted stock plan, through August                          |  |                      |           |  |             |   | 34      |                |  |   | 188                       |   |  |                                                |         |   |       |   |        |   |  |   | 222     |  
|Common stock issued pursuant to restricted stock plan, par adjustment                          |  |                      |           |  |             |   | 159     |                |  |   | (159                      | ) |  |                                                |         |   |       |   |        |   |  |   |        |  
|Common stock issued pursuant to restricted stock plan, post par adjustment, net of forfeitures |  |                      | 15,700     |  |             |   |        |                |  |   | 75                        |   |  |                                                |         |   |       |   |        |   |  |   | 75      |  
|Common stock issued pursuant to Private Placement, net of issuance costs                       |  |                      | 39,975,980 |  |             |   | 400     |                |  |   | 95,580                    |   |  |                                                |         |   |       |   |        |   |  |   | 95,980  |  
|Common stock issued upon conversion of convertible debt                                        |  |                      | 146,145    |  |             |   | 1       |                |  |   | 379                       |   |  |                                                |         |   |       |   |        |   |  |   | 380     |  
|Common stock issued pursuant to Follow-On Offering                                             |  |                      | 776,123    |  |             |   | 8       |                |  |   | 2,010                     |   |  |                                                |         |   |       |   |        |   |  |   | 2,018   |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  
|Balance at December 31, 2010                                                                   |  |                      | 47,409,078 |  |             | $ | 474     |                |  | $ | 133,112                   |   |  | $                                              | (13,108 | ) |       | $ | (6,579 | ) |  | $ | 113,899 |  
|                                                                                               |  |                      |            |  |             |   |         |                |  |   |                           |   |  |                                                |         |   |       |   |        |   |  |   |         |  



See Notes to Consolidated
Financial Statements



122



---

##### Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|-------------------------------------------------------------------------------------------------------- |  | -------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                                         |  | For the years ended December 31, |         
|                                                                                                         |  | 2010                             |          |   | 2009 |   |          | 2008 | 
|OPERATING ACTIVITIES                                                                                     |  |                                  |          |   |      |   |          |      |  |   |          |  
|Net income (loss)                                                                                        |  | $                                | (60,202  | ) |      | $ | (40,085  | )    |  | $ | 13,599   |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities                  |  |                                  |          |   |      |   |          |      |  |   |          |  
|Depreciation                                                                                             |  |                                  | 2,581    |   |      |   | 2,157    |      |  |   | 1,972    |  
|Goodwill impairment                                                                                      |  |                                  | 3,691    |   |      |   |         |      |  |   |         |  
|Amortization of unearned discounts / premiums on investment securities available for sale, net           |  |                                  | 1,829    |   |      |   | 45       |      |  |   | 13       |  
|Deferred income tax expense (benefit)                                                                    |  |                                  | 5,524    |   |      |   | (4,878   | )    |  |   | (1,320   | )
|Net change in income tax refund receivable                                                               |  |                                  | 13,433   |   |      |   | (20,869  | )    |  |   |         |  
|Provision for loan losses                                                                                |  |                                  | 47,100   |   |      |   | 73,400   |      |  |   | 5,619    |  
|Gain on sale of credit card portfolio                                                                    |  |                                  | (1,177   | ) |      |   |         |      |  |   |         |  
|Gain on sales of mortgage loans held for sale, net                                                       |  |                                  | (1,256   | ) |      |   | (1,728   | )    |  |   | (994     | )
|Loss on commercial loans held for sale                                                                   |  |                                  | 7,562    |   |      |   |         |      |  |   |         |  
|Writedowns, gains, and losses on sales of foreclosed real estate                                         |  |                                  | 10,650   |   |      |   | 2,832    |      |  |   | 291      |  
|Loss on prepayment of FHLB advances                                                                      |  |                                  | 33       |   |      |   |         |      |  |   |         |  
|Investment securities gains                                                                              |  |                                  | (10      | ) |      |   | (2       | )    |  |   | (1       | )
|Investment securities available for sale other-than-temporary impairment                                 |  |                                  |         |   |      |   | 49       |      |  |   |         |  
|Originations of mortgage loans held for sale                                                             |  |                                  | (65,463  | ) |      |   | (146,018 | )    |  |   | (78,962  | )
|Proceeds from sale of mortgage loans held for sale                                                       |  |                                  | 65,810   |   |      |   | 151,277  |      |  |   | 77,701   |  
|Compensation expense related to stock options granted                                                    |  |                                  | 30       |   |      |   | 64       |      |  |   | 94       |  
|Income tax benefits from exercises of nonqualified stock options in excess of amount previously provided |  |                                  |         |   |      |   | 133      |      |  |   | 78       |  
|Decrease in interest receivable and other assets, net                                                    |  |                                  | 13       |   |      |   | 1,398    |      |  |   | 1,559    |  
|Increase (decrease) in interest payable and other liabilities, net                                       |  |                                  | 529      |   |      |   | 1,435    |      |  |   | (2,136   | )
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|Net cash provided by operating activities                                                                |  |                                  | 30,677   |   |      |   | 19,210   |      |  |   | 17,513   |  
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|INVESTING ACTIVITIES                                                                                     |  |                                  |          |   |      |   |          |      |  |   |          |  
|Proceeds from sales of securities available for sale                                                     |  |                                  | 40,193   |   |      |   |         |      |  |   |         |  
|Proceeds from maturities of investment securities available for sale                                     |  |                                  | 47,321   |   |      |   | 5,038    |      |  |   | 22,789   |  
|Purchases of investment securities available for sale                                                    |  |                                  | (76,532  | ) |      |   | (16,285  | )    |  |   |         |  
|Purchases of mortgage-backed investment securities available for sale                                    |  |                                  | (127,361 | ) |      |   | (1,494   | )    |  |   | (66,537  | )
|Repayments on mortgage-backed investment securities available for sale                                   |  |                                  | 17,315   |   |      |   | 21,364   |      |  |   | 11,652   |  
|Proceeds from sale of commercial loans held for sale                                                     |  |                                  | 9,216    |   |      |   |         |      |  |   |         |  
|Purchases of FHLB stock                                                                                  |  |                                  |         |   |      |   | (2,447   | )    |  |   | (5,029   | )
|Redemptions of FHLB stock                                                                                |  |                                  | 225      |   |      |   | 2,003    |      |  |   | 1,080    |  
|Decrease (increase) in loans, net                                                                        |  |                                  | 87,085   |   |      |   | 33,219   |      |  |   | (118,680 | )
|Proceeds on sale of credit card portfolio                                                                |  |                                  | 13,375   |   |      |   |         |      |  |   |         |  
|Proceeds on sale of real estate acquired in settlement of loans                                          |  |                                  | 17,616   |   |      |   | 689      |      |  |   | 3,511    |  
|Purchases of premises and equipment, net                                                                 |  |                                  | (1,401   | ) |      |   | (5,415   | )    |  |   | (4,837   | )
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) investing activities                                                      |  |                                  | 27,052   |   |      |   | 36,672   |      |  |   | (156,051 | )
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|CASH FLOW FROM FINANCING ACTIVITIES                                                                      |  |                                  |          |   |      |   |          |      |  |   |          |  
|Increase (decrease) in transaction, money market, and savings deposit accounts, net                      |  |                                  | 17,439   |   |      |   | (19,865  | )    |  |   | (47,595  | )
|(Decrease) increase in time deposit accounts, net                                                        |  |                                  | (58,991  | ) |      |   | 163,283  |      |  |   | 59,488   |  
|Increase (decrease) in retail repurchase agreements, net                                                 |  |                                  | 5,175    |   |      |   | (812     | )    |  |   | 5,077    |  
|(Decrease) increase in commercial paper, net                                                             |  |                                  | (19,061  | ) |      |   | (8,894   | )    |  |   | 1,629    |  
|(Decrease) increase in other short-term borrowings                                                       |  |                                  |         |   |      |   | (35,785  | )    |  |   | 17,785   |  
|Proceeds from FHLB advances                                                                              |  |                                  |         |   |      |   | 5,000    |      |  |   | 84,000   |  
|Repayment of FHLB advances                                                                               |  |                                  | (66,033  | ) |      |   |         |      |  |   |         |  
|Other common stock activity                                                                              |  |                                  | 297      |   |      |   | 359      |      |  |   | 380      |  
|Proceeds from issuance of common stock, net                                                              |  |                                  | 97,998   |   |      |   |         |      |  |   |         |  
|Proceeds from issuance of convertible debt                                                               |  |                                  | 380      |   |      |   |         |      |  |   |         |  
|Cash dividends paid on common stock                                                                      |  |                                  |         |   |      |   | (389     | )    |  |   | (5,153   | )
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|Net cash (used in) provided by financing activities                                                      |  |                                  | (22,796  | ) |      |   | 102,897  |      |  |   | 115,611  |  
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|Net change in cash and due from banks                                                                    |  |                                  | 34,933   |   |      |   | 158,779  |      |  |   | (22,927  | )
|Cash and due from banks at beginning of period                                                           |  |                                  | 188,084  |   |      |   | 29,305   |      |  |   | 52,232   |  
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  
|Cash and due from banks at end of period                                                                 |  | $                                | 223,017  |   |      | $ | 188,084  |      |  | $ | 29,305   |  
|                                                                                                         |  |                                  |          |   |      |   |          |      |  |   |          |  



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|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|---------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                   |  | For the years ended December 31, |        
|                                                                                   |  | 2010                             |         |   | 2009 |   |        | 2008 | 
|Supplemental cash flow disclosures                                                 |  |                                  |         |   |      |   |        |      |  |   |        |  
|Cash paid during the period for:                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Interest expense                                                                   |  | $                                | 16,199  |   |      | $ | 21,256 |      |  | $ | 26,808 |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Income taxes paid (refunds received, net)                                          |  |                                  | (20,302 | ) |      |   | 2,880  |      |  |   | 9,588  |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Significant noncash activities                                                     |  |                                  |         |   |      |   |        |      |  |   |        |  
|Net unrealized gain (loss) on investment securities available for sale, net of tax |  | $                                | 958     |   |      | $ | 1,927  |      |  | $ | (1,369 | )
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Loans transferred from held for investment to held for sale, net                   |  |                                  | 82,935  |   |      |   |       |      |  |   | 155    |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Loans transferred to foreclosed real estate, at fair value                         |  |                                  | 20,423  |   |      |   | 24,628 |      |  |   | 2,778  |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Premises reclassified as held for sale, at fair value                              |  |                                  | 316     |   |      |   |       |      |  |   | 1,651  |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Net unrealized loss on pension plan assets, net of tax                             |  |                                  | (577    | ) |      |   | (2,770 | )    |  |   | (2,010 | )
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  
|Conversion of convertible debt to common stock                                     |  |                                  | 380     |   |      |   |       |      |  |   |       |  
|                                                                                   |  |                                  |         |   |      |   |        |      |  |   |        |  









See Notes to Consolidated Financial Statements



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial Statements



|1. |  | Summary of Significant Accounting Policies
|-- |  | ------------------------------------------



Nature of Operations



The Company is a regional financial services bank holding company organized in 1982 under the laws of South Carolina headquartered in
Greenville, South Carolina. The Company provides, through the Bank, a broad array of commercial banking, consumer banking, trust, investment management, insurance and brokerage services throughout its market area primarily within northwest South
Carolina.



Principles of Consolidation / Basis
of Presentation



The accompanying
Consolidated Financial Statements include the accounts of the Company, which includes its wholly-owned subsidiary, the Bank, and the Banks wholly-owned subsidiary, Palmetto Capital and other subsidiaries of the Bank. All significant
intercompany accounts and transactions have been eliminated in consolidation, and all adjustments necessary for a fair presentation of the financial condition and results of operations for periods presented have been included. Any such adjustments
are of a normal and recurring nature. Assets held by the Company or its subsidiary in a fiduciary or agency capacity for customers are not included in the Companys Consolidated Financial Statements because those items do not represent assets
of the Company or its subsidiary. The accounting and financial reporting policies of the Company conform, in all material respects, to accounting principles generally accepted in the United States of America and to general practices within the
financial services industry.



Financial Accounting Standards Board (FASB) Accounting Standards CodificationTM(ASC)



In June 2009, the FASB issued guidance which restructured
GAAP and simplified access to all authoritative literature by providing a single source of authoritative nongovernmental GAAP. The guidance is presented in a topically organized structure referred to as the FASB ASC. All existing accounting
standards have been superseded and all other accounting literature not included is considered nonauthoritative.



Business Segments



Operating segments are components of an enterprise about which separate financial information is available that are evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and assess performance. Public enterprises are required to report a measure of segment profit or loss, certain specific revenue and expense items for each segment, segment
assets, and information about the way that the operating segments were determined, among other items.



The Company considers business segments by analyzing distinguishable components that are engaged in providing individual products,
services, or groups of related products or services and that are subject to risks and returns that are different from those of other business segments. When determining whether products and services are related, the Company considers the nature of
the products or services, the nature of the production processes, the type or class of customer for which the products or services are designed, and the methods used to distribute the products or provide the services.



During 2009 and 2010, the Company realigned its organization
structure and began the process of more specifically delineating its businesses. However, at this time the Company does not yet have in place a reporting structure to separately report and evaluate various lines of businesses. Accordingly, at
December 31, 2010 the Company had one reportable operating segment.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Use of Estimates



In preparing the Consolidated Financial Statements, the Companys management makes estimates and
assumptions that impact the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements and for the years presented. Actual results could differ from
these estimates and assumptions. Therefore, the results of operations for the year ended December 31, 2010 are not necessarily indicative of the results of operations that may be expected in future periods.



Reclassifications



Certain amounts previously presented in the Consolidated
Financial Statements for prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods net income (loss) or shareholders equity as previously reported.



Risk and Uncertainties



In the normal course of business, the Company encounters two
significant types of overall risk: economic and regulatory. There are three main components of economic risk: credit risk, market risk, and concentration of credit risk. Credit risk is the risk of default on the Companys loan portfolios that
results from borrowers inability or unwillingness to make contractually required payments, or default on repayment of investment securities. Market risk includes primarily interest rate risk. The Company is exposed to interest rate risk to the
degree that its interest-bearing liabilities mature or reprice at different speeds, or different bases, than its interest-earning assets. Market risk also reflects the risk of declines in the valuation of loans held for sale and in the value of the
collateral underlying loans and the value of real estate held by the Company. Concentration of credit risk refers to the risk that, if the Company extends a significant portion of its total outstanding credit to borrowers in a specific geographical
area or industry or on the security of a specific form of collateral, the Company may experience disproportionately high levels of default and losses if those borrowers, or the value of such type of collateral, is adversely impacted by economic or
other factors that are particularly applicable to such borrowers or collateral. Concentration of credit risk is also similarly applicable to the investment securities portfolio.



The Company and the Bank are subject to the regulations of
various government agencies. These regulations can and do change significantly from period to period. The Company and the Bank also undergo periodic examinations by regulatory agencies, which may subject them to changes with respect to asset
valuations, amount of required allowance for loan loss, or operating restrictions.



Subsequent Events



Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide
additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions
that did not exist at the date of the balance sheet but arose after that date. The Company has reviewed events occurring through the date of this filing and no subsequent events have occurred requiring accrual or disclosure in these financial
statements in addition to that included herein.



Cash and Cash Equivalents



Cash and cash equivalents may include cash, interest-bearing bank balances, and federal funds sold. Generally, both cash and cash
equivalents have maturities of three months or less, and accordingly, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



FHLB Stock



FHLB stock is carried at its original cost basis, as cost
approximates fair value and there is no ready market for such investments. Historically, redemption of this stock has been at par value. Dividends are paid on this stock also at the discretion of the FHLB.



Investment Securities Available for Sale



The Companys investments are classified into three
categories. Held-to-maturity investment securities include debt securities that the owner has the intent and ability to hold until maturity and are reported at amortized cost. Trading investment securities include debt and equity securities that are
bought and held for the purpose of sale in the near term and are reported at fair value with unrealized gains and losses included in income. Available for sale investment securities include debt and equity investment securities that the Company
determines may be sold at a future date or that it does not have the intent or ability to hold to maturity. Available for sale investment securities are reported at fair value with unrealized gains and losses excluded from income and reported as a
separate component of shareholders equity, net of deferred income taxes. For additional information regarding fair value estimates and methodologies, see Note 19, Disclosures Regarding Fair Value. Any other-than-temporary impairment related to
credit losses is recognized through earnings while any other-than-temporary impairment related to other factors is recognized in other comprehensive income. Realized gains or losses on available for sale investment securities are computed on a
specific identification basis.



Other-than-temporary impairment analysis is conducted on a quarterly basis or more often if a potential loss-triggering event occurs.
Investment securities are considered to be impaired on an other-than-temporary basis if it is probable that the issuer will be unable to make its contractual payments or if the Company no longer believes the security will recover within the
estimated recovery period. Other-than-temporary impairment is recognized by evaluating separately other-than-temporary impairment losses due to credit issues and losses related to all other factors. Other-than-temporary impairment exists when it is
more likely than not that the security will mature or be sold before its amortized cost basis can be recovered. For debt securities, the Company also considers the cause of the price decline such as the general level of interest rates and industry
and issuer-specific factors, the issuers financial condition, near-term prospects and current ability to make future payments in a timely manner, the issuers ability to service debt, any change in agencies ratings at evaluation
date from acquisition date and any likely imminent action, and for asset-backed securities, the credit performance of the underlying collateral, including delinquency rates, cumulative losses to date, and the remaining credit enhancement compared to
expected credit losses. Additionally, in determining if there is evidence of credit deterioration, the Company evaluates the severity of decline in market value below cost, the period of time for which the decline in fair value has existed, and
the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer.



Unamortized premiums and discounts are recognized in interest income over the contractual life of the security using the interest method.
As principal repayments are received on securities (primarily mortgage-backed securities) a pro-rata portion of the unamortized premium or discount is recognized in interest income. Accretion of unamortized discounts is discontinued for investment
securities that fall below investment grade.



Mortgage Loans Held for Sale



Residential mortgage loans originated with the intent of sale are reported at the lower of cost or estimated fair value on an aggregate
loan basis. Net unrealized losses, if necessary, are provided for through a valuation allowance charged to income. Gains or losses realized on the sale of residential mortgage loans are recognized at the time of sale and are determined as the
difference between the net sale proceeds and the carrying value of loans sold.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Commercial Loans Held for Sale



Commercial loans held for sale are classified as held for
sale based on the Companys intent to sell such loans. These loans are carried at the lower of cost or fair value less estimated selling costs. A valuation allowance is recorded against the loans held for sale for the excess of the recorded
investment in the loan and the fair value less estimated selling costs. Loans which the Company subsequently determines will not be sold are transferred back to the loans held for investment portfolio at the lower of cost or fair value less
estimated selling costs. For additional information regarding fair value estimates and methodologies, see Note 19, Disclosures Regarding Fair Value.



Loans



Loans are reported at their outstanding principal balances net of any unearned income, charge-offs, and unamortized deferred fees and
costs on originated loans. Unearned income, deferred fees and costs, and discounts and premiums are amortized to income over the contractual life of the loan.



Past due and delinquent status is based on contractual terms. Interest on loans deemed past due continues to accrue until the loan is
placed in nonaccrual status.



The accrual of
interest is discontinued when it is determined there is a more than normal risk of future uncollectibility. In most cases, loans are automatically placed in nonaccrual status by the loan system when the loan payment becomes 90 days delinquent and no
acceptable arrangement has been made between the Company and the borrower. The accrual of interest on some loans, however, may continue even after the loan becomes 90 days delinquent in special circumstances deemed appropriate by the Company. Loans
may be manually placed in nonaccrual status if it is determined that some factor other than delinquency (such as imminent foreclosure or bankruptcy proceedings) causes the Company to believe that more than a normal amount of risk exists with regard
to collectability. When the loan is placed in nonaccrual status, accrued interest receivable is reversed. Thereafter, any cash payments received on the nonaccrual loan are applied as a principal reduction until the entire amortized cost has been
recovered. Any additional amounts received are reflected in interest income. Loans are returned to accrual status when the loan is brought current and ultimate collectability of principal and interest is no longer in doubt.



In situations where, for economic or legal reasons related to
a borrowers financial difficulties, a concession to the borrower is granted that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring. The restructuring of a loan may include the transfer
from the borrower to the Company of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan, a modification of the loan terms, or a combination of the above. The
accrual of interest continues on a troubled debt restructuring as long as the loan is performing in accordance with the restructured terms.



Nonrefundable fees and certain direct costs associated with the origination of loans are deferred and recognized as a yield adjustment
over the contractual life of the related loans, or if the related loan is held for sale, until the loan is sold. Recognition of deferred fees and costs is discontinued on nonaccrual loans until they return to accrual status or are charged-off.



Allowance for Loan Losses



The allowance for loan losses represents an amount that the
Company believes will be adequate to absorb probable losses inherent in the loan portfolio as of the balance sheet date. Assessing the adequacy of the allowance for loan losses is a process requiring considerable judgment. Such judgment is
based on evaluations of



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of the overall loan portfolio; economic conditions that may
impact the overall loan portfolio or an individual borrowers ability to repay; the amount and quality of collateral securing the loans; its historical loan loss experience; and borrower and collateral specific considerations for loans
individually evaluated for impairment.



The
allowance for loan losses is a reserve established through a provision for loan losses charged to expense. The allowance for loan losses represents the Companys best estimate of probable losses that have been incurred within the existing
portfolio of loans. The allowance for loan losses is necessary to reserve for estimated probable loan losses inherent in the loan portfolio. The Companys allowance for loan losses methodology is based on historical loss experience by loan
type, specific homogeneous risk pools, and specific loss allocations. The Companys process for determining the appropriate level of the allowance for loan losses is designed to account for asset deterioration as it occurs. The provision for
loan losses reflects loan quality trends, including the levels of and trends related to nonaccrual loans, potential problem loans, criticized loans, and loans charged-off or recovered, among other factors.



The level of the allowance for loan losses reflects the
Companys continuing evaluation of specific lending risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. Lending
risks are driven primarily by the type of loans within the portfolio.



Portions of the allowance for loan losses may be allocated for specific loans. However, the entire allowance for loan losses is available for any loan that, in the Companys judgment, should be
charged-off. While the Company utilizes its best judgment and information available, the ultimate adequacy of the allowance for loan losses is dependent upon a variety of factors beyond its control, including the performance of the loan portfolio,
the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications and collateral valuation.



An allowance for loan losses on specific loans is recorded for an impaired loan when, based on current information and events, it is
probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. Specific allowances for loans considered individually significant and that exhibit probable or observed weaknesses are determined by
analyzing the borrowers ability to repay amounts owed, guarantor support, collateral deficiencies, the relative risk rating of the loan, and economic conditions impacting the borrowers industry, among other things.



The starting point for the general component of the allowance
is the historical loss experience of specific types of loans. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual loan net charge-offs to the total population of
loans in the pool. The Company uses a five-year look-back period when computing historical loss rates. Given the increase in charge-offs beginning in 2009, the Company also utilized a three-year look-back period during 2010 for computing historical
loss rates as an additional reference point in determining the allowance for loan losses.



Historical loss percentages are adjusted for qualitative environmental factors derived from macroeconomic indicators and other factors. Qualitative factors considered in the determination of the
December 31, 2010 and 2009 allowance for loan losses include pervasive factors that generally impact borrowers across the loan portfolio (such as unemployment and consumer price index) and factors that have specific implications to particular
loan portfolios (such as residential home sales or commercial development). Factors evaluated may include changes in delinquent, nonaccrual and troubled debt restructuring loan trends, trends in risk ratings and net loans charged-off, concentrations
of credit, competition and legal and regulatory requirements, trends in the



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



nature and volume of the loan portfolio, national and local economic and business conditions, collateral valuations, the experience and depth of lending management, lending policies and
procedures, underwriting standards and practices, the quality of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other external factors. The general reserve calculated using the historical loss rates and
qualitative factors is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.



Loans identified as losses by management, internal loan
review, and / or bank examiners are charged-off. Each impaired loan is reviewed on a loan-by-loan basis to determine whether the impairment should be recorded as a charge-off or a reserve based on an assessment of the status of the borrower and the
underlying collateral. In general, for collateral dependent loans, any impairment is recorded as a charge-off unless the fair value was based on an internal valuation pending receipt of a third party appraisal or other extenuating circumstances.
Consumer loan accounts are generally charged-off based on pre-defined past due time periods.



Reserve for Unfunded Commitments



The Company estimates probable losses related to unfunded lending commitments. The methodology to determine such losses is inherently similar to the methodology utilized in calculating the allowance for
loan losses; however, commitments have fixed expiration dates and most of the Companys commitments to extend credit have adverse change clauses that allow the Bank to cancel the commitments based on various factors, including deterioration in
the creditworthiness of the borrower. Accordingly, many of the Companys loan commitments are expected to expire without being drawn upon and therefore the total commitment amounts do not necessarily represent potential credit exposure. The
reserve for unfunded lending commitments is included in Other liabilities in the Consolidated Balance Sheets. Changes to the reserve for unfunded commitments are recorded through other noninterest expense in the Consolidated Statements of Income
(Loss).



Mortgage-Servicing Rights



The Company recognizes a mortgage-servicing
asset upon the sale of mortgage loans for which the Company retains the underlying servicing obligation. Mortgage-servicing assets are initially measured at fair value and amortized to expense over the estimated life of the servicing obligation.



The fair value of mortgage-servicing rights is
determined at the date of sale using the present value of estimated future net servicing income, using assumptions that market participants use in their estimates of values. The Company presents separately servicing assets and servicing liabilities,
which are subsequently measured at the lower of cost or fair value in the Consolidated Balance Sheets. Gain or loss on sale of mortgage loans is based on proceeds received, the value of any mortgage-servicing rights recognized, and the previous
carrying amount of the loans transferred and any interests the Company continues to hold based on relative fair value at the date of transfer. Mortgage-servicing rights are included in Other assets in the Consolidated Balance Sheets.



The Company utilizes a third party specialist to assist with
the quarterly determination of the fair value of its mortgage servicing rights, as well as capitalization, impairment, and amortization rates. Estimates of the amount and timing of prepayment rates, loan loss experience, costs to service loans, and
discount rates are used in the estimate of fair value. Amortization of mortgage servicing rights is based on the ratio of net servicing income received in the current period to total net servicing income projected to be realized. Projected net
servicing income is determined based on the estimated future balance of the underlying mortgage loan portfolio as it declines over time from prepayments and scheduled loan amortization. Future prepayment rates are estimated based on current interest
rate levels, other economic conditions, market forecasts, and relevant characteristics of the mortgage-servicing rights portfolio such as loan types, interest rate stratification, and recent prepayment experience. The Company believes that the
modeling techniques and assumptions used are reasonable.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Impairment valuations are based on projections using a discounted cash flow method that
includes assumptions regarding prepayments, interest rates, servicing costs, and other factors. Impairment is measured on a disaggregated basis for each stratum of the mortgage servicing rights, which is segregated based on predominate risk
characteristics, including interest rate and loan type. Subsequent increases in value are recognized to the extent of the previously recorded impairment.



Premises and Equipment, net



Land is reported at cost. Building and improvements, furniture and equipment, and software are carried at cost, less accumulated
depreciation, computed principally by the straight-line method based on the estimated useful lives of the related asset. Estimated lives range from twelve to thirty-nine years for buildings and improvements and from five to twelve years for
furniture and equipment. Estimated lives range from three to five years for computer software. Estimated lives of Bank automobiles are typically five years. Leasehold improvements are generally depreciated over the lesser of the lease term or the
estimated useful lives of the improvements.



Maintenance and repairs of such premises and equipment are charged to expense as incurred. Improvements that extend the useful lives of
the respective assets are capitalized.



Impairment of Long-Lived Assets



The Company periodically reviews the carrying value of its long-lived assets including, but not limited to, premises and equipment, for
impairment when events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be held and used, impairments are recognized when the carrying amount of a long-lived asset is not
recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss is
the amount by which the carrying amount of a long-lived asset exceeds its fair value.



Long-lived assets to be sold are classified as held for sale and are no longer depreciated. Certain criteria must be met in order for the long-lived asset to be classified as held for sale, including that
a sale is probable and expected to occur within a one year period. Long-lived assets classified as held for sale are recorded at the lower of carrying amount or fair value less estimated costs to sell.



The Company recorded no impairment loss relative to its
long-lived assets for the years ended December 31, 2010, 2009, and 2008.



Long-lived assets to be disposed of by abandonment or in an exchange for similar productive long-lived assets are classified as held for sale and used until disposed. The Company had no such assets at
December 31, 2010 or 2009.



Goodwill and
Core Deposit Intangibles



Goodwill represents
the excess of the cost of businesses acquired over the fair value of the net assets acquired. Goodwill is assigned to reporting units and is then tested for impairment at least annually, or on an interim basis if an event occurs or circumstances
arise that would more likely than not reduce the fair value of the reporting unit below its carrying value. The first step of the Companys goodwill impairment test, used to identify potential impairment, compares the fair value of its
reporting unit with its carrying amount, including goodwill. If the fair value of its reporting unit exceeds its carrying amount, goodwill is considered not impaired,



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



thus the second step of the impairment test is unnecessary. If the carrying amount of its reporting unit exceeds the fair value, the second step of the goodwill impairment test is performed to
measure the amount of impairment loss, if any. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If
the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. After a goodwill
impairment loss is recognized, the adjusted carrying amount of goodwill is its new accounting basis. Once an impairment loss is recognized, future increases in fair value do not result in the reversal of previously recognized losses. Based on an
impairment assessment, during the year ended December 31, 2010, the Company wrote-off the entire balance of its goodwill through a $3.7 million impairment charge.



Other intangible assets are acquired assets that lack
physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. The
Companys intangible assets related to core deposit intangibles were fully amortized in 2009.



Foreclosed Real Estate



Foreclosed real estate is carried at fair value less estimated selling costs, establishing a new cost basis. Fair value of such real estate is reviewed regularly and writedowns are recorded when it is
determined that the carrying value of the real estate exceeds the fair value less estimated costs to sell. Writedowns resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the
sale of foreclosed properties are charged to expense. Costs relating to the development and improvement of such property are capitalized.



Accumulated Other Comprehensive Loss



The Company discloses changes in comprehensive income in the Consolidated Statements of Changes in Shareholders Equity and
Comprehensive Income (Loss). Comprehensive income (loss) includes all changes in shareholders equity during a period except those resulting from transactions with shareholders.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table summarizes the components of accumulated other comprehensive loss,
net of tax impact, at the dates and for the periods indicated (in thousands).



|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|---------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                   |  | For the years ended December 31, |        
|                                                                                   |  | 2010                             |         |   | 2009 |   |         | 2008 | 
|Net Unrealized (Losses) Gains on Investment Securities Available for Sale          |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, beginning of year                                                         |  | $                                | 306     |   |      | $ | (1,621  | )    |  | $ | (252   | )
|Other comprehensive income (loss):                                                 |  |                                  |         |   |      |   |         |      |  |   |        |  
|Unrealized holding gains (losses) arising during the period                        |  |                                  | (64     | ) |      |   | 3,211   |      |  |   | (2,201 | )
|Income tax (expense) benefit                                                       |  |                                  | 24      |   |      |   | (1,216  | )    |  |   | 832    |  
|Less: Reclassification adjustment for (gains) losses included in net (loss) income |  |                                  | 1,608   |   |      |   | (104    | )    |  |   |       |  
|Income tax expense (benefit)                                                       |  |                                  | (610    | ) |      |   | 36      |      |  |   |       |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  |                                  | 958     |   |      |   | 1,927   |      |  |   | (1,369 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, end of year                                                               |  |                                  | 1,264   |   |      |   | 306     |      |  |   | (1,621 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net Unrealized (Losses) Gains on Impact of Defined Benefit Pension Plan            |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, beginning of year                                                         |  |                                  | (7,266  | ) |      |   | (4,496  | )    |  |   | (2,486 | )
|Other comprehensive loss:                                                          |  |                                  |         |   |      |   |         |      |  |   |        |  
|Impact of FASB ASC 715                                                             |  |                                  | (887    | ) |      |   | (4,261  | )    |  |   | (3,092 | )
|Income tax benefit                                                                 |  |                                  | 310     |   |      |   | 1,491   |      |  |   | 1,082  |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  |                                  | (577    | ) |      |   | (2,770  | )    |  |   | (2,010 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Balance, end of year                                                               |  |                                  | (7,843  | ) |      |   | (7,266  | )    |  |   | (4,496 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|                                                                                   |  | $                                | (6,579  | ) |      | $ | (6,960  | )    |  | $ | (6,117 | )
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Total other comprehensive income (loss), end of year                               |  | $                                | 381     |   |      | $ | (843    | )    |  | $ | (3,379 | )
|Net (loss) income                                                                  |  |                                  | (60,202 | ) |      |   | (40,085 | )    |  |   | 13,599 |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  
|Comprehensive (loss) income                                                        |  | $                                | (59,821 | ) |      | $ | (40,928 | )    |  | $ | 10,220 |  
|                                                                                   |  |                                  |         |   |      |   |         |      |  |   |        |  



Income Taxes



The Company files consolidated federal and state income tax
returns. Federal income tax expense or benefit has been allocated to subsidiaries on a separate return basis. The Company accounts for income taxes based on two components of income tax expense: current and deferred. Current income tax expense
approximates taxes to be paid or refunded for the current period and includes income tax expense related to uncertain tax positions, if any.



Deferred income taxes are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is based
on the tax impacts of the differences between the book and tax bases of assets and liabilities and recognizes enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax
assets and liabilities between periods.



Deferred
tax assets are recognized subject to the Companys judgment that realization is more likely than not. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize. The tax
position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Interest and penalties, if any, are recognized as a component of income tax expense.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The Company reviews the deferred tax assets for recoverability based on history of
earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income available under tax law, including future
reversals of existing temporary differences, future taxable income exclusive of reversing differences, taxable income in prior carryback years, projections of future operating results, cumulative tax losses over the past three years, tax loss
deductibility limitations, and available tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance against the deferred tax asset must
be established with a corresponding charge to income tax expense. The deferred tax assets and valuation allowance are evaluated each quarter, and a portion of the valuation allowance may be reversed in future periods. The determination of how much
of the valuation allowance that may be reversed and the timing is based on future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.



Net Income (Loss) per Common Share



Basic income (loss) per common share is based on net income
(loss) divided by the weighted average number of common shares outstanding during the period. Diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options,
result in the issuance of common stock that share in the income (loss) of the Company.



Potential common shares are not included in the denominator of the diluted per share computation when inclusion would be anti-dilutive. Accordingly, no potential common shares were included in the
computation of the diluted per share amount for the years ended December 31, 2010 or 2009.



Employee Benefit PlanDefined Benefit Pension Plan



Prior to 2008, the Company offered a noncontributory, defined benefit pension plan that covered all full-time employees having at least
twelve months of continuous service and having attained age 21. The plan was originally designed to produce a designated retirement benefit, and benefits were fully vested after five years of service. No vesting occurred until five years of service
had been achieved. In the fourth quarter of 2007, the Company notified employees that, effective 2008, it would cease accruing pension benefits for employees with regard to its noncontributory, defined benefit pension plan. Although no previously
accrued benefits were lost, employees no longer accrue benefits for service subsequent to 2007.



Until January 1, 2011, the Companys trust department administered the plans assets. The plans assets are now managed by third party administrator. Contributions to the plan are made
as required by the Employee Retirement Income Security Act of 1974.



The Company accounts for the plan using an actuarial model. This model allocates pension costs over the service period of employees in the plan. The underlying principle is that employees render services
ratably over this period and, therefore, the income statement impacts of pension benefits should follow a similar pattern.



The funded status of the Companys pension plan is recognized on the Consolidated Balance Sheets. The funded status is the difference
between the plan assets and the projected benefit obligation at the balance sheet date. For additional information regarding the defined benefit pension, see Note 14, Employee Benefit Plans.



Equity Based CompensationStock Option and Restricted Stock Plans



The Company accounts for employee stock options as
compensation expense in the income statement based on the fair value on the measurement date, which, for the Company, is the date of the grant. Compensation



134



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



expense is recognized over the vesting period of the related stock options. Fair value of stock options is estimated using an option pricing model that takes into account fair value of the
Companys stock, volatility measures, the grant-date level of interest rates, the term of the option and estimated pre-vesting forfeiture rates.



The value of restricted stock awards is established as the fair value of the stock at the time of the grant. Compensation expense for
restricted stock awards is measured at fair value and recognized in compensation expense over the service period. Forfeitures are accounted for by eliminating compensation expense for unvested shares as forfeitures occur. Shares of restricted stock
are subject to pro rata restrictions as to continuous employment for a specified time period following the date of grant, currently five years. During this period, the holder is entitled to full voting rights and dividends.



Derivative Financial Instruments



The Company recognizes all derivatives as either assets or
liabilities in the Consolidated Balance Sheets and measures those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the
derivative is held and whether the derivative qualifies for hedge accounting. The Company did not apply hedge accounting to any of its derivative instruments for the years ended December 31, 2010, 2009, or 2008.



The Company originates certain residential loans with the
intention of selling these loans. Between the time that it enters into an interest rate lock commitment to originate a residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market
prices related to these commitments. The Company also enters into forward sale agreements of to be issued loans. The commitments to originate residential loans and forward sales commitments are freestanding derivative instruments and are
recorded on the Consolidated Balance Sheets at fair value. Changes in fair value are recorded within Mortgage-banking in the Consolidated Statements of Income (Loss).



Fair Valuation Measurements



The Company provides disclosures about the fair value of
assets and liabilities recognized in the Consolidated Balance Sheets in periods subsequent to initial recognition, including whether the measurements are made on a recurring basis (for example, investment securities available-for-sale) or on a
nonrecurring basis (for example, impaired loans).



Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Under the fair value hierarchy, the Company is required to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. Three levels of inputs are used to measure fair value:



| |  |  | Level 1  quoted prices in active markets for identical assets or liabilities;
| | - |  | ------------------------------------------------------------------------------



| |  |  | Level 2  observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are
not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3  unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or
liabilities.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Disclosures about the fair value of all financial instruments whether or not recognized
in the Consolidated Balance Sheets for which it is practicable to estimate that value are required. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly impacted by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized through immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. For additional
information regarding fair value estimates and methodologies, see Note 19, Disclosures Regarding Fair Value.



Valuation of the Companys Common Stock



On a periodic basis, the Company utilizes the market price
of its common stock within various valuations and calculations relating to the defined benefit pension plan assets, trust department assets under management, employee retirement accounts, impairment analysis of goodwill, granting of awards under its
restricted stock plan, the calculation of diluted earnings per share, and the valuation of such stock serving as loan collateral.



The Companys common stock is not listed on an exchange or quoted on the OTC Bulletin Board. The Companys common stock is,
however, quoted on the Pink Sheets under the symbol PLMT.PK. Although the Companys common stock is quoted on the Pink Sheets, there is currently only a limited public trading market of the Companys common stock, and private
trading also has been limited. In addition, buyers and sellers may privately negotiate transactions. Because there is not an established market for the Companys common stock, it may not be aware of all prices at which the Companys common
stock has been traded. Additionally, the Company has not determined whether the trades of which it is aware were the result of arms-length negotiations between the parties. Accordingly, the Company normally determines the value of its common
stock based on the last five trades of the stock facilitated by the Company through the Private Trading System.



Recently Adopted Authoritative Pronouncements



In July 2010, the FASB issued ASU 2010-20 which expanded
disclosures related to allowance for credit losses and the credit quality of financing receivables. The amendments require the allowance and other credit quality disclosures to be provided on a disaggregated basis. The Company adopted the provisions
of this amendment as of December 31, 2010 (see Note 1, Summary of Significant Accounting Policies and Note 4, Loans). Disclosures about troubled debt restructurings required by ASU 2010-20 have been deferred by FASB in an update issued in early
2011. The troubled debt restructurings disclosures are anticipated to be effective for periods ending after June 15, 2011. The adoption of ASU 2010-20 had no impact on the Companys financial position, results of operations, or cash flows.



Applicable Authoritative Pronouncements Issued
Subsequent to December 31, 2010



No
authoritative pronouncements effective for financial reporting periods subsequent to December 31, 2010 have been issued that will have a material impact on the Companys financial position, results of operations, or cash flows.



|2. |  | Cash and Cash Equivalents
|-- |  | -------------------------



Noninterest-Earning Deposits with Financial Institutions



Included in the Cash and due from banks line item in the
Consolidated Balance Sheets at December 31, 2009 was $262 thousand of noninterest-earning deposits with financial institutions. There were no noninterest-earning deposits at December 31, 2010.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Required Reserve Balances



The Federal Reserve Act requires each depository institution
to maintain reserves against its reservable liabilities as prescribed by Federal Reserve regulations. The Bank reports its reservable liabilities to the Federal Reserve on a weekly basis. Weekly reporting institutions maintain reserves on their
reservable liabilities with a 30-day lag. For the maintenance period ended on January 12, 2011, based on reservable liabilities from November 30, 2010 through December 13, 2010, the Federal Reserve required the Bank to maintain
reserves of $11.6 million. After taking into consideration the Companys levels of vault cash, reserves of $2.2 million were required to be maintained with the Federal Reserve.



Concentrations and Restrictions.    In an effort to manage counterparty risk, the
Company generally does not sell federal funds to other financial institutions because they are essentially uncollateralized loans. The Company regularly evaluates the risk associated with the counterparties to these potential transactions to ensure
that it would not be exposed to any significant risks with regard to cash and cash equivalent balances.



Cash and cash equivalents pledged as collateral and therefore restricted at the dates indicated as follows (in thousands).



|                                |  |                  |     |  |                  |   |       | 
|------------------------------- |  | ---------------- | --- |  | ---------------- | - | ----- | 
|                                |  | December 31,2010 |     |  | December 31,2009 |  
|Secure a letter of credit       |  | $                |    |  |                  | $ | 512   | 
|Merchant credit card agreements |  |                  | 451 |  |                  |   | 836   | 
|                                |  |                  |     |  |                  |   |       | 
|Total                           |  | $                | 451 |  |                  | $ | 1,348 | 
|                                |  |                  |     |  |                  |   |       | 



|3. |  | Investment Securities Available for Sale
|-- |  | ----------------------------------------



The following tables summarize the amortized cost, gross unrealized gains included in accumulated other comprehensive income, gross
unrealized losses included in accumulated other comprehensive income, and fair values of investment securities available for sale at the dates indicated (in thousands). At December 31, 2010 and 2009 the Company did not have any investment
securities classified as held to maturity.



|                                               |  |                   |         |  |                      |   |       |                       |  |   |           |   |  |   |         | 
|---------------------------------------------- |  | ----------------- | ------- |  | -------------------- | - | ----- | --------------------- |  | - | --------- | - |  | - | ------- | 
|                                               |  | December 31, 2010 |        
|                                               |  | Amortizedcost     |         |  | Grossunrealizedgains |   |       | Grossunrealizedlosses |  |   | Fairvalue |  
|U.S. Treasury and federal agencies             |  | $                 | 37,430  |  |                      | $ | 2     |                       |  | $ | (6        | ) |  | $ | 37,426  | 
|State and municipal                            |  |                   | 51,243  |  |                      |   | 1,687 |                       |  |   | (468      | ) |  |   | 52,462  | 
|Collateralized mortgage obligations            |  |                   | 107,876 |  |                      |   | 671   |                       |  |   | (376      | ) |  |   | 108,171 | 
|Other mortgage-backed (federal agencies)       |  |                   | 20,189  |  |                      |   | 647   |                       |  |   | (120      | ) |  |   | 20,716  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |           |   |  |   |         | 
|Total investment securities available for sale |  | $                 | 216,738 |  |                      | $ | 3,007 |                       |  | $ | (970      | ) |  | $ | 218,775 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |           |   |  |   |         | 
|                                               | 
|                                               |  | December 31, 2009 |        
|                                               |  | Amortizedcost     |         |  | Grossunrealizedgains |   |       | Grossunrealizedlosses |  |   | Fairvalue |  
|U.S. Treasury and federal agencies             |  | $                 | 16,294  |  |                      | $ | 3     |                       |  | $ |          |   |  | $ | 16,297  | 
|State and municipal                            |  |                   | 44,908  |  |                      |   | 1,880 |                       |  |   | (3        | ) |  |   | 46,785  | 
|Collateralized mortgage obligations            |  |                   | 42,508  |  |                      |   | 168   |                       |  |   | (2,358    | ) |  |   | 40,318  | 
|Other mortgage-backed (federal agencies)       |  |                   | 15,783  |  |                      |   | 838   |                       |  |   | (35       | ) |  |   | 16,586  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |           |   |  |   |         | 
|Total investment securities available for sale |  | $                 | 119,493 |  |                      | $ | 2,889 |                       |  | $ | (2,396    | ) |  | $ | 119,986 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |           |   |  |   |         | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following tables summarize the number of securities in each category of investment
securities available for sale, the fair value, and the gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated (dollars in
thousands).



|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |           |   |  |                       |   |        |   |  |   |           |  |  |                       |    |  |  |   |        |  |  |   |       | 
|---------------------------------------------- |  | ------------------- | -- |  | ------------------- | - | ------ | --------------------- |  | - | --- |  |  | --------- | - |  | --------------------- | - | ------ | - |  | - | --------- |  |  | --------------------- | -- |  |  | - | ------ |  |  | - | ----- | 
|                                               |  | December 31, 2010   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fairvalue           |   |        | Grossunrealizedlosses |  |   | #   |  |  | Fairvalue |   |  | Grossunrealizedlosses |   |        | # |  |   | Fairvalue |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 2  |  |                     | $ | 21,428 |                       |  | $ | 6   |  |  |           |  |  |                       | $ |       |   |  | $ |          |  |  |                       | 2  |  |  | $ | 21,428 |  |  | $ | 6     | 
|State and municipal                            |  |                     | 12 |  |                     |   | 7,211  |                       |  |   | 468 |  |  |           |  |  |                       |   |       |   |  |   |          |  |  |                       | 12 |  |  |   | 7,211  |  |  |   | 468   | 
|Collateralized mortgage obligations            |  |                     | 10 |  |                     |   | 38,295 |                       |  |   | 376 |  |  |           |  |  |                       |   |       |   |  |   |          |  |  |                       | 10 |  |  |   | 38,295 |  |  |   | 376   | 
|Other mortgage-backed (federal agencies)       |  |                     | 3  |  |                     |   | 6,861  |                       |  |   | 120 |  |  |           |  |  |                       |   |       |   |  |   |          |  |  |                       | 3  |  |  |   | 6,861  |  |  |   | 120   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |           |   |  |                       |   |        |   |  |   |           |  |  |                       |    |  |  |   |        |  |  |   |       | 
|Total investment securities available for sale |  |                     | 27 |  |                     | $ | 73,795 |                       |  | $ | 970 |  |  |           |  |  |                       | $ |       |   |  | $ |          |  |  |                       | 27 |  |  | $ | 73,795 |  |  | $ | 970   | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |           |   |  |                       |   |        |   |  |   |           |  |  |                       |    |  |  |   |        |  |  |   |       | 
|                                               | 
|                                               |  | December 31, 2009   |   
|                                               |  | Less than 12 months |    |  | 12 months or longer |   |        | Total                 | 
|                                               |  | #                   |    |  | Fairvalue           |   |        | Grossunrealizedlosses |  |   | #   |  |  | Fairvalue |   |  | Grossunrealizedlosses |   |        | # |  |   | Fairvalue |  |  | Grossunrealizedlosses |   
|U.S. Treasury and federal agencies             |  |                     | 1  |  |                     | $ | 300    |                       |  | $ |    |  |  |           |  |  |                       | $ |       |   |  | $ |          |  |  |                       | 1  |  |  | $ | 300    |  |  | $ |      | 
|State and municipal                            |  |                     | 2  |  |                     |   | 662    |                       |  |   | 3   |  |  |           |  |  |                       |   |       |   |  |   |          |  |  |                       | 2  |  |  |   | 662    |  |  |   | 3     | 
|Collateralized mortgage obligations            |  |                     | 3  |  |                     |   | 10,323 |                       |  |   | 412 |  |  |           | 6 |  |                       |   | 16,624 |   |  |   | 1,946     |  |  |                       | 9  |  |  |   | 26,947 |  |  |   | 2,358 | 
|Other mortgage-backed (federal agencies)       |  |                     | 2  |  |                     |   | 1,444  |                       |  |   | 35  |  |  |           |  |  |                       |   |       |   |  |   |          |  |  |                       | 2  |  |  |   | 1,444  |  |  |   | 35    | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |           |   |  |                       |   |        |   |  |   |           |  |  |                       |    |  |  |   |        |  |  |   |       | 
|Total investment securities available for sale |  |                     | 8  |  |                     | $ | 12,729 |                       |  | $ | 450 |  |  |           | 6 |  |                       | $ | 16,624 |   |  | $ | 1,946     |  |  |                       | 14 |  |  | $ | 29,353 |  |  | $ | 2,396 | 
|                                               |  |                     |    |  |                     |   |        |                       |  |   |     |  |  |           |   |  |                       |   |        |   |  |   |           |  |  |                       |    |  |  |   |        |  |  |   |       | 



Other-Than-Temporary
Impairment



Based on its other-than-temporary
impairment analysis at December 31, 2010, the Company concluded that gross unrealized losses detailed in the preceding table were not other-than-temporarily impaired as of that date.



Based on the other-than-temporary impairment analysis at December 31, 2009, one collateralized mortgage
obligation with a fair value of $2.3 million and amortized cost of $3.3 million was other-than-temporarily impaired. This conclusion was based on the fair value of the security being below the amortized cost and the Companys analysis of
broker-provided fair values as verified by other external sources. Due to the fact that at the time of the analysis the Company did not intend to sell this security nor was it more likely than not that it would have to sell the security prior
to the recovery of its amortized cost basis less any current period credit loss, the amount of impairment related to credit loss was recognized in earnings and the amount of impairment related to other matters was recognized in other
comprehensive income. For the year ended December 31, 2009, a $49



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



thousand other-than-temporary credit impairment was recognized in Other noninterest expense in the Consolidated Statements of Income (Loss).



Ratings



The following table summarizes Moodys ratings, by
segment, of the investment securities available for sale based on fair value, at December 31, 2010. An Aaa rating is based not only on the credit of the issuer, but may also include consideration of the structure of the securities and the
credit quality of the collateral.



|                              |  |                                  |     |   |                    |  |     |                                   |  |  |                                         |   |  |  |     |  
|----------------------------- |  | -------------------------------- | --- | - | ------------------ |  | --- | --------------------------------- |  |  | --------------------------------------- | - |  |  | --- | -
|                              |  | U.S. Treasuryand federalagencies |     |   | State andmunicipal |  |     | Collateralizedmortgageobligations |  |  | Other mortgage-backed (federalagencies) |  
|Aaa                           |  |                                  | 100 | % |                    |  | 8   | %                                 |  |  | 100                                     | % |  |  | 100 | %
|Aa1-A1                        |  |                                  |    |   |                    |  | 64  |                                   |  |  |                                        |   |  |  |    |  
|Baa1                          |  |                                  |    |   |                    |  | 10  |                                   |  |  |                                        |   |  |  |    |  
|Not rated or withdrawn rating |  |                                  |    |   |                    |  | 18  |                                   |  |  |                                        |   |  |  |    |  
|                              |  |                                  |     |   |                    |  |     |                                   |  |  |                                         |   |  |  |     |  
|Total                         |  |                                  | 100 | % |                    |  | 100 | %                                 |  |  | 100                                     | % |  |  | 100 | %
|                              |  |                                  |     |   |                    |  |     |                                   |  |  |                                         |   |  |  |     |  



Of the state and municipal
investment securities not rated or with withdrawn ratings by Moodys at December 31, 2010, 24% were rated AAA by Standard and Poors, 47% were rated AA+, 22% were rated AA, 5% were rated AA-, and 2%, or $204 thousand, were not rated
by Standard and Poors.



Maturities



The following table summarizes the amortized
cost and estimated fair value of investment securities available for sale at December 31, 2010 by contractual maturity (in thousands). Expected maturities may differ from contractual maturities because issuers may have the right to call or
prepay obligations. Collateralized mortgage obligations and other mortgage-backed securities are shown separately since they are not due at a single maturity date.



|                                                    |  |               |         |  |           |   |         | 
|--------------------------------------------------- |  | ------------- | ------- |  | --------- | - | ------- | 
|                                                    |  | Amortizedcost |         |  | Fairvalue |  
|Due in one year or less                             |  | $             | 40,819  |  |           | $ | 40,845  | 
|Due after one year through five years               |  |               | 24,924  |  |           |   | 26,134  | 
|Due after five year through ten years               |  |               | 13,220  |  |           |   | 13,608  | 
|Due after ten years                                 |  |               | 9,710   |  |           |   | 9,301   | 
|Collateralized mortgage obligations                 |  |               | 107,876 |  |           |   | 108,171 | 
|Other mortgage-backed securities (federal agencies) |  |               | 20,189  |  |           |   | 20,716  | 
|                                                    |  |               |         |  |           |   |         | 
|Total investment securities available for sale      |  | $             | 216,738 |  |           | $ | 218,775 | 
|                                                    |  |               |         |  |           |   |         | 



The weighted average life of
investment securities available for sale was 3.0 years, based on expected prepayment activity, at December 31, 2010. Since 59% of the portfolio, based on amortized cost, is collateralized mortgage obligations or other mortgage-backed
securities, the expected remaining maturity may differ from contractual maturity because borrowers generally have the right to prepay obligations before the underlying mortgages mature.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Pledged



Public depositors from state and local municipalities
typically require that the Bank pledge investment grade securities to the accounts to ensure repayment. Although the funds are usually a low cost, relatively stable source of funding for the Bank, availability depends on the particular
governments fiscal policies and cash flow needs.



Investments securities were pledged as collateral for the following at the dates indicated (in thousands).



|                                       |  |                  |         |  |                  |   |         | 
|-------------------------------------- |  | ---------------- | ------- |  | ---------------- | - | ------- | 
|                                       |  | December 31,2010 |         |  | December 31,2009 |  
|Public funds deposits                  |  | $                | 67,260  |  |                  | $ | 73,185  | 
|Federal funds from correspondent banks |  |                  |        |  |                  |   | 6,300   | 
|FHLB advances and line of credit       |  |                  | 48,344  |  |                  |   | 29,767  | 
|                                       |  |                  |         |  |                  |   |         | 
|Total                                  |  | $                | 115,604 |  |                  | $ | 109,252 | 
|                                       |  |                  |         |  |                  |   |         | 



Concentrations



The following table summarizes issuer
concentrations of collateralized mortgage obligations whose aggregate book values exceed 10% of shareholders equity at December 31, 2010 (dollars in thousands).



|            |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|----------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer      |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Freddie Mac |  | $                   | 30,226 |  |                         | $ | 30,112 |                                              |  |  | 26.4 | %
|Fannie Mae  |  |                     | 24,930 |  |                         |   | 24,934 |                                              |  |  | 21.9 | %
|Ginnie Mae  |  |                     | 50,387 |  |                         |   | 50,394 |                                              |  |  | 44.2 | %



The following table summarizes issuer concentrations of other mortgage-backed investment securities whose book values exceed 10% of shareholders equity at December 31, 2010 (dollars in
thousands).



|           |  |                     |        |  |                         |   |        |                                              |  |  |      |  
|---------- |  | ------------------- | ------ |  | ----------------------- | - | ------ | -------------------------------------------- |  |  | ---- | -
|Issuer     |  | Aggregatefair value |        |  | Aggregateamortized cost |   |        | Amortized cost as a % ofshareholders equity | 
|Fannie Mae |  | $                   | 15,523 |  |                         | $ | 15,014 |                                              |  |  | 13.2 | %



Realized Gains and Losses



The following table summarizes the gross realized gains and losses on investment securities available for sale for the periods indicated (in thousands).



|                   |  |                                 |        |   |      |   |   |      |  |   |   | 
|------------------ |  | ------------------------------- | ------ | - | ---- | - | - | ---- |  | - | - | 
|                   |  | For the years endedDecember 31, |       
|                   |  | 2010                            |        |   | 2009 |   |   | 2008 | 
|Realized gains     |  | $                               | 1,149  |   |      | $ | 2 |      |  | $ | 1 | 
|Realized losses    |  |                                 | (1,139 | ) |      |   |  |      |  |   |  | 
|                   |  |                                 |        |   |      |   |   |      |  |   |   | 
|Net realized gains |  | $                               | 10     |   |      | $ | 2 |      |  | $ | 1 | 
|                   |  |                                 |        |   |      |   |   |      |  |   |   | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|4. |  | Loans
|-- |  | -----



Disclosure guidance related to a companys allowance for loan losses and the credit quality of its financing receivables require the
loans and allowance for loan losses disclosures to be provided on a disaggregated basis. This disaggregated basis has been defined as portfolio segments, the level at which the Company develops and documents its methodology to determine its
allowance for loan losses, and classes, a level of information below the portfolio segment that provides an understanding as to the nature and extent of exposure in our loan portfolio. For reporting purposes, loan classes are based on FDIC code, and
portfolio segments are an aggregation of those classes based on the methodology used by the Company to develop and document its allowance for loan losses. FDIC codes are based on the underlying loan collateral.



The tabular disclosures in this Note include amounts related
to commercial loans held for sale, which are reported separately from our gross loan portfolio on the Consolidated Balance Sheets and are subject to different accounting and reporting requirements. Inclusion of commercial loans held for sale with
the related disclosures for loans held for investment provides a more accurate and relevant picture of the Companys loan exposures given the relative size and characteristics of commercial loans held for sale.



The following table summarizes gross loans, categorized by
portfolio segment, at the dates indicated (dollars in thousands).



|                                     |  |                   |         |   |                   |  |       |       |  |   |            |  |  |  |       |  
|------------------------------------ |  | ----------------- | ------- | - | ----------------- |  | ----- | ----- |  | - | ---------- |  |  |  | ----- | -
|                                     |  | December 31, 2010 |         |   | December 31, 2009 | 
|                                     |  | Total             |         |   | % of total        |  |       | Total |  |   | % of total | 
|Commercial real estate               |  | $                 | 573,822 |   |                   |  | 66.8  | %     |  | $ | 695,263    |  |  |  | 66.8  | %
|Single-family residential            |  |                   | 178,980 |   |                   |  | 20.8  |       |  |   | 203,330    |  |  |  | 19.6  |  
|Commercial and industrial            |  |                   | 47,812  |   |                   |  | 5.6   |       |  |   | 61,788     |  |  |  | 5.9   |  
|Consumer                             |  |                   | 52,652  |   |                   |  | 6.1   |       |  |   | 76,296     |  |  |  | 7.3   |  
|Other                                |  |                   | 6,317   |   |                   |  | 0.7   |       |  |   | 3,635      |  |  |  | 0.4   |  
|                                     |  |                   |         |   |                   |  |       |       |  |   |            |  |  |  |       |  
|Total loans                          |  | $                 | 859,583 |   |                   |  | 100.0 | %     |  | $ | 1,040,312  |  |  |  | 100.0 | %
|                                     |  |                   |         |   |                   |  |       |       |  |   |            |  |  |  |       |  
|Less: Commercial loans held for sale |  |                   | (66,157 | ) |                   |  |       |       |  |   |           |  |  |  |       |  
|                                     |  |                   |         |   |                   |  |       |       |  |   |            |  |  |  |       |  
|Loans, gross                         |  | $                 | 793,426 |   |                   |  |       |       |  | $ | 1,040,312  |  |  |  |       |  
|                                     |  |                   |         |   |                   |  |       |       |  |   |            |  |  |  |       |  



Loans included in the
preceding loan composition table are net of participations sold, unearned income, charge-offs, and unamortized deferred fees and costs on originated loans. Participations sold totaled $12.5 million at both December 31, 2010 and 2009. Unearned
income, deferred fees and costs, and discounts and premiums totaled $299 thousand and $452 thousand at December 31, 2010 and 2009, respectively.



Credit Card Portfolio



In December 2010, the Company sold its credit card portfolio for a net gain of $1.2 million and entered into a joint marketing agreement
with the buyer. Certain accounts, primarily accounts of deceased cardholders, seriously delinquent accounts, accounts in bankruptcy and lost/stolen/fraud accounts, were specifically excluded from the sale under terms of the sale agreement. Of the
$12.8 million of balances sold, approximately $508 thousand of such accounts were sold subject to a one year recourse provision. Under the terms of the recourse provision, the Company is obligated to repurchase these balances if the buyer incurs a
loss on such accounts during the recourse period. The repurchase price is equal to the amount of the loss plus the associated premium paid on such balance and at December 31, 2010 the estimated liability with respect to the recourse obligation
was $139 thousand.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Pledged



To borrow from the FHLB, members must pledge collateral.
Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. At December 31, 2010 and 2009, $346.3 million and $407.0 million of gross
loans were pledged to collateralize FHLB advances and letters of credit, respectively, of which $92.5 million and $162.0 million, respectively, was available as lendable collateral.



At December 31, 2010 and December 31, 2009, $10.9 million and $108.8 million, respectively, of loans
were pledged as collateral to cover the various Federal Reserve System services that are available for use by the Company. The maximum maturity for potential borrowings is overnight. Any future potential borrowings from the Federal Reserve Discount
Window would be at the secondary credit rate and must be used for operational issues. The Federal Reserve has the discretion to deny approval of borrowing requests.



Concentrations



The following table summarizes loans secured by commercial
real estate, categorized by FDIC code, at December 31, 2010 (dollars in thousands). Of the aggregate balance of commercial loans held for sale, 98.6% are commercial real estate loans based on FDIC code.



|                                                     |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|---------------------------------------------------- |  | ------------------------------------------- | ------- |  | -------------------------------------------------------------- | - | ------ | ------------------------------- |  | - | ----------------------------------------------- |  |  | ---------------------------------- | ---- | - |  |  | ----- | -
|                                                     |  | Commercialreal estateincluded ingross loans |         |  | Commercial realestate included incommercial loansheld for
sale |   |        | Totalcommercialreal estateloans |  |   | % of grossloans andcommercialloans heldfor sale |  |  | % of Bankstotal regulatorycapital |     
|Secured by commercial real estate                    |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Construction, land development, and other land loans |  | $                                           | 125,331 |  |                                                                | $ | 11,122 |                                 |  | $ | 136,453                                         |  |  |                                    | 15.9 | % |  |  | 104.5 | %
|Multifamily residential                              |  |                                             | 18,327  |  |                                                                |   | 7,943  |                                 |  |   | 26,270                                          |  |  |                                    | 3.1  |   |  |  | 20.1  |  
|Nonfarm nonresidential                               |  |                                             | 364,939 |  |                                                                |   | 46,160 |                                 |  |   | 411,099                                         |  |  |                                    | 47.8 |   |  |  | 314.7 |  
|                                                     |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Total loans secured by commercial real estate        |  | $                                           | 508,597 |  |                                                                | $ | 65,225 |                                 |  | $ | 573,822                                         |  |  |                                    | 66.8 | % |  |  | 439.3 | %
|                                                     |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table further categorizes loans secured by commercial real estate at
December 31, 2010 (dollars in thousands).



|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|----------------------------------------------------------------- |  | ------------------------------------------- | ------- |  | -------------------------------------------------------------- | - | ------ | ------------------------------- |  | - | ----------------------------------------------- |  |  | ---------------------------------- | ---- | - |  |  | ----- | -
|                                                                  |  | Commercialreal estateincluded ingross loans |         |  | Commercial realestate included incommercial loansheld for
sale |   |        | Totalcommercialreal estateloans |  |   | % of grossloans andcommercialloans heldfor sale |  |  | % of Bankstotal regulatorycapital |     
|Development commercial real estate loans                          |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Landunimproved (commercial or residential)                       |  | $                                           | 46,286  |  |                                                                | $ | 2,174  |                                 |  | $ | 48,460                                          |  |  |                                    | 5.7  | % |  |  | 37.1  | %
|Land developmentcommercial                                       |  |                                             | 12,676  |  |                                                                |   | 463    |                                 |  |   | 13,139                                          |  |  |                                    | 1.5  |   |  |  | 10.1  |  
|Land developmentresidential                                      |  |                                             | 45,858  |  |                                                                |   | 7,939  |                                 |  |   | 53,797                                          |  |  |                                    | 6.3  |   |  |  | 41.2  |  
|Commercial construction:                                          |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Retail                                                            |  |                                             | 4,425   |  |                                                                |   |       |                                 |  |   | 4,425                                           |  |  |                                    | 0.5  |   |  |  | 3.4   |  
|Office                                                            |  |                                             | 241     |  |                                                                |   |       |                                 |  |   | 241                                             |  |  |                                    |     |   |  |  | 0.2   |  
|Multifamily                                                       |  |                                             | 1,693   |  |                                                                |   |       |                                 |  |   | 1,693                                           |  |  |                                    | 0.2  |   |  |  | 1.3   |  
|Industrial and warehouse                                          |  |                                             | 947     |  |                                                                |   |       |                                 |  |   | 947                                             |  |  |                                    | 0.1  |   |  |  | 0.7   |  
|Miscellaneous commercial                                          |  |                                             | 3,275   |  |                                                                |   |       |                                 |  |   | 3,275                                           |  |  |                                    | 0.4  |   |  |  | 2.4   |  
|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Total development commercial real estate loans                    |  |                                             | 115,401 |  |                                                                |   | 10,576 |                                 |  |   | 125,977                                         |  |  |                                    | 14.7 |   |  |  | 96.4  |  
|Existing and other commercial real estate loans                   |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Hotel / motel                                                     |  |                                             | 62,036  |  |                                                                |   | 33,533 |                                 |  |   | 95,569                                          |  |  |                                    | 11.1 |   |  |  | 73.2  |  
|Retail                                                            |  |                                             | 17,650  |  |                                                                |   | 6,375  |                                 |  |   | 24,025                                          |  |  |                                    | 2.8  |   |  |  | 18.4  |  
|Office                                                            |  |                                             | 23,469  |  |                                                                |   | 1,656  |                                 |  |   | 25,125                                          |  |  |                                    | 2.9  |   |  |  | 19.2  |  
|Multifamily                                                       |  |                                             | 18,327  |  |                                                                |   | 7,943  |                                 |  |   | 26,270                                          |  |  |                                    | 3.1  |   |  |  | 20.1  |  
|Industrial and warehouse                                          |  |                                             | 11,538  |  |                                                                |   | 1,488  |                                 |  |   | 13,026                                          |  |  |                                    | 1.5  |   |  |  | 10.0  |  
|Healthcare                                                        |  |                                             | 13,008  |  |                                                                |   |       |                                 |  |   | 13,008                                          |  |  |                                    | 1.5  |   |  |  | 10.0  |  
|Miscellaneous commercial                                          |  |                                             | 119,191 |  |                                                                |   | 2,637  |                                 |  |   | 121,828                                         |  |  |                                    | 14.2 |   |  |  | 93.3  |  
|Residential constructionspeculative                              |  |                                             | 820     |  |                                                                |   | 546    |                                 |  |   | 1,366                                           |  |  |                                    | 0.2  |   |  |  | 1.0   |  
|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Total existing and other commercial real estate loans             |  |                                             | 266,039 |  |                                                                |   | 54,178 |                                 |  |   | 320,217                                         |  |  |                                    | 37.3 |   |  |  | 245.2 |  
|Commercial real estate owner occupied and residential loans       |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Secured by:                                                       |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Commercialowner occupied                                         |  |                                             | 118,046 |  |                                                                |   | 471    |                                 |  |   | 118,517                                         |  |  |                                    | 13.8 |   |  |  | 90.7  |  
|Commercial constructionowner occupied                            |  |                                             | 3,525   |  |                                                                |   |       |                                 |  |   | 3,525                                           |  |  |                                    | 0.4  |   |  |  | 2.7   |  
|Residential constructioncontract                                 |  |                                             | 5,586   |  |                                                                |   |       |                                 |  |   | 5,586                                           |  |  |                                    | 0.6  |   |  |  | 4.3   |  
|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Total commercial real estate owner occupied and residential loans |  |                                             | 127,157 |  |                                                                |   | 471    |                                 |  |   | 127,628                                         |  |  |                                    | 14.8 |   |  |  | 97.7  |  
|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  
|Total loans secured by commercial real estate                     |  | $                                           | 508,597 |  |                                                                | $ | 65,225 |                                 |  | $ | 573,822                                         |  |  |                                    | 66.8 | % |  |  | 439.3 | %
|                                                                  |  |                                             |         |  |                                                                |   |        |                                 |  |   |                                                 |  |  |                                    |      |   |  |  |       |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Asset Quality



The Companys loan portfolio is currently weighted toward commercial real estate lending. Commercial real
estate loans have higher risks than other real estate loans because repayment is sensitive to interest rate changes, governmental regulation of real property, general economic and market conditions, and the availability of long-term financing
particularly in the current economic environment. Commercial and industrial loans are generally secured by the assets being financed or other business assets, such as accounts receivable or inventory, and generally incorporate a personal guarantee.
In the case of loans secured by accounts receivable or inventory, the availability of funds for repayment of these loans may depend substantially on the ability of the borrower to collect amounts due from its customers or to liquidate inventory at
sufficient prices. Underwriting standards for single-family real estate purpose loans are heavily regulated by statutory requirements. However, these loans have risks associated with declines in collateral value. Many consumer loans are unsecured
and depend solely on the borrowers availability of funds for the repayment of the loans.



Credit Quality Indicators.    The Company regularly monitors the credit quality of its loan portfolio. Credit quality refers to the current and expected ability of borrowers to
repay their obligations according to the contractual terms of such loans. Credit quality is evaluated through assignment of individual loan grades, as well as past-due and performing status analysis. Credit quality indicators allow the Company to
assess the inherent loss on certain individual and pools of loans.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The Company uses an internal risk rating system to classify and monitor the credit
quality of all commercial loans. Loan risk ratings are based on a graduated scale representing increasing likelihood of loss. Responsibility for the assignment of risk ratings to commercial loans rests with the individual loan officer assigned to
each loan, subject to verification by the Credit Administration department that is independent of the loan officers. Risk ratings are also reviewed periodically by an independent third party loan review firm that reports directly to the Board of
Directors. Individual loan officers are also responsible for ensuring risk ratings remain appropriate over the life of the loan. Loan risk ratings are summarized as follows:



|           |  |                  |  |                                                                                                                                                                                                                                                                                                                                
|---------- |  | ---------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|RiskRating |  | Description      |  | Specific Characteristics                                                                                                                                                                                                                                                                                                       
|1          |  | Superior Quality |  | Fully secured by liquid collateral held at the Company                                                                                                                                                                                                                                                                         
|2          |  | High Quality     |  | Secured loans to public companies with satisfactory credit ratings and financial strength
or secured by properly margined public securities                                                                                                                                                                                    
|3          |  | Satisfactory     |  | Loans with reasonable credit risk to borrowers with satisfactory credit and financial
strength; may include unsecured loans with defined primary and secondary repayment sources                                                                                                                                               
|4          |  | Pass             |  | Loans with an elevated credit risk to borrowers with an adequate credit history and
financial strength; includes loans with inherent industry risk with support from principals and/or guarantors                                                                                                                              
|W          |  | Watch            |  | Loans with an elevated credit risk to borrowers with an adequate credit history and
financial strength and are experiencing declining trends (e.g., financial, economic, or industry specific)                                                                                                                                 
|5          |  | Special Mention  |  | Loans with potential credit weakness that deserve management attention; if left
uncorrected, these potential weaknesses may result in deterioration of repayment prospects for the loan                                                                                                                                        
|6          |  | Substandard      |  | Loans inadequately protected by the current sound worth and paying capacity of the
borrower or of the collateral pledged; have well-defined weaknesses that jeopardize the liquidation of the loan; distinct possibility that the Company will sustain some loss if the deficiencies are not corrected                         
|7          |  | Doubtful         |  | Loans with all the weaknesses of Substandard with additional factors that make
collection or liquidation in full highly questionable and improbable; generally these loans are placed on nonaccrual status                                                                                                                   
|8          |  | Loss             |  | Loans considered uncollectible that are immediately charged-off; some recovery may exist,
but the probability of such recovery does not warrant reflecting the loan as an asset                                                                                                                                                
|NR         |  | Not Rated        |  | Primarily consists of individual consumer loans not assigned a risk rating in accordance
with the Companys Loan Policy. Also, commercial loans in process for which an assigned risk rating has not yet been determined; underwriting steps are currently being taken to determine the appropriate risk rating to be
assigned.



Credit quality of the
consumer loan portfolio is monitored through review of delinquency measures and nonaccrual levels on a portfolio-level basis. The Companys policy for placing loans on nonaccrual discussed in Note 1. Summary of Significant Accounting Policies.
Higher levels of amounts past due and loans on nonaccrual are indicative of increased credit risk and higher potential inherent losses within these loan portfolios.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table summarizes the Companys internal credit quality indicators on
gross loans, by class, at December 31, 2010 (in thousands).



|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------------------------------- | ------- |  | ---------------------- | - | ------ | --------------------- |  | - | ---------------------------------------------------- |  |  | -------------------------- | ------ |  |  | - | ------- | -
|                                                                        |  | Construction, landdevelopment andother land loans |         |  | Multifamilyresidential |   |        | Nonfarmnonresidential |  |   | Commercialreal estate incommercialloans heldfor sale |  |  | Totalcommercialreal estate |       
|Grade 1                                                                 |  | $                                                 | 53      |  |                        | $ |       |                       |  | $ |                                                     |  |  | $                          |       |  |  | $ | 53      |  
|Grade 2                                                                 |  |                                                   |        |  |                        |   |       |                       |  |   | 834                                                  |  |  |                            |       |  |  |   | 834     |  
|Grade 3                                                                 |  |                                                   | 13,188  |  |                        |   | 3,728  |                       |  |   | 131,695                                              |  |  |                            |       |  |  |   | 148,611 |  
|Grade 4                                                                 |  |                                                   | 9,146   |  |                        |   | 549    |                       |  |   | 99,182                                               |  |  |                            |       |  |  |   | 108,877 |  
|Grade W                                                                 |  |                                                   | 10,654  |  |                        |   | 1,085  |                       |  |   | 28,268                                               |  |  |                            |       |  |  |   | 40,007  |  
|Grade 5                                                                 |  |                                                   | 7,550   |  |                        |   | 11,168 |                       |  |   | 41,046                                               |  |  |                            | 4,114  |  |  |   | 63,878  |  
|Grade 6                                                                 |  |                                                   | 34,157  |  |                        |   | 1,769  |                       |  |   | 59,440                                               |  |  |                            | 42,450 |  |  |   | 137,816 |  
|Grade 7                                                                 |  |                                                   | 21,071  |  |                        |   |       |                       |  |   | 3,622                                                |  |  |                            | 18,661 |  |  |   | 43,354  |  
|Not risk rated*                                                         |  |                                                   | 29,512  |  |                        |   | 28     |                       |  |   | 852                                                  |  |  |                            |       |  |  |   | 30,392  |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   |         |  
|                                                                        |  | $                                                 | 125,331 |  |                        | $ | 18,327 |                       |  | $ | 364,939                                              |  |  | $                          | 65,225 |  |  | $ | 573,822 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   |         |  
|Less: Commercial real estate included in commercial loans held for sale |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   | (65,225 | )
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   |         |  
|Total                                                                   |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  | $ | 508,597 |  
|                                                                        |  |                                                   |         |  |                        |   |        |                       |  |   |                                                      |  |  |                            |        |  |  |   |         |  

|*- |  | Consumer real estate loans of $29.5 million, included within construction, land development, and other land loans, are not risk rated, in accordance with our policy
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------





|           |  |                          |        | 
|---------- |  | ------------------------ | ------ | 
|           |  | Commercial andindustrial |       
|Grade 1    |  | $                        | 1,932  | 
|Grade 2    |  |                          | 487    | 
|Grade 3    |  |                          | 22,027 | 
|Grade 4    |  |                          | 10,534 | 
|Grade W    |  |                          | 3,778  | 
|Grade 5    |  |                          | 1,171  | 
|Grade 6    |  |                          | 5,779  | 
|Grade 7    |  |                          | 1,736  | 
|Not graded |  |                          | 368    | 
|           |  |                          |        | 
|Total      |  | $                        | 47,812 | 
|           |  |                          |        | 



|                                                                                 |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   |         |  
|-------------------------------------------------------------------------------- |  | ------------------------------------------------ | ------ |  | --------------------------------------------- | - | ------- | ---------------------------------------------- |  | - | ------------------------------------------------------------- |  |  | ---------------------------------- | --- |  |  | - | ------- | -
|                                                                                 |  | Single-familyresidentialrevolving,open
 endloans |        |  | Single-familyresidentialclosed end,first lien |   |         | Single-familyresidentialclosed end,junior lien |  |   | Single-familyresidentialloans 
incommercialloans heldfor sale |  |  | Totalsingle-familyresidentialloans |    
|Performing                                                                       |  | $                                                | 58,874 |  |                                               | $ | 101,414 |                                                |  | $ | 8,289                                                         |  |  | $                                  |    |  |  | $ | 168,577 |  
|Nonperforming                                                                    |  |                                                  | 998    |  |                                               |   | 7,607   |                                                |  |   | 866                                                           |  |  |                                    | 932 |  |  |   | 10,403  |  
|                                                                                 |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   |         |  
|Total                                                                            |  | $                                                | 59,872 |  |                                               | $ | 109,021 |                                                |  | $ | 9,155                                                         |  |  | $                                  | 932 |  |  | $ | 178,980 |  
|                                                                                 |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   |         |  
|Less: Single-family residential loans included in commercial loans held for sale |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   | (932    | )
|                                                                                 |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   |         |  
|Total                                                                            |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  | $ | 178,048 |  
|                                                                                 |  |                                                  |        |  |                                               |   |         |                                                |  |   |                                                               |  |  |                                    |     |  |  |   |         |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|              |  |              |     |  |                |   |        |                |  |   |        | 
|------------- |  | ------------ | --- |  | -------------- | - | ------ | -------------- |  | - | ------ | 
|              |  | Credit cards |     |  | Consumer-other |   |        | Total Consumer | 
|Performing    |  | $            | 126 |  |                | $ | 52,041 |                |  | $ | 52,167 | 
|Nonperforming |  |              | 26  |  |                |   | 459    |                |  |   | 485    | 
|              |  |              |     |  |                |   |        |                |  |   |        | 
|Total         |  | $            | 152 |  |                | $ | 52,500 |                |  | $ | 52,652 | 
|              |  |              |     |  |                |   |        |                |  |   |        | 



|              |  |       |       | 
|------------- |  | ----- | ----- | 
|              |  | Other |      
|Performing    |  | $     | 6,317 | 
|Nonperforming |  |       |      | 
|              |  |       |       | 
|Total         |  | $     | 6,317 | 
|              |  |       |       | 

The following table summarizes delinquencies, by class, at December 31, 2010 (in thousands).



|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | ------------------ | ------ |  | ---------------------------------------- | - | ------- | -------------------------------------- |  | - | ------------- |  |  | ------- | ------- | - | ---------- | - | ------- | - |  | - | ------- | -
|                                                             |  | 30-89 DaysPast Due |        |  | Greater than90 Days PastDue onNonaccrual |   |         | RecordedInvestment> 90 DaysandAccruing |  |   | Total PastDue |  |  | Current |         |   | Totalloans |  
|Construction, land development and other land loans          |  | $                  | 7,240  |  |                                          | $ | 52,528  |                                        |  | $ |              |  |  | $       | 59,768  |   |            | $ | 76,686  |   |  | $ | 136,454 |  
|Multifamily residential                                      |  |                    |       |  |                                          |   | 7,943   |                                        |  |   |              |  |  |         | 7,943   |   |            |   | 18,327  |   |  |   | 26,270  |  
|Nonfarm nonresidential                                       |  |                    | 2,566  |  |                                          |   | 18,781  |                                        |  |   |              |  |  |         | 21,347  |   |            |   | 389,751 |   |  |   | 411,098 |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Total commercial real estate                                 |  |                    | 9,806  |  |                                          |   | 79,252  |                                        |  |   |              |  |  |         | 89,058  |   |            |   | 484,764 |   |  |   | 573,822 |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Single-family real estate, revolving, open end loans         |  |                    | 687    |  |                                          |   | 998     |                                        |  |   |              |  |  |         | 1,685   |   |            |   | 58,187  |   |  |   | 59,872  |  
|Single-family real estate, closed end, first lien            |  |                    | 3,004  |  |                                          |   | 7,607   |                                        |  |   |              |  |  |         | 10,611  |   |            |   | 99,342  |   |  |   | 109,953 |  
|Single-family real estate, closed end, junior lien           |  |                    | 280    |  |                                          |   | 866     |                                        |  |   |              |  |  |         | 1,146   |   |            |   | 8,009   |   |  |   | 9,155   |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Total single-family residential                              |  |                    | 3,971  |  |                                          |   | 9,471   |                                        |  |   |              |  |  |         | 13,442  |   |            |   | 165,538 |   |  |   | 178,980 |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Commercial and industrial                                    |  |                    | 371    |  |                                          |   | 2,197   |                                        |  |   | 68            |  |  |         | 2,636   |   |            |   | 45,176  |   |  |   | 47,812  |  
|                                                             |  |                    |        |  |                                          |  
|Credit cards                                                 |  |                    |       |  |                                          |   | 26      |                                        |  |   |              |  |  |         | 26      |   |            |   | 126     |   |  |   | 152     |  
|All other consumer                                           |  |                    | 937    |  |                                          |   | 459     |                                        |  |   |              |  |  |         | 1,396   |   |            |   | 51,104  |   |  |   | 52,500  |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Total consumer                                               |  |                    | 937    |  |                                          |   | 485     |                                        |  |   |              |  |  |         | 1,422   |   |            |   | 51,230  |   |  |   | 52,652  |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Farmland                                                     |  |                    |       |  |                                          |   |        |                                        |  |   |              |  |  |         |        |   |            |   | 3,667   |   |  |   | 3,667   |  
|Obligations of states and political subdivisions of the U.S. |  |                    |       |  |                                          |   |        |                                        |  |   |              |  |  |         |        |   |            |   | 990     |   |  |   | 990     |  
|Other                                                        |  |                    |       |  |                                          |   |        |                                        |  |   |              |  |  |         |        |   |            |   | 1,660   |   |  |   | 1,660   |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Total                                                        |  |                    | 15,085 |  |                                          |   | 91,405  |                                        |  |   | 68            |  |  |         | 106,558 |   |            |   | 753,025 |   |  |   | 859,583 |  
|Less: Commercial loans held for sale                         |  |                    |       |  |                                          |   | (27,940 | )                                      |  |   |              |  |  |         | (27,940 | ) |            |   | (38,217 | ) |  |   | (66,157 | )
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  
|Total gross loans                                            |  | $                  | 15,085 |  |                                          | $ | 63,465  |                                        |  | $ | 68            |  |  | $       | 78,618  |   |            | $ | 714,808 |   |  | $ | 793,426 |  
|                                                             |  |                    |        |  |                                          |   |         |                                        |  |   |               |  |  |         |         |   |            |   |         |   |  |   |         |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table summarizes nonaccrual loans, by class, at the dates indicated (in
thousands).



|                                                                  |  |              |         |   |      |   |        | 
|----------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------ | 
|                                                                  |  | December 31, |        
|                                                                  |  | 2010         |         |   | 2009 |  
|Construction, land development and other land loans               |  | $            | 52,528  |   |      | $ | 47,901 | 
|Multifamily residential                                           |  |              | 7,943   |   |      |   | 9,844  | 
|Nonfarm nonresidential                                            |  |              | 18,781  |   |      |   | 23,330 | 
|                                                                  |  |              |         |   |      |   |        | 
|Total commercial real estate                                      |  |              | 79,252  |   |      |   | 81,075 | 
|                                                                  |  |              |         |   |      |   |        | 
|Single-family real estate, revolving, open end loans              |  |              | 998     |   |      |   | 127    | 
|Single-family real estate, closed end, first lien                 |  |              | 7,607   |   |      |   | 7,079  | 
|Single-family real estate, closed end, junior lien                |  |              | 866     |   |      |   | 446    | 
|                                                                  |  |              |         |   |      |   |        | 
|Total single-family residential                                   |  |              | 9,471   |   |      |   | 7,652  | 
|                                                                  |  |              |         |   |      |   |        | 
|Commercial and industrial                                         |  |              | 2,197   |   |      |   | 7,475  | 
|                                                                  |  |             
|Credit cards                                                      |  |              | 26      |   |      |   | 372    | 
|All other consumer                                                |  |              | 459     |   |      |   | 312    | 
|                                                                  |  |              |         |   |      |   |        | 
|Total consumer                                                    |  |              | 485     |   |      |   | 684    | 
|                                                                  |  |              |         |   |      |   |        | 
|Farmland                                                          |  |              |        |   |      |   | 50     | 
|                                                                  |  |              |         |   |      |   |        | 
|Total nonaccrual loans                                            |  |              | 91,405  |   |      |   | 96,936 | 
|Less: Nonaccrual loans included in commercial loans held for sale |  |              | (27,940 | ) |      |   |       | 
|                                                                  |  |              |         |   |      |   |        | 
|Adjusted nonaccrual loans                                         |  | $            | 63,465  |   |      | $ | 96,936 | 
|                                                                  |  |              |         |   |      |   |        | 



While a loan is in nonaccrual
status, cash received is applied to the principal balance. Additional interest income of $4.3 million would have been reported during the year ended December 31, 2010 had loans classified as nonaccrual during the period performed in accordance
with their original terms. As a result, the Companys earnings did not include this interest income.



Troubled Debt Restructurings.    At December 31, 2010, the principal balance of troubled debt
restructurings totaled $44.9 million, of which loans totaling $17.2 million are classified as commercial loans held for sale.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



At December 31, 2009, the principal balance of troubled debt restructurings totaled
$14.6 million, respectively. During 2010, no troubled debt restructurings were removed from this classification.



Impaired Loans.    The following table summarizes the composition of and information relative to impaired
loans, by class, at December 31, 2010 (in thousands).



|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|------------------------------------------------------- |  | ------------------ | ------ |  | ----------------------------- | - | ------ | ---------------- |  | - | ------------------ |  |  | ---------------------- | ------ |  | ------------------ | - | ------ | ---------------------- |  | - | ---------------- |  |  | - | ------- |  |  | - | ----- | 
|                                                        |  | Gross Loans        |        |  | Commercial LoansHeld for Sale |   |        | Total Loans      | 
|                                                        |  | RecordedInvestment |        |  | UnpaidPrincipalBalance        |   |        | RelatedAllowance |  |   | RecordedInvestment |  |  | UnpaidPrincipalBalance |        |  | RecordedInvestment |   |        | UnpaidPrincipalBalance |  |   | RelatedAllowance | 
|With no related allowance recorded:                     |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 29,183 |  |                               | $ | 39,953 |                  |  |   |                    |  |  | $                      | 11,123 |  |                    | $ | 25,303 |                        |  | $ | 40,306           |  |  | $ | 65,256  |  |  |   |       | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        | 7,943  |  |                    |   | 14,010 |                        |  |   | 7,943            |  |  |   | 14,010  |  |  |   |       | 
|Nonfarm nonresidential                                  |  |                    | 11,504 |  |                               |   | 17,099 |                  |  |   |                    |  |  |                        | 19,674 |  |                    |   | 30,367 |                        |  |   | 31,178           |  |  |   | 47,466  |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 40,687 |  |                               |   | 57,052 |                  |  |   |                    |  |  |                        | 38,740 |  |                    |   | 69,680 |                        |  |   | 79,427           |  |  |   | 126,732 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|Single-family real estate, closed end, first lien       |  |                    | 2,567  |  |                               |   | 6,233  |                  |  |   |                    |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 3,162            |  |  |   | 7,607   |  |  |   |       | 
|Single-family real estate, closed end, junior lien      |  |                    |       |  |                               |   |       |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 2,567  |  |                               |   | 6,233  |                  |  |   |                    |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 3,162            |  |  |   | 7,607   |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 117    |  |                               |   | 117    |                  |  |   |                    |  |  |                        |       |  |                    |   |       |                        |  |   | 117              |  |  |   | 117     |  |  |   |       | 
|Total impaired loans with no related allowance recorded |  | $                  | 43,371 |  |                               | $ | 63,402 |                  |  |   |                    |  |  | $                      | 39,335 |  |                    | $ | 71,054 |                        |  | $ | 82,706           |  |  | $ | 134,456 |  |  |   |       | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|With an allowance recorded:                             |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 11,164 |  |                               | $ | 17,527 |                  |  | $ | 3,103              |  |  |                        |        |  |                    |   |        |                        |  | $ | 11,164           |  |  | $ | 17,527  |  |  | $ | 3,103 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 10,936 |  |                               |   | 10,936 |                  |  |   | 2,273              |  |  |                        |        |  |                    |   |        |                        |  |   | 10,936           |  |  |   | 10,936  |  |  |   | 2,273 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 22,100 |  |                               |   | 28,463 |                  |  |   | 5,376              |  |  |                        |        |  |                    |   |        |                        |  |   | 22,100           |  |  |   | 28,463  |  |  |   | 5,376 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |        |  |                    |   |        |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 1,300  |  |                               |   | 1,300  |                  |  |   | 94                 |  |  |                        |        |  |                    |   |        |                        |  |   | 1,300            |  |  |   | 1,300   |  |  |   | 94    | 
|Single-family real estate, closed end, junior lien      |  |                    | 165    |  |                               |   | 165    |                  |  |   | 57                 |  |  |                        |        |  |                    |   |        |                        |  |   | 165              |  |  |   | 165     |  |  |   | 57    | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 1,465  |  |                               |   | 1,465  |                  |  |   | 151                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,465            |  |  |   | 1,465   |  |  |   | 151   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 1,381  |  |                               |   | 1,450  |                  |  |   | 819                |  |  |                        |        |  |                    |   |        |                        |  |   | 1,381            |  |  |   | 1,450   |  |  |   | 819   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans with an allowance recorded         |  | $                  | 24,946 |  |                               | $ | 31,378 |                  |  | $ | 6,346              |  |  |                        |        |  |                    |   |        |                        |  | $ | 24,946           |  |  | $ | 31,378  |  |  | $ | 6,346 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total:                                                  |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Construction, land development and other land loans     |  | $                  | 40,347 |  |                               | $ | 57,480 |                  |  | $ | 3,103              |  |  | $                      | 11,123 |  |                    | $ | 25,303 |                        |  | $ | 51,470           |  |  | $ | 82,783  |  |  | $ | 3,103 | 
|Multifamily residential                                 |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        | 7,943  |  |                    |   | 14,010 |                        |  |   | 7,943            |  |  |   | 14,010  |  |  |   |      | 
|Nonfarm nonresidential                                  |  |                    | 22,440 |  |                               |   | 28,035 |                  |  |   | 2,273              |  |  |                        | 19,674 |  |                    |   | 30,367 |                        |  |   | 42,114           |  |  |   | 58,402  |  |  |   | 2,273 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total commercial real estate                            |  |                    | 62,787 |  |                               |   | 85,515 |                  |  |   | 5,376              |  |  |                        | 38,740 |  |                    |   | 69,680 |                        |  |   | 101,527          |  |  |   | 155,195 |  |  |   | 5,376 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Single-family real estate, revolving, open end loans    |  |                    |       |  |                               |   |       |                  |  |   |                   |  |  |                        |       |  |                    |   |       |                        |  |   |                 |  |  |   |        |  |  |   |      | 
|Single-family real estate, closed end, first lien       |  |                    | 3,867  |  |                               |   | 7,533  |                  |  |   | 94                 |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 4,462            |  |  |   | 8,907   |  |  |   | 94    | 
|Single-family real estate, closed end, junior lien      |  |                    | 165    |  |                               |   | 165    |                  |  |   | 57                 |  |  |                        |       |  |                    |   |       |                        |  |   | 165              |  |  |   | 165     |  |  |   | 57    | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total single-family residential                         |  |                    | 4,032  |  |                               |   | 7,698  |                  |  |   | 151                |  |  |                        | 595    |  |                    |   | 1,374  |                        |  |   | 4,627            |  |  |   | 9,072   |  |  |   | 151   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Commercial and industrial                               |  |                    | 1,498  |  |                               |   | 1,567  |                  |  |   | 819                |  |  |                        |       |  |                    |   |       |                        |  |   | 1,498            |  |  |   | 1,567   |  |  |   | 819   | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 
|Total impaired loans                                    |  | $                  | 68,317 |  |                               | $ | 94,780 |                  |  | $ | 6,346              |  |  | $                      | 39,335 |  |                    | $ | 71,054 |                        |  | $ | 107,652          |  |  | $ | 165,834 |  |  | $ | 6,346 | 
|                                                        |  |                    |        |  |                               |   |        |                  |  |   |                    |  |  |                        |        |  |                    |   |        |                        |  |   |                  |  |  |   |         |  |  |   |       | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Interest income recognized on impaired loans during the year ended December 31,
2010 was $1.5 million. The average balance of total impaired loans was $105.7 million for the same period.



At December 31, 2009, the balance of impaired loans was $96.8 million. Of that balance, $11.3 million of the impaired loans had a
related allowance for loan losses of $5.3 million. The average balance of impaired loans was $82.5 million and $22.6 million for the years ended December 31, 2009 and 2008, respectively.



Allowance for Loan Losses



The following table summarizes the allowance for loan losses
and recorded investment in gross loans, by portfolio segment, at and for the period ended December 31, 2010 (in thousands).



|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|----------------------------------------------------------------------- |  | --------------------- | ------- |  | ------------------------ | - | ------- | ----------------------- |  | - | -------- |  |  | ----- | ------ |  | ----- | - | ----- |  |  | - | ------- | 
|                                                                        |  | CommercialReal Estate |         |  | Single-familyResidential |   |         | CommercialandIndustrial |  |   | Consumer |  |  | Other |        |  | Total |  
|Allowance for loan losses:                                              |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, beginning of period                          |  | $                     | 13,369  |  |                          | $ | 3,683   |                         |  | $ | 4,853    |  |  | $     | 2,173  |  |       | $ | 1     |  |  | $ | 24,079  | 
|Provision for loan losses                                               |  |                       | 40,899  |  |                          |   | 4,500   |                         |  |   | 620      |  |  |       | 408    |  |       |   | 673   |  |  |   | 47,100  | 
|Less: Allowance reclassified to loans held for sale valuation allowance |  |                       | 2,352   |  |                          |   | 6       |                         |  |   |         |  |  |       |       |  |       |   |      |  |  |   | 2,358   | 
|Less: Allowance associated with credit credit card portfolio sale       |  |                       |        |  |                          |   |        |                         |  |   |         |  |  |       | 452    |  |       |   |      |  |  |   | 452     | 
|Loan charge-offs                                                        |  |                       | 33,481  |  |                          |   | 4,214   |                         |  |   | 3,135    |  |  |       | 1,483  |  |       |   | 647   |  |  |   | 42,960  | 
|Loan recoveries                                                         |  |                       | 544     |  |                          |   | 98      |                         |  |   | 154      |  |  |       | 729    |  |       |   |      |  |  |   | 1,525   | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Net loans charged-off                                                   |  |                       | 32,937  |  |                          |   | 4,116   |                         |  |   | 2,981    |  |  |       | 754    |  |       |   | 647   |  |  |   | 41,435  | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, end of period                                |  | $                     | 18,979  |  |                          | $ | 4,061   |                         |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Individually evaluated for impairment                                   |  | $                     | 5,376   |  |                          | $ | 151     |                         |  | $ | 819      |  |  | $     |       |  |       | $ |      |  |  | $ | 6,346   | 
|Collectively evaluated for impairment                                   |  |                       | 13,603  |  |                          |   | 3,910   |                         |  |   | 1,673    |  |  |       | 1,375  |  |       |   | 27    |  |  |   | 20,588  | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Allowance for loan losses, end of period                                |  | $                     | 18,979  |  |                          | $ | 4,061   |                         |  | $ | 2,492    |  |  | $     | 1,375  |  |       | $ | 27    |  |  | $ | 26,934  | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Gross loans, end of period:                                             |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Individually evaluated for impairment                                   |  | $                     | 62,787  |  |                          | $ | 4,032   |                         |  | $ | 1,498    |  |  | $     |       |  |       | $ |      |  |  | $ | 68,317  | 
|Collectively evaluated for impairment                                   |  |                       | 445,810 |  |                          |   | 174,016 |                         |  |   | 46,314   |  |  |       | 52,652 |  |       |   | 6,317 |  |  |   | 725,109 | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 
|Total gross loans                                                       |  | $                     | 508,597 |  |                          | $ | 178,048 |                         |  | $ | 47,812   |  |  | $     | 52,652 |  |       | $ | 6,317 |  |  | $ | 793,426 | 
|                                                                        |  |                       |         |  |                          |   |         |                         |  |   |          |  |  |       |        |  |       |   |       |  |  |   |         | 





|5. |  | Commercial Loans Held for Sale and Valuation Allowance
|-- |  | ------------------------------------------------------



In September 2010, the Company decided to market for sale
commercial loans totaling $90.9 million at September 30, 2010. During the fourth quarter of 2010, five of these loans were sold, representing two relationships, with a gross book value of $10.4 million for an aggregate loss of $3.5 million.
During the fourth quarter of 2010, $6.0 million of commercial loans held for sale were transferred back to loans held for investment, as the Companys intentions with respect to these loans had changed.



The Company is continuing its efforts to sell the remaining
loans held for sale. At December 31, 2010, commercial loans held for sale totaled $66.2 million, of which $2.0 million of these loans were under contract for



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



sale and expected to close in the first quarter 2011. Writedowns of $1.1 million were recorded in the fourth quarter 2010 to reduce the value of these loans to the contract value less estimated
costs to sell based on the bids accepted by the Company.



|6. |  | Premises and Equipment
|-- |  | ----------------------



The following table summarizes the premises and equipment balances, net at the dates indicated (in thousands).



|                              |  |              |         |   |      |   |         |  
|----------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                              |  | December 31, |        
|                              |  | 2010         |         |   | 2009 |  
|Land                          |  | $            | 6,534   |   |      | $ | 6,534   |  
|Buildings                     |  |              | 19,386  |   |      |   | 19,904  |  
|Leasehold improvements        |  |              | 5,200   |   |      |   | 5,313   |  
|Furniture and equipment       |  |              | 12,571  |   |      |   | 20,908  |  
|Software                      |  |              | 3,562   |   |      |   | 3,719   |  
|Bank automobiles              |  |              | 137     |   |      |   | 820     |  
|Capital lease asset           |  |              | 1,085   |   |      |   | 420     |  
|                              |  |              |         |   |      |   |         |  
|Premises and equipment, gross |  |              | 48,475  |   |      |   | 57,618  |  
|Accumulated depreciation      |  |              | (20,366 | ) |      |   | (28,013 | )
|                              |  |              |         |   |      |   |         |  
|Premises and equipment, net   |  | $            | 28,109  |   |      | $ | 29,605  |  
|                              |  |              |         |   |      |   |         |  



During 2010, the Company
wrote-off $8.8 million of obsolete furniture and equipment and the related accumulated depreciation. In connection with these write-offs, the Company recognized depreciation expense of $91 thousand.



Depreciation expense for the years ended December 31,
2010, 2009, and 2008 was $2.6 million, $2.2 million, and $2.0 million, respectively.



At December 31, 2010, a vacant bank-owned branch facility with a net book value of $235 thousand is under contract for sale and included in Other assets in the Consolidated Balance Sheets. Based on
the contract price, the Company recorded a writedown of $24 thousand, included in Other noninterest expense, for the year ended December 31, 2010. The Company had no property and equipment classified as held for sale at December 31, 2009.



|7. |  | Goodwill and Core Deposit Intangibles
|-- |  | -------------------------------------



Goodwill resulted from past business combinations from 1988
through 1999. The Company performed annual impairment testing as of June 30 each year. As discussed in Note 1, Summary of Significant Accounting Policies, the Company also performed quarterly impairment tests of recorded goodwill in 2010 due to
the overall adverse economic environment and the negative impact on the banking industry as a whole, including the impact to the Company resulting in net losses and a decline in its market capitalization. As a result, in the third quarter of 2010
the Company recorded a goodwill impairment charge of $3.7 million resulting from its impairment analysis at September 30, 2010. Accordingly, there was no goodwill at December 31, 2010. At December 31, 2009, the balance of goodwill was
$3.7 million, and no impairment loss was recognized during 2009 or 2008.



Core deposit intangibles originated from the value assigned to deposit liabilities acquired in past acquisitions. Amortization expense related to core deposit intangibles totaled $34 thousand during 2009
and $45 thousand during 2008. The Company fully amortized the remaining core deposit intangibles in 2009.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|8. |  | Mortgage-Banking Activities
|-- |  | ---------------------------



Mortgage loans serviced for the benefit of others amounted to $423.6 million and $426.6 million at December 31, 2010 and
December 31, 2009, respectively, and are excluded from the Consolidated Balance Sheets.



The book value of mortgage-servicing rights at December 31, 2010 and December 31, 2009 was $2.9 million and $3.0 million, respectively. Mortgage-servicing rights are included within Other assets
in the Consolidated Balance Sheets. The fair value of mortgage-servicing rights at both December 31, 2010 and December 31, 2009 was $3.6 million.



Mortgage-Servicing Rights Activity



The following table summarizes the changes in mortgage-servicing rights at the dates and for the periods indicated (in thousands).



|                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  
|------------------------------------------------------------------------------------ |  | ------------------------------- | ----- | - | ---- | - | ------ | ---- |  | - | ----- | -
|                                                                                     |  | For the years endedDecember 31, |      
|                                                                                     |  | 2010                            |       |   | 2009 |   |        | 2008 | 
|Mortgage-servicing rights portfolio, net of valuation allowance, beginning of period |  | $                               | 3,039 |   |      | $ | 2,932  |      |  | $ | 2,949 |  
|Capitalized mortgage-servicing rights                                                |  |                                 | 655   |   |      |   | 1,378  |      |  |   | 864   |  
|Mortgage-servicing rights portfolio amortization and impairment                      |  |                                 | (798  | ) |      |   | (1,271 | )    |  |   | (881  | )
|                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  
|Mortgage-servicing rights portfolio, net of valuation allowance, end of period       |  | $                               | 2,896 |   |      | $ | 3,039  |      |  | $ | 2,932 |  
|                                                                                     |  |                                 |       |   |      |   |        |      |  |   |       |  



Amortization



The following table summarizes the estimated future
amortization expense of the Companys mortgage-servicing rights at December 31, 2010 for the periods indicated (in thousands).



|                                    |  |   |       | 
|----------------------------------- |  | - | ----- | 
|During the years ended December 31, |  |   |      
|2011                                |  | $ | 878   | 
|2012                                |  |   | 689   | 
|2013                                |  |   | 535   | 
|2014                                |  |   | 411   | 
|2015                                |  |   | 312   | 
|Thereafter                          |  |   | 71    | 
|                                    |  |   |       | 
|                                    |  | $ | 2,896 | 
|                                    |  |   |       | 



Valuation Allowance



The following table summarizes the activity
in the valuation allowance for impairment of the mortgage-servicing rights portfolio for the periods indicated (in thousands).



|                                                              |  |                                 |    |   |      |   |    |      |  |   |    | 
|------------------------------------------------------------- |  | ------------------------------- | -- | - | ---- | - | -- | ---- |  | - | -- | 
|                                                              |  | For the years endedDecember 31, |   
|                                                              |  | 2010                            |    |   | 2009 |   |    | 2008 | 
|Valuation allowance, beginning of period                      |  | $                               | 40 |   |      | $ | 30 |      |  | $ | 10 | 
|Additions charged to and (reduction credited from) operations |  |                                 | (1 | ) |      |   | 10 |      |  |   | 20 | 
|                                                              |  |                                 |    |   |      |   |    |      |  |   |    | 
|Valuation allowance, end of period                            |  | $                               | 39 |   |      | $ | 40 |      |  | $ | 30 | 
|                                                              |  |                                 |    |   |      |   |    |      |  |   |    | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|9. |  | Foreclosed Real Estate and Personal Property
|-- |  | --------------------------------------------



Composition



The following table summarizes foreclosed real estate and
foreclosed personal property, at the dates indicated (in thousands).



|                                                   |  |              |        |  |      |   |        | 
|-------------------------------------------------- |  | ------------ | ------ |  | ---- | - | ------ | 
|                                                   |  | December 31, |       
|                                                   |  | 2010         |        |  | 2009 |  
|Foreclosed real estate                             |  | $            | 19,983 |  |      | $ | 27,826 | 
|Foreclosed automobiles                             |  |              | 104    |  |      |   | 188    | 
|                                                   |  |              |        |  |      |   |        | 
|Total foreclosed real estate and personal property |  | $            | 20,087 |  |      | $ | 28,014 | 
|                                                   |  |              |        |  |      |   |        | 



Foreclosed Real Estate
Activity



The following table summarizes the
changes in the foreclosed real estate portfolio at the dates and for the periods indicated (in thousands). Foreclosed real estate is net of participations sold of $4.6 million and $10.2 million at December 31, 2010 and 2009, respectively.



|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  
|----------------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                      |  | At and for the years endedDecember 31, |        
|                                                      |  | 2010                                   |         |   | 2009 |   |        | 2008 | 
|Foreclosed real estate, beginning of period           |  | $                                      | 27,826  |   |      | $ | 6,719  |      |  | $ | 7,743  |  
|Plus: New foreclosed real estate                      |  |                                        | 20,423  |   |      |   | 24,628 |      |  |   | 2,778  |  
|Less: Proceeds from sale of foreclosed real estate    |  |                                        | (17,616 | ) |      |   | (689   | )    |  |   | (3,511 | )
|Less: Gain / (loss) on sale of foreclosed real estate |  |                                        | 587     |   |      |   | (72    | )    |  |   | (123   | )
|Less: Provision charged to expense                    |  |                                        | (11,237 | ) |      |   | (2,760 | )    |  |   | (168   | )
|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  
|Foreclosed real estate, end of period                 |  | $                                      | 19,983  |   |      | $ | 27,826 |      |  | $ | 6,719  |  
|                                                      |  |                                        |         |   |      |   |        |      |  |   |        |  



Subsequent to December 31, 2010,
four properties with an aggregate net carrying amount of $2.2 million were sold at a loss of $62 thousand. At February 22, 2011, 11 additional properties with an aggregate net carrying amount of $5.4 million were under contract for sale to close in
the first and/or second quarter of 2011.



|10. |  | Deposits
|--- |  | --------



Composition



The following table summarizes the composition of deposits at the dates indicated (in thousands).



|                                           |  |              |           |  |      |   |           | 
|------------------------------------------ |  | ------------ | --------- |  | ---- | - | --------- | 
|                                           |  | December 31, |          
|                                           |  | 2010         |           |  | 2009 |  
|Transaction deposit accounts               |  | $            | 434,108   |  |      | $ | 449,867   | 
|Money market deposit accounts              |  |              | 143,143   |  |      |   | 119,082   | 
|Savings deposit accounts                   |  |              | 49,472    |  |      |   | 40,335    | 
|Time deposit accounts $100,000 and greater |  |              | 247,169   |  |      |   | 263,664   | 
|Time deposit accounts less than $100,000   |  |              | 299,470   |  |      |   | 341,966   | 
|                                           |  |              |           |  |      |   |           | 
|Total deposits                             |  | $            | 1,173,362 |  |      | $ | 1,214,914 | 
|                                           |  |              |           |  |      |   |           | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



At December 31, 2010, $692 thousand of overdrawn transaction deposit accounts were
reclassified to loans, compared with $542 thousand at December 31, 2009. The Company had no brokered deposits at December 31, 2010 or 2009.



Time Deposit Account Maturities



The following table summarizes the maturity distribution of time deposit accounts outstanding at December 31, 2010 during the periods
indicated (in thousands).



|           |  |   |         | 
|---------- |  | - | ------- | 
|2011       |  | $ | 367,673 | 
|2012       |  |   | 47,567  | 
|2013       |  |   | 127,564 | 
|2014       |  |   | 519     | 
|2015       |  |   | 3,282   | 
|Thereafter |  |   | 34      | 
|           |  |   |         | 
|           |  | $ | 546,639 | 
|           |  |   |         | 



Jumbo Time Deposit Accounts



Jumbo time deposit accounts are accounts
with balances totaling $100,000 or greater at the date indicated. The following table summarizes the jumbo time deposit accounts by maturity at December 31, 2010 (in thousands).



|                                      |  |   |         | 
|------------------------------------- |  | - | ------- | 
|Three months or less                  |  | $ | 44,092  | 
|Over three months through six months  |  |   | 17,994  | 
|Over six months through twelve months |  |   | 90,171  | 
|                                      |  |   |         | 
|Twelve months or less                 |  | $ | 152,257 | 
|Over twelve months                    |  |   | 94,912  | 
|                                      |  |   |         | 
|Total jumbo time deposit accounts     |  | $ | 247,169 | 
|                                      |  |   |         | 



Jumbo time deposit accounts
totaled $263.7 million at December 31, 2009.



Interest Expense on Deposit Accounts



The following table summarizes interest paid on deposits for the periods indicated (in thousands).



|                                         |  |                                  |        |  |      |   |        |      |  |   |        | 
|---------------------------------------- |  | -------------------------------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | 
|                                         |  | For the years ended December 31, |       
|                                         |  | 2010                             |        |  | 2009 |   |        | 2008 | 
|Transaction deposit accounts             |  | $                                | 248    |  |      | $ | 526    |      |  | $ | 4,966  | 
|Money market deposit accounts            |  |                                  | 622    |  |      |   | 602    |      |  |   | 1,922  | 
|Savings deposit accounts                 |  |                                  | 124    |  |      |   | 132    |      |  |   | 129    | 
|Time deposit accounts                    |  |                                  | 12,566 |  |      |   | 18,251 |      |  |   | 16,677 | 
|                                         |  |                                  |        |  |      |   |        |      |  |   |        | 
|Total interest expense on total deposits |  | $                                | 13,560 |  |      | $ | 19,511 |      |  | $ | 23,694 | 
|                                         |  |                                  |        |  |      |   |        |      |  |   |        | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|11. |  | Borrowings
|--- |  | ----------



The following table provides detail with respect to its borrowings composition at the dates and for the periods indicated (dollars in
thousands).



|                                                                     |  |                                        |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                     |  | At and for the years
endedDecember 31, |        
|                                                                     |  | 2010                                   |         |   | 2009 |   |         | 2008 | 
|Retail repurchase agreements                                         |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      | 20,720  |   |      | $ | 15,545  |      |  | $ | 16,357  |  
|Average amount outstanding during year                               |  |                                        | 22,809  |   |      |   | 23,227  |      |  |   | 18,063  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 26,106  |   |      |   | 29,461  |      |  |   | 21,817  |  
|Rate paid at year-end*                                               |  |                                        | 0.25    | % |      |   | 0.25    | %    |  |   | 0.25    | %
|Weighted average rate paid during the year                           |  |                                        | 0.25    |   |      |   | 0.25    |      |  |   | 1.37    |  
|                                                                     |  |                                        |        
|Commercial paper                                                     |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      |        |   |      | $ | 19,061  |      |  | $ | 27,955  |  
|Average amount outstanding during year                               |  |                                        | 8,435   |   |      |   | 24,085  |      |  |   | 32,415  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 18,948  |   |      |   | 27,041  |      |  |   | 37,487  |  
|Rate paid at year-end*                                               |  |                                        |        | % |      |   | 0.25    | %    |  |   | 0.25    | %
|Weighted average rate paid during the year                           |  |                                        | 0.25    |   |      |   | 0.25    |      |  |   | 1.11    |  
|                                                                     |  |                                        |        
|Other short-term borrowingslines of credit from correspondent banks |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      |        |   |      | $ |        |      |  | $ | 35,785  |  
|Average amount outstanding during year                               |  |                                        | 1       |   |      |   | 5,335   |      |  |   | 13,240  |  
|Maximum amount outstanding at any month-end                          |  |                                        |        |   |      |   | 17,295  |      |  |   | 38,171  |  
|Rate paid at year-end                                                |  |                                        |        | % |      |   |        | %    |  |   | 0.68    | %
|Weighted average rate paid during the year                           |  |                                        |        |   |      |   | 0.62    |      |  |   | 2.27    |  
|                                                                     |  |                                        |        
|FHLB borrowings                                                      |  |                                        |         |   |      |   |         |      |  |   |         |  
|Amount outstanding at year-end                                       |  | $                                      | 35,000  |   |      | $ | 101,000 |      |  | $ | 96,000  |  
|Average amount outstanding during year                               |  |                                        | 95,231  |   |      |   | 78,166  |      |  |   | 76,718  |  
|Maximum amount outstanding at any month-end                          |  |                                        | 101,000 |   |      |   | 170,000 |      |  |   | 111,000 |  
|Rate paid at year-end                                                |  |                                        | 2.99    | % |      |   | 2.01    | %    |  |   | 1.78    | %
|Weighted average rate paid during the year                           |  |                                        | 1.79    |   |      |   | 2.27    |      |  |   | 2.61    |  



|* |  | Rates paid are tiered based on level of deposit. Rate presented represents the average rate for all tiers offered at year-end.
|- |  | ------------------------------------------------------------------------------------------------------------------------------



Retail Repurchase Agreements



Retail repurchase agreements represent overnight secured
borrowing arrangements between the Bank and certain customers. Retail repurchase agreements are securities transactions, not insured deposits.



Commercial Paper



Through June 30, 2010 using a master note arrangement between the Company and the Bank, Palmetto Master Notes were issued as an
alternative investment for commercial sweep accounts. These master notes were unsecured but backed by the full faith and credit of the Company. The commercial paper was issued only in conjunction with deposits in the Banks automated sweep
accounts. Effective July 1, 2010, the Company terminated the commercial paper program, and all commercial paper accounts were converted to a new money market sweep account.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Correspondent Bank Line of Credit



At December 31, 2010, the Company had access to a line
of credit from a correspondent bank. From August 24, 2009 to October 31, 2010, this line of credit was secured by U.S. Treasury and federal agency securities. Effective November 1, 2010 the Company was no longer required to pledge
collateral for this line of credit.



The following
table summarizes the Companys line of credit funding utilization and availability at the dates indicated (in thousands).



|                                                           |  |              |       |  |      |   |       | 
|---------------------------------------------------------- |  | ------------ | ----- |  | ---- | - | ----- | 
|                                                           |  | December 31, |      
|                                                           |  | 2010         |       |  | 2009 |  
|Correspondent bank line of credit accommodations           |  | $            | 5,000 |  |      | $ | 5,000 | 
|Utilized correspondent bank line of credit accommodations  |  |              |      |  |      |   |      | 
|                                                           |  |              |       |  |      |   |       | 
|Available correspondent bank line of credit accommodations |  | $            | 5,000 |  |      | $ | 5,000 | 
|                                                           |  |              |       |  |      |   |       | 



This correspondent bank line of
credit funding source may be canceled at any time at the correspondent banks discretion.



FHLB Borrowings



As disclosed in Note 3, Investment Securities Available for Sale, and Note 4, Loans, the Company pledges investment securities and loans to collateralize FHLB advances and letters of credit. Additionally,
the Company may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages, as calculated by the FHLB.



The Company is a member of the FHLB of Atlanta, which is one
of twelve regional FHLBs that administer home financing credit for depository institutions. As an FHLB member, the Company is required to purchase and maintain stock in the FHLB. No ready market exists for this stock, and it has no quoted
market value. Purchases and redemptions are normally transacted each quarter to adjust our investment to the required amount based on the FHLB requirements, and requests for redemptions are met at the discretion of the FHLB. The carrying value of
this stock was $6.8 million and $7.0 million at December 31, 2010 and 2009, respectively.



The following table summarizes FHLB borrowed funds utilization and availability at the dates indicated (in thousands).



|                                                                                                             |  |                  |         |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------ |  | ---------------- | ------- | - | ---------------- | - | -------- | -
|                                                                                                             |  | December 31,2010 |         |   | December 31,2009 |  
|Available lendable loan collateral value to serve against FHLB advances and letters of credit                |  | $                | 92,464  |   |                  | $ | 162,014  |  
|Available lendable investment security collateral value to serve against FHLB advances and letters of credit |  |                  | 46,275  |   |                  |   | 26,791   |  
|Advances and letters of credit                                                                               |  |                  |         |   |                  |   |          |  
|FHLB advances                                                                                                |  |                  | (35,000 | ) |                  |   | (101,000 | )
|Letters of credit                                                                                            |  |                  | (50,000 | ) |                  |   | (50,000  | )
|Excess / (deficiency)                                                                                        |  |                  | 53,303  |   |                  |   | 55       |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table summarizes FHLB borrowings at December 31, 2010 (dollars in
thousands). The Companys outstanding FHLB advances do not have embedded call options.



|                  |  |   |          |   |  |   |          |       |  |   |        |  
|----------------- |  | - | -------- | - |  | - | -------- | ----- |  | - | ------ | -
|                  |  |   |          |   |  |   |          | Total | 
|Borrowing balance |  | $ | 30,000   |   |  | $ | 5,000    |       |  | $ | 35,000 |  
|Interest rate     |  |   | 2.89     | % |  |   | 3.61     | %     |  |   | 2.99   | %
|Maturity date     |  |   | 3/7/2011 |   |  |   | 4/2/2013 |       |  |   |        |  



Any FHLB advance with
a fixed interest rate is subject to a prepayment fee in the event of full or partial repayment prior to maturity or the expiration of any interim interest rate period. In December 2010 and January 2011, the Company prepaid $61.0 million and $30.0
million, respectively, of FHLB advances resulting in prepayment penalties of $33 thousand and $136 thousand, respectively.



In January 2010, the Company was notified by the FHLB that it could only rollover existing advances as they matured and that incremental
borrowings would not be allowed; however, in December 2010 the Company was notified by the FHLB that its borrowing capacity had been restored up to 10% of total assets.



Federal Reserve Discount Window



At December 31, 2010 and December 31, 2009, $10.9
million and $ 108.8 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that are available for use by the Company. Primary credit is available through the Discount Window to generally
sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. The Companys maximum maturity for potential borrowings is overnight. Although the
Company has not drawn on this availability since established in 2009 or during 2010, any potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues, and the Federal
Reserve has the discretion to deny approval of borrowing requests.



Convertible Debt



In March 2010, the Company issued unsecured convertible promissory notes in an aggregate principal amount of $380 thousand to members of the Board of Directors. The notes bore interest at 10% per
year payable quarterly, had a stated maturity of March 31, 2015, were prepayable by the Company at any time at the discretion of the Board of Directors, and were mandatorily convertible into stock of the Company at the same terms and conditions
as other investors that participate in the Companys next stock offering. The proceeds from the issuance of the notes were contributed to the Bank as a capital contribution. Upon the consummation of the Private Placement on October 7,
2010, the convertible promissory notes were converted into shares of the Companys common stock at the same price per share as the common stock issued in the Private Placement, and the accrued interest was paid on October 7, 2010.



|12. |  | Shareholders Equity
|--- |  | --------------------



Authorized Common Shares



The Company has authorized common stock of 75.0 million shares. In the Private Placement, 39,975,980 shares of common stock were
issued on October 7, 2010, 1,230,029 shares were issued in December 2010 and January 2011 in connection with the follow-on offering to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional
investors in the Private Placement in the first quarter 2011, resulting in remaining authorized but unissued common shares of 24,486,278 at February 22, 2011. The gross proceeds from the issuance of common stock in 2010 were reduced by issuance
costs of $8.0 million.





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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



In connection with the Private Placement, the Company evaluated the appropriate
accounting for the transaction by analyzing investor ownership, independence, risk, solicitation and collaboration considerations. Based on the Companys analysis of these factors, it concluded that the Private Placement transaction resulted in
a recapitalization of the Companys ownership for which push-down accounting was not required.



During 2010, the Companys shareholders approved an amendment to the Companys Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock
from 25.0 million shares to 75.0 million shares and reduce the par value of the common stock from $5.00 per share to $0.01 per share.



As disclosed in Note 14, Employee Benefit Plans, the Company has reserved a total of 274,656 shares for issuance under various equity
incentive plans at February 22, 2011.



Authorized Preferred Shares



The Company has authorized preferred stock of 2.5 million shares with such preferences, limitations and relative rights, within legal
limits, of the class, or one or more series within the class, as are set by the Board of Directors. To date, the Company has not issued any preferred shares.



Cash Dividends



For the years ended December 31, 2009 and 2008, cash dividends were declared by the Companys Board of Directors and paid
totaling $389 thousand, or $0.06 per common share, and $5.2 million, or $0.80 per common share, respectively. Under the Consent Order, payment of a dividend on its common stock requires prior notification to and non-objection from the applicable
banking regulators.



|13. |  | Income Taxes
|--- |  | ------------



The following table summarizes income tax expense (benefit) attributable to continuing operations for the periods indicated (in
thousands).



|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  
|-------------------------------------------- |  | -------------------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                             |  | For the years ended December 31, |       
|                                             |  | 2010                             |        |   | 2009 |   |         | 2008 | 
|Current income tax (benefit) expense         |  |                                  |        |   |      |   |         |      |  |   |        |  
|Federal                                      |  | $                                | (6,866 | ) |      | $ | (17,250 | )    |  | $ | 8,272  |  
|State                                        |  |                                  |       |   |      |   |        |      |  |   | 610    |  
|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  
|Total current (benefit) expense              |  |                                  | (6,866 | ) |      |   | (17,250 | )    |  |   | 8,882  |  
|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  
|                                             |  |                                  |       
|Deferred income tax (benefit) expense        |  |                                  |        |   |      |   |         |      |  |   |        |  
|Federal                                      |  |                                  | 5,512  |   |      |   | (4,873  | )    |  |   | (1,421 | )
|State                                        |  |                                  | 12     |   |      |   | (5      | )    |  |   | 3      |  
|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  
|Total deferred (benefit) expense             |  |                                  | 5,524  |   |      |   | (4,878  | )    |  |   | (1,418 | )
|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  
|Total current and deferred (benefit) expense |  | $                                | (1,342 | ) |      | $ | (22,128 | )    |  | $ | 7,464  |  
|                                             |  |                                  |        |   |      |   |         |      |  |   |        |  



There was no excess tax benefit
from equity based awards recorded in shareholders equity during the year ended December 31, 2010, and $133 thousand and $78 thousand of such tax benefit during the years ended December 31, 2009 and 2008, respectively.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table reconciles the Companys statutory federal income tax rate to
the effective income tax rate for the periods indicated.



|                                                    |  |                                 |       |   |      |  |      |      |  |  |      |  
|--------------------------------------------------- |  | ------------------------------- | ----- | - | ---- |  | ---- | ---- |  |  | ---- | -
|                                                    |  | For the years endedDecember 31, |      
|                                                    |  | 2010                            |       |   | 2009 |  |      | 2008 | 
|U.S. statutory federal income tax rate              |  |                                 | 35.0  | % |      |  | 35.0 | %    |  |  | 35.0 | %
|Changes from statutory rates resulting from:        |  |                                 |       |   |      |  |      |      |  |  |      |  
|Tax-exempt income                                   |  |                                 | 0.9   |   |      |  | 0.9  |      |  |  | (3.1 | )
|Expenses not deductible for tax purposes            |  |                                 | (0.1  | ) |      |  | (0.2 | )    |  |  | 0.9  |  
|State taxes, net of Federal income tax benefit      |  |                                 |      |   |      |  |     |      |  |  | 1.9  |  
|Increase in deferred income tax valuation allowance |  |                                 | (33.4 | ) |      |  |     |      |  |  |     |  
|Other                                               |  |                                 | (0.2  | ) |      |  | (0.1 | )    |  |  | 0.7  |  
|                                                    |  |                                 |       |   |      |  |      |      |  |  |      |  
|Effective tax rate                                  |  |                                 | 2.2   | % |      |  | 35.6 | %    |  |  | 35.4 | %
|                                                    |  |                                 |       |   |      |  |      |      |  |  |      |  



The Company had no net deferred
tax assets at December 31, 2010 and a net deferred tax asset of $5.8 million at December 31, 2009. The following table summarizes the Companys deferred tax assets, related valuation allowance, and deferred tax liabilities at the
dates indicated (in thousands).



|                                                             |  |              |         |   |      |   |        |  
|------------------------------------------------------------ |  | ------------ | ------- | - | ---- | - | ------ | -
|                                                             |  | December 31, |        
|                                                             |  | 2010         |         |   | 2009 |  
|Deferred tax assets                                          |  |              |         |   |      |   |        |  
|Allowance for loan losses                                    |  | $            | 9,427   |   |      | $ | 8,428  |  
|Nonaccrual loan interest                                     |  |              | 706     |   |      |   | 546    |  
|Valuation allowance for commercial loans held for sale       |  |              | 829     |   |      |   |       |  
|Writedowns of foreclosed real estate                         |  |              | 4,840   |   |      |   | 956    |  
|Pension plan contributions                                   |  |              | 1,825   |   |      |   | 1,297  |  
|Recognized built-in loss carryforward                        |  |              | 5,563   |   |      |   |       |  
|Alternative minimum tax credit carryforward                  |  |              | 475     |   |      |   |       |  
|Federal net operating loss carryforward                      |  |              | 1,420   |   |      |   |       |  
|Other                                                        |  |              | 791     |   |      |   | 248    |  
|                                                             |  |              |         |   |      |   |        |  
|Deferred tax assets, gross                                   |  |              | 25,876  |   |      |   | 11,475 |  
|Valuation allowance                                          |  |              | (20,520 | ) |      |   |       |  
|                                                             |  |              |         |   |      |   |        |  
|Deferred tax assets after valuation allowance                |  |              | 5,356   |   |      |   | 11,475 |  
|                                                             |  |              |         |   |      |   |        |  
|Deferred tax liabilities                                     |  |              |         |   |      |   |        |  
|Premises, equipment and capital leases                       |  |              | (1,467  | ) |      |   | (1,343 | )
|Intangible assets                                            |  |              |        |   |      |   | (673   | )
|Deferred loan fees and costs, net                            |  |              | (1,765  | ) |      |   | (2,073 | )
|Unrealized gains on investment securities available for sale |  |              | (773    | ) |      |   | (187   | )
|Mortgage-servicing rights                                    |  |              | (1,014  | ) |      |   | (1,064 | )
|Other                                                        |  |              | (337    | ) |      |   | (336   | )
|                                                             |  |              |         |   |      |   |        |  
|Total deferred tax liabilities, gross                        |  |              | (5,356  | ) |      |   | (5,676 | )
|                                                             |  |              |         |   |      |   |        |  
|Deferred tax asset, net                                      |  | $            |        |   |      | $ | 5,799  |  
|                                                             |  |              |         |   |      |   |        |  



At December 31, 2010, the
Companys gross deferred tax assets totaled $25.9 million. Based on the Companys projections of future taxable income over the next three years, cumulative tax losses over the



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



previous three years, limitations on future utilization of various deferred tax assets under the Internal Revenue Code, and available tax planning strategies, the Company recorded a valuation
allowance in the amount of $20.5 million through a charge against income tax expense (benefit).



The Company expects to receive a refund in 2011 of previously paid federal income tax for the 2008 tax year of approximately $7.4 million as a result of utilizing a carryback of most of the 2010 income
tax net operating loss. The Company has a net operating loss carryforward of approximately $3.6 million which will expire in 2030 if not utilized to offset taxable income prior to that date.



During 2009, the Internal Revenue Service temporarily extended the net operating loss carryback period from two
years to five years. As of December 31, 2009, the Companys analysis concluded that it was more likely than not that all of its net deferred income tax assets would be realized based on net operating loss carrybacks refundable from income
taxes previously paid. As a result, no valuation allowance was recorded at December 31, 2009. As a result of the income tax net operating loss in 2009, the Company filed a tax refund claim receivable for tax years 2004  2007 and federal
and state tax refund claims for estimated taxes paid in 2009 totaling $20.9 million. All of these refund claims were received during 2010, reduced by $661 thousand as a result of the filing of an amended 2009 federal tax return in June 2010.



The Company is subject to U.S. federal and South
Carolina state income tax. Tax authorities in various jurisdictions may examine the Company. During 2008, the Internal Revenue Service examined the Company for tax years 2006 through 2007. With few exceptions, the Company and the Bank are not
subject to federal and state income tax examinations for taxable years prior to 2007.



|14. |  | Employee Benefit Plans
|--- |  | ----------------------



Defined Benefit Pension Plan



Historically, the Company has offered a noncontributory, defined benefit pension plan that covered all full-time employees having at least
twelve months of continuous service and having attained age 21. During the fourth quarter of 2007, the Company notified employees that it would cease accruing pension benefits for employees with regard to the noncontributory, defined benefit pension
plan. Although no previously accrued benefits were lost, employees no longer accrue benefits for service subsequent to 2007.



The Company recognizes the funded status of the defined benefit postretirement plan in the Consolidated Balance Sheets. Gains and losses,
prior service costs and credits, and any remaining transition amounts that had not yet been recognized through net periodic benefit cost as of December 31, 2007 are recognized in accumulated other comprehensive income, net of tax impacts, until
they are amortized as a component of net periodic cost.



Unless a business entity remeasures both its plan assets and benefit obligations during the fiscal year, the funded status it reports in its Consolidated Balance Sheets will be the same asset or liability
recognized in the previous year-end Consolidated Balance Sheets adjusted for subsequent accruals of net periodic benefit cost that exclude the amortization of amounts previously recognized in other comprehensive income and contributions to a funded
plan, or benefit payments. The Company recorded a corresponding reduction of $2.0 million, after-tax, to accumulated other comprehensive income (loss) in shareholders equity in order to recognize the underfunded status of its defined benefit
pension plan at December 31, 2008, an additional reduction of $2.8 million, after-tax, to accumulated other comprehensive income (loss) in shareholders equity in order to recognize the underfunded status of its defined benefit pension
plan at December 31, 2009, and an additional reduction of $577 thousand, after-tax, to accumulated other comprehensive income (loss) in shareholders equity in order to recognize the underfunded status of its defined benefit pension plan
at December 31, 2010.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Defined Benefit Pension Plan Funded Status. The following table summarizes the
combined change in benefit obligation, defined benefit pension plan assets, and funded status of the Companys defined benefit pension plan at the dates and for the periods indicated (in thousands).



|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|---------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                               |  | At and for the years endedDecember 31, |        
|                                               |  | 2010                                   |         |   | 2009 |   |         | 2008 | 
|Change in benefit obligation                   |  |                                        |         |   |      |   |         |      |  |   |        |  
|Benefit obligation, beginning of period        |  | $                                      | 16,908  |   |      | $ | 11,270  |      |  | $ | 13,934 |  
|Interest cost                                  |  |                                        | 1,015   |   |      |   | 923     |      |  |   | 683    |  
|Net actuarial loss (gain)                      |  |                                        | 2,176   |   |      |   | 5,836   |      |  |   | (1,788 | )
|Benefits paid                                  |  |                                        | (1,017  | ) |      |   | (1,121  | )    |  |   | (1,559 | )
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|Benefit obligation, end of period              |  |                                        | 19,082  |   |      |   | 16,908  |      |  |   | 11,270 |  
|                                               |  |                                        |        
|Change in plan assets                          |  |                                        |         |   |      |   |         |      |  |   |        |  
|Fair value of plan assets, beginning of period |  |                                        | 13,202  |   |      |   | 10,774  |      |  |   | 15,914 |  
|Return on plan assets                          |  |                                        | 1,604   |   |      |   | 1,748   |      |  |   | (3,594 | )
|Employer contribution                          |  |                                        | 78      |   |      |   | 1,801   |      |  |   | 13     |  
|Benefits paid                                  |  |                                        | (1,016  | ) |      |   | (1,121  | )    |  |   | (1,559 | )
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|Fair value of plan assets, end of period       |  |                                        | 13,868  |   |      |   | 13,202  |      |  |   | 10,774 |  
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|Funded status                                  |  |                                        | (5,214  | ) |      |   | (3,706  | )    |  |   | (496   | )
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|Net actuarial loss                             |  |                                        | (12,066 | ) |      |   | (11,179 | )    |  |   | (6,918 | )
|Income tax benefit                             |  |                                        | (4,223  | ) |      |   | (3,913  | )    |  |   | (2,422 | )
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  
|Accumulated other comprehensive loss impact    |  | $                                      | (7,843  | ) |      | $ | (7,266  | )    |  | $ | (4,496 | )
|                                               |  |                                        |         |   |      |   |         |      |  |   |        |  



The Companys net accrued
liability recognized at December 31, 2010, 2009, and 2008 is included in Other liabilities in the Consolidated Balance Sheets.



Cost of Defined Benefit Pension Plan.    The following table summarizes the adjusted net periodic expense
(income) components for the Companys defined benefit pension plan, which is included in Salaries and other personnel expense in the Consolidated Statements of Income (Loss), for the periods indicated (in thousands).



|                                          |  |                                 |        |   |      |   |      |      |  |   |        |  
|----------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ---- | ---- |  | - | ------ | -
|                                          |  | For the years endedDecember 31, |       
|                                          |  | 2010                            |        |   | 2009 |   |      | 2008 | 
|Interest cost                             |  | $                               | 1,015  |   |      | $ | 923  |      |  | $ | 683    |  
|Expected return on plan assets            |  |                                 | (1,023 | ) |      |   | (899 | )    |  |   | (1,267 | )
|Amortization of net actuarial loss (gain) |  |                                 | 708    |   |      |   | 725  |      |  |   | (19    | )
|                                          |  |                                 |        |   |      |   |      |      |  |   |        |  
|Net periodic pension expense (income)     |  | $                               | 700    |   |      | $ | 749  |      |  | $ | (603   | )
|                                          |  |                                 |        |   |      |   |      |      |  |   |        |  



As a result of the
Companys decision to curtail the plan effective on January 1, 2008, no costs relative to service costs have been necessary since that date as employees no longer accrue benefits for services rendered.



Actuarial gains and losses are the unanticipated change in
the unfunded liability over a given year, i.e. the excess of the actual unfunded liability over the predicted unfunded liability resulting from unanticipated events. Actuarial gains and losses result from actual asset returns deviating from the
assumed rate, changes in the discount rate used to measure plan obligations, and other variances in demographic experience such as retirements and mortality.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Defined Benefit Pension Plan Assumptions.    One of the
principal components of the net periodic pension expense calculation is the expected long-term rate of return on plan assets. The use of an expected long-term rate of return on plan assets may cause the Company to recognize pension income returns
that are greater or less than the actual returns of plan assets in any given year. The expected long-term rate of return is designed to approximate the actual long-term rate of return over time and is not expected to change significantly. Therefore,
the pattern of income/expense recognition should match the stable pattern of services provided by the Companys employees over the life of the Companys pension obligation. To ensure that the expected rate of return is reasonable, the
Company considers such factors as long-term historical return experience for major asset class categories and considers any material forward-looking return expectations for these major asset classes. Differences between expected and actual returns
in each year, if any, are included in the net actuarial gain or loss amount, which is recognized in other comprehensive income. The Company generally amortizes any net actuarial gain or loss in excess of a predetermined corridor in net periodic
pension expense calculations. Expected returns on defined benefit pension plan assets are developed by the Company in conjunction with input from external advisors and take into account the investment policy, actual investment allocation, and
long-term expected rates of return on the relevant asset classes.



The Company uses a discount rate to determine the present value of its future benefit obligations. The discount rate is determined in consultation with the third party actuary and is set by matching the
projected benefit cash flow to the Citigroup pension yield curve. The yield curve reflects the plan specific duration.



The pension plan includes common stock of the Company, which is not traded on an exchange and the value of which is subject to change
based on its financial results. At December 31, 2010, the fair value of Company common stock included in the plan was 0.3% of total fair value of assets of the plan. Additionally, the Company periodically evaluates other assumptions involving
demographic factors, such as retirement age, mortality, and turnover and updates such factors to reflect experience and expectations for the future.



The following table summarizes the assumptions used in computing the benefit obligation and the adjusted net periodic expense (income) for
the periods indicated.



|                                                         |  |                                 |      |   |      |  |      |      |  |  |      |  
|-------------------------------------------------------- |  | ------------------------------- | ---- | - | ---- |  | ---- | ---- |  |  | ---- | -
|                                                         |  | For the years endedDecember 31, |     
|                                                         |  | 2010                            |      |   | 2009 |  |      | 2008 | 
|Assumptions used in computing benefit obligation:        |  |                                 |      |   |      |  |      |      |  |  |      |  
|Discount rate                                            |  |                                 | 5.35 | % |      |  | 5.90 | %    |  |  | 5.70 | %
|Rate of increase in compensation levels                  |  |                                 | n/a  |   |      |  | n/a  |      |  |  | 3.50 |  
|Assumptions used in computing net periodic benefit cost: |  |                                 |      |   |      |  |      |      |  |  |      |  
|Discount rate                                            |  |                                 | 5.90 |   |      |  | 5.70 |      |  |  | 5.70 |  
|Expected long-term rate of return on plan assets         |  |                                 | 8.00 |   |      |  | 8.00 |      |  |  | 8.00 |  
|Rate of compensation increase                            |  |                                 | n/a  |   |      |  | n/a  |      |  |  | 3.50 |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Defined Benefit Pension Plan Assets.    The following table
summarizes the fair value of defined benefit pension plan assets by major category at the dates indicated (in thousands).



|                                       |  |              |        |  |      |   |        | 
|-------------------------------------- |  | ------------ | ------ |  | ---- | - | ------ | 
|                                       |  | December 31, |       
|                                       |  | 2010         |        |  | 2009 |  
|Investments, at fair value             |  |              |        |  |      |   |        | 
|Interest-bearing cash                  |  | $            | 787    |  |      | $ | 427    | 
|U.S. government and agency securities  |  |              | 513    |  |      |   | 2,745  | 
|Municipal securities                   |  |              | 738    |  |      |   |       | 
|Corporate bonds                        |  |              | 3,211  |  |      |   | 2,951  | 
|Corporate stocks                       |  |              | 1,734  |  |      |   | 1,755  | 
|Palmetto Bancshares, Inc. common stock |  |              | 42     |  |      |   | 192    | 
|Pooled funds                           |  |              | 6,805  |  |      |   | 5,072  | 
|Accrued interest receivable            |  |              | 38     |  |      |   | 60     | 
|                                       |  |              |        |  |      |   |        | 
|Total assets                           |  | $            | 13,868 |  |      | $ | 13,202 | 
|                                       |  |              |        |  |      |   |        | 



The investment objectives of the
defined benefit pension plan assets are designed to maintain full funding with respect to the projected benefit obligation and to maximize returns in order to minimize contributions within reasonable and prudent levels of risk. The precise amount
for which these obligations will be settled depends on future events, including the life expectancy of the defined benefit pension plans participants. The obligations are estimated using actuarial assumptions based on the current economic
environment. The defined benefit pension plans investment strategy balances the requirement to generate return, using higher-returning assets, with the need to control risk using less volatile assets. Risks include, but are not limited to,
inflation, volatility in equity values, and changes in interest rates that could cause the defined benefit pension plan to become underfunded, thereby increasing the defined benefit pension plans dependence on contributions from the Company.



Plan assets are managed by professional
investment firms as well as by investment professionals that are employees of the Company as approved by the Board of Directors. The Compensation Committee of the Board of Directors is responsible for maintaining the investment policy of the defined
benefit pension plan, approving the appointment of the investment manager, and reviewing the performance of the defined benefit pension plan assets at least annually.



Investments within the defined benefit pension plan are
diversified with the intent to minimize the risk of large losses to the defined benefit pension plan. The total portfolio is constructed and maintained to provide prudent diversification within each investment category, and the Company assumes that
the volatility of the portfolio will be similar to the market as a whole. The asset allocation ranges represent a long-term perspective. Therefore, rapid unanticipated market shifts may cause the asset mix to fall outside the policy range. Such
divergences should be short-term in nature.



Fair
Value Measurements. Following is a description of the valuation methodology used in determining fair value measurements of the defined benefit pension plan.



| |  |  | Interest-bearing cash. Valued at the net asset value of units held by the pension plan at year-end.
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | U.S. government and agency securities. Valued at the closing price reported in the active market in which the individual securities are traded.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Municipal securities. Valued at the closing price reported in the active market in which the individual securities are traded.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



| |  |  | Corporate bonds. Valued at the closing price reported in the active market in which the bond is traded.
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Corporate stocks. Valued at the closing price reported in the active market in which the individual securities are traded.
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | Palmetto Bancshares, Inc. common stock. The value of the Companys common stock is normally determined based on the last five trades of the stock
facilitated by the Company through the Private Trading System on its website.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pooled funds. Valued at the net asset value of units held by the pension plan at year-end.
| | - |  | ------------------------------------------------------------------------------------------



The preceding methods described may produce a fair value
calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes the valuation methods are appropriate and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.



The following table summarizes the defined benefit pension
plan assets measured at fair value at the dates indicated, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).



|                                    |  |                   |       |  |         |   |        |         |  |   |       |  |  |   |        | 
|----------------------------------- |  | ----------------- | ----- |  | ------- | - | ------ | ------- |  | - | ----- |  |  | - | ------ | 
|                                    |  | December 31, 2010 |      
|                                    |  | Level 1           |       |  | Level 2 |   |        | Level 3 |  |   | Total | 
|Defined benefit pension plan assets |  | $                 | 1,734 |  |         | $ | 12,092 |         |  | $ | 42    |  |  | $ | 13,868 | 



|                                    |  |                   |       |  |         |   |        |         |  |   |       |  |  |   |        | 
|----------------------------------- |  | ----------------- | ----- |  | ------- | - | ------ | ------- |  | - | ----- |  |  | - | ------ | 
|                                    |  | December 31, 2009 |      
|                                    |  | Level 1           |       |  | Level 2 |   |        | Level 3 |  |   | Total | 
|Defined benefit pension plan assets |  | $                 | 1,755 |  |         | $ | 11,255 |         |  | $ | 192   |  |  | $ | 13,202 | 



The following table summarizes the changes in Level 3 assets measured at fair value on a recurring basis at the dates and for the period
indicated (in thousands).



|                           |  |                                       |      |  
|-------------------------- |  | ------------------------------------- | ---- | -
|                           |  | Palmetto Bancshares, Inc.common stock |     
|Balance, December 31, 2009 |  | $                                     | 192  |  
|Total unrealized losses    |  |                                       | (150 | )
|                           |  |                                       |      |  
|Balance, December 31, 2010 |  | $                                     | 42   |  
|                           |  |                                       |      |  



Current and Future Expected
Contributions.    The Pension Protection Act of 2006 imposed a number of burdens on pension plans with an asset to liability ratio of less than 80% with additional burdens imposed if the asset to liability ratio falls below
60%. Due primarily to declining asset values, the Companys plan was 66% funded at January 1, 2009. In June 2009, the Company contributed approximately $1.7 million to the defined benefit pension plan relative to 2008 and $104 thousand to
the defined benefit pension plan relative to 2009. The Company contributed $78 thousand in 2010. These contributions increased and maintained the Companys asset to liability ratio at or above the 80% threshold. Contributions to the
Companys defined benefit pension plan assets totaled $13 thousand during 2008. The Company believes employer contributions in the amount of at least $615 thousand will be made during 2011. Additional contributions may be made depending on the
funded status of the plan.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Expected Future Defined Benefit Pension Plan Payments.    The
following table summarizes the benefits expected to be paid for the next 10 years (in thousands).



|                                    |  |   |       | 
|----------------------------------- |  | - | ----- | 
|During the years ended December 31, |  |   |      
|2011                                |  | $ | 890   | 
|2012                                |  |   | 933   | 
|2013                                |  |   | 999   | 
|2014                                |  |   | 1,054 | 
|2015                                |  |   | 1,072 | 
|2016 - 2020                         |  |   | 6,271 | 



The expected benefits to be paid are based on the same assumptions used to measure the Companys benefit obligation at
December 31, 2010.



401(k) Plan



Employees are given the opportunity to
participate in the Companys 401(k) plan which is designed to supplement an employees retirement income. Under the 401(k) plan, participants are able to defer a portion of their salary into the plan. The Company matches employee
contributions at a rate of $0.60 per dollar up to 6% of an employees eligible compensation. Matching contributions are contributed to the plan prior to the end of each plan year. Prior to December 1, 2009, employees were eligible to
participate in this plan after completing one year of service and reaching age 21. Effective December 1, 2009, employees are eligible to participate in the plan immediately when hired. During the years ended December 31, 2010, 2009, and
2008, the Company made matching contributions to the employee 401(k) plan totaling $426 thousand, $407 thousand, and $327 thousand, respectively.



Collateral Split-Dollar Life Insurance Arrangements



On January 1, 2008, the Company, in accordance with
accounting guidance, changed its accounting policy, recognizing a cumulative-effect adjustment to retained earnings totaling $99 thousand. Deferred compensation expense related to such collateral split-dollar life insurance arrangements was
less than $1 thousand for the years ended December 31, 2010, 2009 and 2008.



Key Man Life Insurance



The Company has purchased life insurance policies on certain key employees. Such policies are recorded in Other assets in the Consolidated Balance Sheets at the cash surrender value less applicable
surrender charges. At both December 31, 2010 and 2009, the cash surrender value of such policies totaled $1.6 million.



|15. |  | Equity Based Compensation
|--- |  | -------------------------



Stock Option Plan



General.    Stock option awards have been granted under the Palmetto Bancshares, Inc. 1997 Stock Compensation
Plan. The Plan terminated in 2007 and no options have been granted under the Plan since then. However, the termination did not impact options previously granted under the Plan. All outstanding options expire at various dates through
December 31, 2016. Of these, 120,010 stock option awards remained outstanding at December 31, 2010 with exercise prices ranging from $15.00 to $30.40 per share. All stock option awards granted have a vesting term of five years and an
exercise period of ten years. The Board determined the terms of



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



the options on the grant date. The option price was at least 100% of fair value of the Companys common stock as of the grant date, and the term of the options was not greater than 10 years.
Under the Plan, the Company could grant nonqualified stock options and incentive stock options. Options granted to employees were considered incentive stock options, while options granted to non-employees were nonqualified stock options.



The Company estimates the fair value of stock options granted
using the Black-Scholes option-pricing model. The estimated grant-date fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The Black-Scholes option-pricing
model estimates the fair value of a stock option based on inputs such as the expected volatility of the Companys stock price, the level of risk-free interest rates, dividend yields, and expected option term.



Stock Option Compensation
Expense.    The compensation expense charged against pretax income during 2010 for stock options was $30 thousand. There was no income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the
deductible portion of this compensation expense. The compensation expense that was charged against pretax net income during 2009 for stock options was $64 thousand. The total income tax benefit recognized in the Consolidated Statements of Income
(Loss) with regard to the deductible portion of this compensation expense was $6 thousand. Estimates of forfeitures are made at the time of grant and were not expected to be significant, therefore, compensation expense is being recognized for all
equity based awards.



At December 31, 2010
and 2009, based on options outstanding at that time, the total compensation expense related to unvested stock option awards granted under the Companys stock option plan but not yet recognized was $1 thousand and $31 thousand, respectively,
before the impact of income taxes. Stock option compensation expense is recognized on a straight-line basis over the vesting period of the option. This remaining compensation expense related to unvested stock option awards is expected to be
recognized during 2011.



Stock Option
Activity.    The following table summarizes stock option activity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan for the periods indicated.



|                                 |  |                         |         |   |                               |   |       | 
|-------------------------------- |  | ----------------------- | ------- | - | ----------------------------- | - | ----- | 
|                                 |  | Stockoptionsoutstanding |         |   | Weighted-averageexerciseprice |  
|Outstanding at December 31, 2007 |  |                         | 198,155 |   |                               | $ | 20.29 | 
|Forfeited                        |  |                         | (4,500  | ) |                               |   | 20.00 | 
|Exercised                        |  |                         | (24,325 | ) |                               |   | 15.61 | 
|                                 |  |                         |         |   |                               |   |       | 
|Outstanding at December 31, 2008 |  |                         | 169,330 |   |                               |   | 20.98 | 
|Forfeited                        |  |                         | (18,120 | ) |                               |   | 13.00 | 
|Exercised                        |  |                         | (4,000  | ) |                               |   | 26.60 | 
|                                 |  |                         |         |   |                               |   |       | 
|Outstanding at December 31, 2009 |  |                         | 147,210 |   |                               |   | 21.80 | 
|Forfeited                        |  |                         | (27,200 | ) |                               |   | 16.83 | 
|Exercised                        |  |                         |        |   |                               |   |      | 
|                                 |  |                         |         |   |                               |   |       | 
|Outstanding at December 31, 2010 |  |                         | 120,010 |   |                               | $ | 22.93 | 
|                                 |  |                         |         |   |                               |   |       | 



Cash received from stock option
exercises under the Companys stock option plan for the years ended December 31, 2009 and 2008 was $106 thousand and $380 thousand, respectively.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Stock Options Outstanding. The following table summarizes information regarding
stock options outstanding and exercisable at December 31, 2010.



|                                           |  |                                             |         |  |                                                  |  |      |                               |  |  |                                             |  |  |                               |         |  |  |   |       | 
|------------------------------------------ |  | ------------------------------------------- | ------- |  | ------------------------------------------------ |  | ---- | ----------------------------- |  |  | ------------------------------------------- |  |  | ----------------------------- | ------- |  |  | - | ----- | 
|                                           |  | Options outstanding                         |         |  | Options exercisable                              | 
|Exercise price or range of exercise prices |  | Number ofstockoptionsoutstandingat 12/31/10 |         |  | Weighted-averageremainingcontractuallife (years) |  |      | Weighted-averageexerciseprice |  |  | Number ofstockoptionsexercisableat 12/31/10 |  |  | Weighted-averageexerciseprice |        
|$15.00 to $20.00                           |  |                                             | 40,010  |  |                                                  |  | 1.55 |                               |  |  | $17.75                                      |  |  |                               | 40,010  |  |  | $ | 17.75 | 
|$23.30 to $26.60                           |  |                                             | 51,200  |  |                                                  |  | 3.36 |                               |  |  | 24.47                                       |  |  |                               | 51,200  |  |  |   | 24.47 | 
|$27.30 to $30.40                           |  |                                             | 28,800  |  |                                                  |  | 5.03 |                               |  |  | 27.39                                       |  |  |                               | 28,640  |  |  |   | 27.37 | 
|                                           |  |                                             |         |  |                                                  |  |      |                               |  |  |                                             |  |  |                               |         |  |  |   |       | 
|Total                                      |  |                                             | 120,010 |  |                                                  |  | 3.15 |                               |  |  | 22.93                                       |  |  |                               | 119,850 |  |  |   | 22.92 | 
|                                           |  |                                             |         |  |                                                  |  |      |                               |  |  |                                             |  |  |                               |         |  |  |   |       | 



At December 31,
2010, the fair value of the Companys common stock did not exceed the exercise price of any options outstanding and exercisable, and therefore the stock options had no intrinsic value. The total intrinsic value of stock options exercised during
the years ended December 31, 2009 and 2008 was $62 thousand and $631 thousand, respectively.



Restricted Stock Plan



Under the 2008 Restricted Stock Plan, 250,000 shares of common stock have been reserved for issuance subject to its anti-dilution provisions. Awards were granted under the Plan during 2009 and 2010.
Through December 31, 2010, 73,540 shares have been granted, of which 14,556 have vested, and 12,800 were forfeited. Forfeitures are returned to the available pool for future issuance. The following table summarizes restricted stock activity at the
date and for the periods indicated.



|                                                                   |  |                          |         |   |                            |   |       | 
|------------------------------------------------------------------ |  | ------------------------ | ------- | - | -------------------------- | - | ----- | 
|                                                                   |  | Shares ofrestrictedstock |         |   | Weighted-averagegrantprice |  
|Shares available for issuance under the 2008 Restricted Stock Plan |  |                          | 250,000 |   |                            |   |       | 
|2009 Grants                                                        |  |                          | (55,040 | ) |                            | $ | 35.63 | 
|2009 Forfeitures                                                   |  |                          | 10,000  |   |                            |   | 42.00 | 
|2010 Grants                                                        |  |                          | (18,500 | ) |                            |   | 2.60  | 
|2010 Forfeitures                                                   |  |                          | 2,800   |   |                            |   | 42.00 | 
|                                                                   |  |                          |         |   |                            |   |       | 
|Remaining shares available for issuance at December 31, 2010       |  |                          | 189,260 |   |                            |   |       | 
|                                                                   |  |                          |         |   |                            |   |       | 

In January 2011, 34,614 shares of restricted stock were granted to directors of the Company as
compensation for their annual Board retainers.



The value of the restricted stock awarded is established as the fair value of the stock at the time of the grant. The Company
measures compensation expense for restricted stock awards at fair value and recognizes compensation expense over the service period. As such, expense relative to 2009 grants is recognized ratably over the five year vesting period of the stock award
grants. The compensation expense that was charged against pretax income during 2010 and 2009 for restricted stock awards was $297 thousand and $253 thousand, respectively. The total income tax benefit recognized in the Consolidated Statements
of Income (Loss) with regard to the deductible portion of this compensation expense for the same periods was $1 thousand and $89 thousand, respectively. Forfeitures are accounted for by eliminating compensation expense for unvested shares as
forfeitures occur. At December 31, 2010, based on restricted stock awards outstanding at that time, the total pretax compensation expense related to unvested restricted stock awards granted under the restricted stock plan but not yet
recognized was $920 thousand. This expense is expected to be recognized through 2015.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Shares of restricted stock granted to employees and directors under the Plan are subject
to pro rata restrictions as to continuous employment and service as a director, respectively, for a specified time period following the date of grant, currently five years. During this period, the holder is entitled to full voting rights and
dividends.



2011 Palmetto Bancshares, Inc.
Stock Plan



In February 2011, the Board of
Directors approved the 2011 Plan to further support the alignment of management and shareholder interests. The 2011 Plan allows for the Board of Directors to grant stock options and restricted stock awards to key management personnel with vesting
provisions including a combination of time vesting and performance metrics related to the Banks successfully resolving the Consent Order and the Companys return to profitability. The Board has recommended that 2,000,000 shares be
designated for issuance under the 2011 Plan. The Board will seek shareholder approval for the 2011 Plan, and it is the Companys intention to include a proposal for approval of the 2011 Plan in the proxy statement for the next annual
shareholders meeting currently scheduled for May 19, 2011.



|16. |  | Average Share Information
|--- |  | -------------------------



The following table summarizes the reconciliation of the numerators and denominators of the basic and diluted net income (loss) per common
share computations for the periods indicated.



|                                                                |  |                                  |            |   |      |   |           |      |  |   |           | 
|--------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | --------- | ---- |  | - | --------- | 
|                                                                |  | For the years ended December 31, |           
|                                                                |  | 2010                             |            |   | 2009 |   |           | 2008 | 
|Weighted average common shares outstandingbasic                |  |                                  | 15,913,000 |   |      |   | 6,449,754 |      |  |   | 6,438,071 | 
|Dilutive impact resulting from potential common share issuances |  |                                  |           |   |      |   |          |      |  |   | 81,778    | 
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           | 
|Weighted average common shares outstandingdiluted              |  |                                  | 15,913,000 |   |      |   | 6,449,754 |      |  |   | 6,519,849 | 
|                                                                |  |                                  |            |   |      |   |           |      |  |   |           | 
|Per Share Data                                                  |  |                                  |            |   |      |   |           |      |  |   |           | 
|Net income (loss)basic                                         |  | $                                | (3.78      | ) |      | $ | (6.21     | )    |  | $ | 2.11      | 
|Net income (loss)diluted                                       |  |                                  | (3.78      | ) |      |   | (6.21     | )    |  |   | 2.09      | 



Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average
number of shares of common stock outstanding during the period. For diluted net income per share, the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had
been issued. If dilutive, common stock equivalents are calculated for stock options and restricted stock shares using the treasury stock method. No potential common shares were included in the computation of the diluted loss per share amount for the
years ended December 31, 2010 and 2009 as inclusion would be antidilutive given the Companys net loss during the periods.



|17. |  | Commitments, Guarantees, and Other Contingencies
|--- |  | ------------------------------------------------



Lending Commitments and Standby Letters of Credit



Unused lending commitments to customers are
not recorded in the Consolidated Balance Sheets until funds are advanced. For commercial customers, lending commitments generally take the form of unused revolving credit arrangements to finance customers working capital requirements. For
retail customers, lending commitments are generally unused lines of credit secured by residential property. The Company routinely extends lending commitments for both floating and fixed rate loans.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



The following table summarizes the contractual amounts of the Companys unused
lending commitments relating to extension of credit with off-balance sheet risk at December 31, 2010 (in thousands).



|                                                                                        |  |   |         | 
|--------------------------------------------------------------------------------------- |  | - | ------- | 
|Commitments to extend credit:                                                           |  |   |         | 
|Revolving, open-end lines secured by single-family residential properties               |  | $ | 47,054  | 
|Commercial real estate, construction, and land development loans secured by real estate |  |   |         | 
|Single-family residential construction loan commitments                                 |  |   | 2,081   | 
|Commercial real estate, other construction loan, and land development loan commitments  |  |   | 13,442  | 
|Commercial and industrial loan commitments                                              |  |   | 12,465  | 
|Overdraft protection line commitments                                                   |  |   | 29,062  | 
|Other                                                                                   |  |   | 6,938   | 
|                                                                                        |  |   |         | 
|Total commitments to extend credit                                                      |  | $ | 111,042 | 



Standby letters of credit are issued for customers in connection with contracts between the customers and third parties. Letters of credit
are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The maximum potential amount of undiscounted future payments related to letters of credit was $2.7 million and $4.6 million at
December 31, 2010 and December 31, 2009, respectively.



The reserve for unfunded commitments at December 31, 2010 and December 31, 2009 was $99 thousand and $128 thousand, respectively, and is recorded in Other liabilities in the Consolidated Balance
Sheets.



Credit Card Recourse



See Note 4, Loans, for recourse provision related to certain
credit card accounts sold in 2010.



Loan
Participations



With regard to participations
sold disclosed in Note 4, Loans, and Note 8, Foreclosed Real Estate and Personal Property, the Company serves as the lead bank and is therefore responsible for certain administration and other management functions as agent to the participating
banks. The participation agreements include certain standard representations and warranties related to the Companys duties to the participating banks.



Derivatives



See Note 18, Derivative Financial Instruments and Hedging Activities, for further discussion regarding the Companys off-balance
sheet arrangements and commitments related to its derivative loan commitments and freestanding derivatives.



Long-Term Contractual Obligations



In addition to the contractual commitments and arrangements previously described, the Company enters into other contractual obligations in
the ordinary course of business. The following table summarizes these contractual obligations at December 31, 2010 (in thousands) except obligations for employee benefit plans as these obligations are paid from separately identified assets. See
Note 14, Employee Benefit Plans, for discussion regarding this employee benefit plan.



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Notes To Consolidated Financial
Statements(Continued)



|                                          |  |                   |         |  |                           |   |         |                           |  |   |                |  |  |       |        |  |  |   |         | 
|----------------------------------------- |  | ----------------- | ------- |  | ------------------------- | - | ------- | ------------------------- |  | - | -------------- |  |  | ----- | ------ |  |  | - | ------- | 
|Other contractual obligations             |  | Less thanone year |         |  | Over onethroughthreeyears |   |         | Overthreethroughfiveyears |  |   | Over fiveyears |  |  | Total |       
|Real property operating lease obligations |  | $                 | 1,867   |  |                           | $ | 3,358   |                           |  | $ | 3,118          |  |  | $     | 12,740 |  |  | $ | 21,083  | 
|Time deposit accounts                     |  |                   | 367,673 |  |                           |   | 175,131 |                           |  |   | 3,801          |  |  |       | 34     |  |  |   | 546,639 | 
|FHLB advances                             |  |                   | 30,000  |  |                           |   | 5,000   |                           |  |   |                |  |  |       |        |  |  |   | 35,000  | 
|                                          |  |                   |         |  |                           |   |         |                           |  |   |                |  |  |       |        |  |  |   |         | 
|Total other contractual obligations       |  | $                 | 399,540 |  |                           | $ | 183,489 |                           |  | $ | 6,919          |  |  | $     | 12,774 |  |  | $ | 602,722 | 
|                                          |  |                   |         |  |                           |   |         |                           |  |   |                |  |  |       |        |  |  |   |         | 



In January 2011, the Company
prepaid $30.0 million of FHLB advances due in 2011.



Obligations under noncancelable real property operating lease agreements noted above are payable over several years with the longest
obligation expiring in 2029. Option periods that the Company has not yet exercised are not included in the preceding table.



Real property operating lease obligations summarized in the preceding table:



| |  |  | Are net of payments to be received under a sublease agreement with a third party with regard to the Companys previous Blackstock Road banking
office for which it is contracted under a lease agreement as Lessee. This lease is scheduled to expire in February 2011.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Include obligations with regard to one banking office that was consolidated during 2008 that is leased by the Company and currently vacant. The Company
is considering options with regard to this leased location.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Do not include periodic increases in lease payments for the Rock Hill operating building lease and operating lease for additional office space. Lease
payment increases are subject to consumer price index changes. The Company does not believe that future minimum lease payments relative to these locations will significantly differ from current obligations at December 31, 2010. Therefore,
current lease obligations have been used to determine the operating lease obligations in the preceding table. Obligations under these operating lease agreements are payable over several years with the building lease expiring in 2015 and the
additional office space lease expiring in 2011.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Do not include the parking leases in downtown Greenville which are paid month-to-month.
| | - |  | ---------------------------------------------------------------------------------------



The Company relocated the corporate headquarters to downtown
Greenville, South Carolina during March 2009 into a leased facility.



The Company enters into agreements with third parties with respect to the leasing, servicing, and maintenance of equipment. However, because the Company believes that these agreements are immaterial when
considered individually, or in the aggregate, with regard to the Consolidated Financial Statements, it has not included such agreements in the preceding contractual obligations table. Therefore, the Company believes that noncompliance with terms of
such agreements would not have a material impact on its business, financial condition, results of operations, and cash flows. Furthermore, as most such commitments are entered into for a 12-month period with option extensions, long-term obligations
beyond 2011 cannot be reasonably estimated at this time.



Short-Term Contractual and Noncontractual Obligations



In conjunction with the Companys annual budgeting process, capital expenditures are approved for the coming year. During the
budgeting process for 2011, the Board of Directors approved $2.4 million in capital



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



expenditures related to technology and facilities. Generally, purchase obligations are not made in advance of such purchases, although to obtain discounted pricing the Company may enter into such
arrangements. In addition, the Company anticipates that expenditures will be required during 2011 that could not have been expected and, therefore, were not approved in the budgeting process. Funds to fulfill both budgeted and nonbudgeted
commitments will come from its operational cash flows.



Although the Company expects to make capital expenditures in years subsequent to 2011, capital expenditures are reviewed by the Company on an annual basis. Therefore, the Company has not yet estimated
such capital expenditure obligations for years subsequent to 2011.



Legal Proceedings



The Company is subject to actual and threatened legal proceedings and other claims arising out of the conduct of its business. Some of these suits and proceedings seek damages, fines, or penalties. These
suits and proceedings are being defended by or contested on the Companys behalf. On the basis of information presently available, the Company does not believe that existing proceedings and claims will have a material effect on its financial
position or results of operations.



|18. |  | Derivative Financial Instruments and Hedging Activities
|--- |  | -------------------------------------------------------



At December 31, 2010 and 2009, the Companys only
derivative instruments related to residential mortgage lending activities. The Company originates certain residential loans with the intention of selling these loans. Between the time that the Company enters into an interest rate lock commitment to
originate a residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments. The Company also enters into forward sale agreements of to be
issued loans. The commitments to originate residential loans and forward sales commitments are freestanding derivative instruments and are recorded on the Consolidated Balance Sheets at fair value. They do not qualify for hedge accounting
treatment. Fair value adjustments are recorded within Mortgage-banking in the Consolidated Statements of Income (Loss).



At December 31, 2010, commitments to originate conforming loans totaled $12.2 million. At December 31, 2010, these derivative
loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $103 thousand and negative fair values, included with Other liabilities in the Consolidated Balance Sheets, totaling $40 thousand.
At December 31, 2009, commitments to originate conforming loans totaled $7.0 million. At December 31, 2009, these derivative loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets,
totaling $52 thousand, and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $11 thousand. The net change in derivative loan commitment fair values during the years ended December 31, 2010 and
2009, resulted in net derivative loan commitment income of $22 thousand and $41 thousand, respectively.



Forward sales commitments totaled $19.6 million at December 31, 2010. At December 31, 2010, forward sales commitments had
positive fair values, included with Other assets in the Consolidated Balance Sheets, totaling $175 thousand and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $96 thousand. At December 31,
2009, forward sales commitments totaled $10.0 million. At December 31, 2009, these forward sales commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $92 thousand, and negative fair
values, included within Other liabilities in the Consolidated Balance Sheets, totaling $1 thousand. The net change in forward sales commitment fair values during the years ended December 31, 2010 and 2009 resulted in a loss of $12 thousand and
income of $91 thousand, respectively.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|19. |  | Disclosures Regarding Fair Value
|--- |  | --------------------------------



Valuation Methodologies



Following is a description of the valuation methodologies used for fair value measurements.



Investment Securities Available for
Sale.    Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured
using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions.
Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, as well as securities that are traded by dealers or brokers in active over-the-counter markets. Instruments classified as Level 1 are instruments
that have been priced directly from dealer trading desks and represent actual prices at which such securities have traded within active markets. Level 2 securities are valued based on pricing models that use relevant observable information generated
by transactions that have occurred in the market place that involve similar securities. Level 3 securities include asset-backed securities in less liquid markets.



Mortgage Loans Held for
Sale.    Mortgage loans held for sale are carried at the lower of cost or fair value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar
characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2.



Commercial loans held for sale.    Loans held for sale are measured at the lower of cost or fair value.
Commercial loans held for sale for which binding sales contracts have been entered into as of the balance sheet date are considered Level 1 instruments. Collateral dependent commercial loans held for sale are valued based on independent collateral
appraisals less estimated selling costs and are generally classified as Level 2 assets. If quoted market prices, binding sales contracts or appraised collateral values are not available, the Company considers discounted cash flow analyses with
market assumptions and classifies such loans as Level 3 instruments.



Impaired loans.    Impaired loans are recorded at fair value less estimated selling costs. Once a loan is identified as individually impaired, the Company measures impairment.
The fair value of impaired loans is estimated using one of several methods, including collateral value and discounted cash flows and, in rare cases, the market value of the note. Those impaired loans not requiring an allowance represent loans for
which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans. At December 31, 2010 and 2009, a majority of the total impaired loans were evaluated based
on the fair value of the collateral. When the fair value of the collateral is based on a contract, the Company records the impaired loan as nonrecurring Level 1. If the collateral is based on another observable market price or a current appraised
value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market
price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loans effective interest rate. The measurement of
impaired loans using future cash flows discounted at the loans effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. The Company
measures the fair



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



value of collateral dependent impaired loans based on the fair value of the collateral securing these loans. These measurements are classified as Level 1, Level 2 or Level 3 within the valuation
hierarchy. When the fair value of the collateral is based on a contract, the Company records the impaired loan as nonrecurring Level 1, If the collateral is based on another observable market price or a current appraised value, the Company records
the impaired loan as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records
the impaired loan as nonrecurring Level 3. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.



Foreclosed real estate and personal
property.    Foreclosed real estate and personal property is carried at the lower of carrying value or fair value less estimated selling costs. Fair value is generally based upon current appraisals, comparable sales, and
other estimates of value obtained principally from independent sources, adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as
nonrecurring Level 2. However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions
from the time of valuation. In situations where management adjustments are significant to the fair value measurement in its entirety, such measurements are classified as Level 3 within the valuation hierarchy.



Goodwill.    Goodwill is subject
to impairment testing. The Company tests goodwill for impairment by comparing the business units carrying value to the implied fair value. In the event the fair value is determined to be less than the carrying value, the asset is recorded at
fair value as determined by the valuation model. As such, if applicable, the Company classifies goodwill subjected to nonrecurring fair value adjustments as Level 3.



Derivative Financial
Instruments.    Currently, the Company enters into loan commitments and forward sales commitments. The valuation of these instruments is computed using internal valuation models utilizing observable market-based inputs. As
such, derivative financial instruments subjected to recurring fair value adjustments are classified as Level 2.



Assets and Liabilities Measured at Fair Value on a Recurring Basis



The following table summarizes assets and liabilities measured at fair value on a recurring basis at the dates
indicated, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).



|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|-------------------------------------------------------- |  | ----------------- | ------ |  | ------- | - | ------- | ------- |  | - | ----- |  |  | - | ------- | 
|                                                         |  | December 31, 2010 |       
|                                                         |  | Level 1           |        |  | Level 2 |   |         | Level 3 |  |   | Total | 
|Assets                                                   |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Investment securities available for sale                 |  | $                 | 33,522 |  |         | $ | 185,253 |         |  | $ |      |  |  | $ | 218,775 | 
|Derivative financial instruments                         |  |                   |       |  |         |   | 278     |         |  |   |      |  |  |   | 278     | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Total assets measured at fair value on a recurring basis |  | $                 | 33,522 |  |         | $ | 185,531 |         |  | $ |      |  |  | $ | 219,053 | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Liabilities                                              |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 
|Derivative financial instruments                         |  | $                 |       |  |         | $ | 136     |         |  | $ |      |  |  | $ | 136     | 
|                                                         |  |                   |        |  |         |   |         |         |  |   |       |  |  |   |         | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|                                                         |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 
|-------------------------------------------------------- |  | ----------------- | ------ |  | ------- | - | ------ | ------- |  | - | ------ |  |  | - | ------- | 
|                                                         |  | December 31, 2009 |       
|                                                         |  | Level 1           |        |  | Level 2 |   |        | Level 3 |  |   | Total  | 
|Assets                                                   |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 
|Investment securities available for sale                 |  | $                 | 16,297 |  |         | $ | 63,371 |         |  | $ | 40,318 |  |  | $ | 119,986 | 
|Derivative financial instruments                         |  |                   |       |  |         |   | 144    |         |  |   |       |  |  |   | 144     | 
|                                                         |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 
|Total assets measured at fair value on a recurring basis |  | $                 | 16,297 |  |         | $ | 63,515 |         |  | $ | 40,318 |  |  | $ | 120,130 | 
|                                                         |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 
|Liabilities                                              |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 
|Derivative financial instruments                         |  | $                 |       |  |         | $ | 12     |         |  | $ |       |  |  | $ | 12      | 
|                                                         |  |                   |        |  |         |   |        |         |  |   |        |  |  |   |         | 



The following table reconciles
the beginning and ending balances of investment securities available for sale fair value measurements using significant unobservable inputs on a recurring basis at the dates and for the period indicated (in thousands).



|                                                            |  |         |          |  
|----------------------------------------------------------- |  | ------- | -------- | -
|                                                            |  | Level 3 |         
|Balance, December 31, 2009                                  |  | $       | 40,318   |  
|Total gains (losses) / realized and unrealized included in: |  |         |          |  
|Net income / loss                                           |  |         | (371     | )
|Accumulated other comprehensive income                      |  |         | 525      |  
|Purchases                                                   |  |         | 105,440  |  
|Sales                                                       |  |         | (34,352  | )
|Paydowns                                                    |  |         | (3,389   | )
|Transfers out of Level Three                                |  |         | (108,171 | )
|                                                            |  |         |          |  
|Balance, December 31, 2010                                  |  | $       |         |  
|                                                            |  |         |          |  



See Note 14, Employee Benefit
Plans, for detailed disclosure regarding the fair value of defined benefit pension plan assets at December 31, 2010.



Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis



For financial assets measured at fair value on a nonrecurring basis that were still reflected in the balance
sheet at period end, the following tables summarize the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at period end (in thousands).



|                                                                  |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|----------------------------------------------------------------- |  | ----------------- | ----- |  | ------- | - | ------ | ------- |  | - | ------ |  |  | - | ------- | 
|                                                                  |  | December 31, 2010 |      
|                                                                  |  | Level 1           |       |  | Level 2 |   |        | Level 3 |  |   | Total  | 
|Assets                                                            |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Mortgage loans held for sale                                      |  | $                 |      |  |         | $ | 4,793  |         |  | $ |       |  |  | $ | 4,793   | 
|Commercial loans held for sale                                    |  |                   | 1,303 |  |         |   | 21,231 |         |  |   | 43,623 |  |  |   | 66,157  | 
|Impaired loans in gross loans                                     |  |                   |      |  |         |   | 43,920 |         |  |   | 6,649  |  |  |   | 50,569  | 
|Real estate and personal property acquired in settlement of loans |  |                   | 5,999 |  |         |   | 13,939 |         |  |   | 149    |  |  |   | 20,087  | 
|                                                                  |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 
|Total assets measured at fair value on a nonrecurring basis       |  | $                 | 7,302 |  |         | $ | 83,883 |         |  | $ | 50,421 |  |  | $ | 141,606 | 
|                                                                  |  |                   |       |  |         |   |        |         |  |   |        |  |  |   |         | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|                                                                  |  |                   |   |  |         |   |         |         |  |   |        |  |  |   |         | 
|----------------------------------------------------------------- |  | ----------------- | - |  | ------- | - | ------- | ------- |  | - | ------ |  |  | - | ------- | 
|                                                                  |  | December 31, 2009 |  
|                                                                  |  | Level 1           |   |  | Level 2 |   |         | Level 3 |  |   | Total  | 
|Assets                                                            |  |                   |   |  |         |   |         |         |  |   |        |  |  |   |         | 
|Mortgage loans held for sale                                      |  | $                 |  |  |         | $ | 3,884   |         |  | $ |       |  |  | $ | 3,884   | 
|Impaired loans in gross loans                                     |  |                   |  |  |         |   | 75,209  |         |  |   | 14,097 |  |  |   | 89,306  | 
|Real estate and personal property acquired in settlement of loans |  |                   |  |  |         |   | 25,522  |         |  |   | 2,492  |  |  |   | 28,014  | 
|                                                                  |  |                   |   |  |         |   |         |         |  |   |        |  |  |   |         | 
|Total assets measured at fair value on a nonrecurring basis       |  | $                 |  |  |         | $ | 104,615 |         |  | $ | 16,589 |  |  | $ | 121,204 | 
|                                                                  |  |                   |   |  |         |   |         |         |  |   |        |  |  |   |         | 



Carrying Amounts and
Estimated Fair Value of Principal Financial Assets and Liabilities



For assets and liabilities that are not presented on the balance sheet at fair value, the Company uses several different valuation methodologies as outlined below.



For financial instruments that have quoted market prices,
those quotes are used to determine fair value. Financial instruments that have no defined maturity, have a remaining maturity of 180 days or less, or reprice frequently to a market rate, are assumed to have a fair value that approximates reported
book value. If no market quotes are available, financial instruments are valued by discounting the expected cash flows using an estimated current market interest rate for the financial instrument.



Certain of the Companys assets and liabilities are
financial instruments whose fair value equals or closely approximates carrying value. Such financial instruments are reported in the following balance sheet captions: cash and cash equivalents, retail repurchase agreements, commercial paper, and
other short-term borrowings.



Fair value estimates
are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect the premium or discount on any particular financial instrument that could result from the sale
of the Companys entire holdings. Because no ready market exists for a significant portion of its financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly impact the estimates.



Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that are not financial instruments. Significant assets and liabilities that are not financial instruments include those resulting from the Companys mortgage-banking
operations, the value of the long-term relationships with the Companys deposit customers, deferred income taxes, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can
have a significant impact on fair value estimates and have not been considered in the estimates.



Commitments to extend credit are primarily short-term and are generally at variable market rates. Commitments to extend credit may be terminated by the Company based on material adverse change clauses.
Standby letters of credit are generally short-term and have no associated rate unless funding occurs. As such, commitments to extend credit and standby letters of credit are deemed to have no material fair value.



The following table summarizes the carrying amount and fair
values for other financial instruments included in the Consolidated Balance Sheets at the dates indicated (in thousands).



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|                  |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|----------------- |  | ----------------- | --------- |  | ----------------- | - | --------- | -------------- |  | - | ---------- |  |  | - | --------- | 
|                  |  | December 31, 2010 |           |  | December 31, 2009 |  
|                  |  | Carryingamount    |           |  | Fair value        |   |           | Carryingamount |  |   | Fair value | 
|Assets            |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Loans (1)         |  | $                 | 715,923   |  |                   | $ | 709,018   |                |  | $ | 926,927    |  |  | $ | 914,557   | 
|                  |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Total assets      |  | $                 | 715,923   |  |                   | $ | 709,018   |                |  | $ | 926,927    |  |  | $ | 914,557   | 
|                  |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Liabilities       |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Deposits          |  | $                 | 1,173,362 |  |                   | $ | 1,178,905 |                |  | $ | 1,214,914  |  |  | $ | 1,206,857 | 
|FHLB advances     |  |                   | 35,000    |  |                   |   | 35,224    |                |  |   | 101,000    |  |  |   | 100,119   | 
|                  |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 
|Total liabilities |  | $                 | 1,208,362 |  |                   | $ | 1,214,129 |                |  | $ | 1,315,914  |  |  | $ | 1,306,976 | 
|                  |  |                   |           |  |                   |   |           |                |  |   |            |  |  |   |           | 



|(1) |  | Includes Loans, net less impaired loans valued based on the fair value of underlying collateral.
|--- |  | ------------------------------------------------------------------------------------------------



|20. |  | Holding Company Condensed Financial Information
|--- |  | -----------------------------------------------



Since the Company is a holding company and does not conduct
operations, its primary sources of liquidity are equity issuances, dividends upstreamed from the Bank and funds received through stock option exercises.



The following tables summarize the holding companys financial condition, results of operations, and cash flows at the dates and for
the periods indicated (in thousands).



Condensed
Balance Sheets



|                                           |  |              |         |  |      |   |        | 
|------------------------------------------ |  | ------------ | ------- |  | ---- | - | ------ | 
|                                           |  | December 31, |        
|                                           |  | 2010         |         |  | 2009 |  
|Assets                                     |  |              |         |  |      |   |        | 
|Cash and cash equivalents                  |  | $            | 2,505   |  |      | $ | 1,050  | 
|Due from subsidiary                        |  |              |        |  |      |   | 19,486 | 
|Investment in subsidiary                   |  |              | 112,402 |  |      |   | 74,009 | 
|Goodwill                                   |  |              |        |  |      |   | 704    | 
|Other                                      |  |              | 12      |  |      |   | 114    | 
|                                           |  |              |         |  |      |   |        | 
|Total assets                               |  | $            | 114,919 |  |      | $ | 95,363 | 
|                                           |  |              |         |  |      |   |        | 
|Liabilities and shareholders equity       |  |              |         |  |      |   |        | 
|Commercial paper                           |  | $            |        |  |      | $ | 19,061 | 
|Intercompany restricted stock settlement   |  |              | 920     |  |      |   | 1,287  | 
|Other                                      |  |              | 100     |  |      |   |       | 
|Shareholders equity                       |  |              | 113,899 |  |      |   | 75,015 | 
|                                           |  |              |         |  |      |   |        | 
|Total liabilities and shareholders equity |  | $            | 114,919 |  |      | $ | 95,363 | 
|                                           |  |              |         |  |      |   |        | 



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Condensed Statements of Income (Loss)



|                                                      |  |                                  |         |   |      |   |         |      |  |   |        |  
|----------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                      |  | For the years ended December 31, |        
|                                                      |  | 2010                             |         |   | 2009 |   |         | 2008 | 
|Interest income from commercial paper (Master notes)  |  | $                                | 21      |   |      | $ | 60      |      |  | $ | 359    |  
|Dividends received from subsidiary                    |  |                                  |        |   |      |   | 389     |      |  |   | 4,616  |  
|Equity in undistributed earnings (loss) of subsidiary |  |                                  | (59,366 | ) |      |   | (40,412 | )    |  |   | 8,984  |  
|Interest expense on commercial paper (Master notes)   |  |                                  | (21     | ) |      |   | (60     | )    |  |   | (359   | )
|Goodwill impairment                                   |  |                                  | (704    | ) |      |   |        |      |  |   |       |  
|Other operating income                                |  |                                  |        |   |      |   |        |      |  |   |       |  
|Other operating expense                               |  |                                  | (132    | ) |      |   | (62     | )    |  |   | (1     | )
|                                                      |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net income (loss)                                     |  | $                                | (60,202 | ) |      | $ | (40,085 | )    |  | $ | 13,599 |  
|                                                      |  |                                  |         |   |      |   |         |      |  |   |        |  



Condensed Statements of Cash
Flows



|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  
|------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                                  |  | For the years ended December 31, |        
|                                                                                                  |  | 2010                             |         |   | 2009 |   |         | 2008 | 
|Operating Activities                                                                              |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net income (loss)                                                                                 |  | $                                | (60,202 | ) |      | $ | (40,085 | )    |  | $ | 13,599 |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |  |                                  |         |   |      |   |         |      |  |   |        |  
|Decrease (increase) in due from subsidiary                                                        |  |                                  | 19,486  |   |      |   | 8,463   |      |  |   | (1,626 | )
|Increase in equity in undistributed loss (earnings) of subsidiary                                 |  |                                  | 59,366  |   |      |   | 40,412  |      |  |   | (8,984 | )
|Goodwill impairment                                                                               |  |                                  | 704     |   |      |   |        |      |  |   |       |  
|(Increase) decrease in other assets                                                               |  |                                  | 102     |   |      |   | (103    | )    |  |   | 2      |  
|Increase (decrease) in other liabilities                                                          |  |                                  | 30      |   |      |   | 1,540   |      |  |   |       |  
|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net cash provided by operating activities                                                         |  |                                  | 19,486  |   |      |   | 10,227  |      |  |   | 2,991  |  
|Investing Activities                                                                              |  |                                  |         |   |      |   |         |      |  |   |        |  
|Capital contribution in subsidiary                                                                |  |                                  | (97,348 | ) |      |   |        |      |  |   |       |  
|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net cash used in investing activities                                                             |  |                                  | (97,348 | ) |      |   |        |      |  |   |       |  
|Financing Activities                                                                              |  |                                  |         |   |      |   |         |      |  |   |        |  
|(Decrease) increase in commercial paper                                                           |  |                                  | (19,061 | ) |      |   | (8,894  | )    |  |   | 1,629  |  
|Proceeds from issuance of common stock                                                            |  |                                  | 98,378  |   |      |   |        |      |  |   |       |  
|Proceeds from exercise of stock options                                                           |  |                                  |        |   |      |   | 106     |      |  |   | 380    |  
|Cash dividends declared on common stock                                                           |  |                                  |        |   |      |   | (389    | )    |  |   | (5,153 | )
|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  
|Net cash provided by (used in) financing activities                                               |  |                                  | 79,317  |   |      |   | (9,177  | )    |  |   | (3,144 | )
|Net increase (decrease) in cash and cash equivalents                                              |  |                                  | 1,455   |   |      |   | 1,050   |      |  |   | (153   | )
|Cash and cash equivalents, beginning of the period                                                |  |                                  | 1,050   |   |      |   |        |      |  |   | 153    |  
|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  
|Cash and cash equivalents, end of the period                                                      |  | $                                | 2,505   |   |      | $ | 1,050   |      |  | $ |       |  
|                                                                                                  |  |                                  |         |   |      |   |         |      |  |   |        |  



|21. |  | Regulatory Capital Requirements and Dividend Restrictions
|--- |  | ---------------------------------------------------------



Capital Requirements



The following table summarizes the Companys and the
Banks actual and required capital ratios at the dates indicated (dollars in thousands). The Company and the Bank were classified in the well-capitalized category at December 31, 2010 and the adequately-capitalized category at
December 31, 2009.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Since December 31, 2010, no conditions or events have occurred, of which the
Company is aware, that have resulted in a material change in the Companys or the Banks category other than as reported in this Annual Report on Form 10-K.



|                                       |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|-------------------------------------- |  | ------ | ------- |  | --------------------------- |  | ----- | ------------------------------------------------------------- |  | - | ------ |  |  | ------ | ---- | - | ----- | - | ------- |  |  |  | ----- | -
|                                       |  | Actual |         |  | For capitaladequacypurposes |  |       | To be wellcapitalized underprompt correctiveaction provisions | 
|                                       |  | amount |         |  | ratio                       |  |       | amount                                                        |  |   | ratio  |  |  | amount |      |   | ratio |  
|At December 31, 2010                   |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Total capital to risk-weighted assets  |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  | $      | 132,118 |  |                             |  | 14.43 | %                                                             |  | $ | 73,261 |  |  |        | 8.00 | % |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 130,632 |  |                             |  | 14.25 |                                                               |  |   | 73,339 |  |  |        | 8.00 |   |       | $ | 91,674  |  |  |  | 10.00 | %
|Tier 1 capital to risk-weighted assets |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  |        | 120,478 |  |                             |  | 13.16 |                                                               |  |   | 36,631 |  |  |        | 4.00 |   |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 118,981 |  |                             |  | 12.98 |                                                               |  |   | 36,669 |  |  |        | 4.00 |   |       |   | 55,004  |  |  |  | 6.00  |  
|Tier 1 leverage ratio                  |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  |        | 120,478 |  |                             |  | 8.22  |                                                               |  |   | 58,634 |  |  |        | 4.00 |   |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 118,981 |  |                             |  | 8.12  |                                                               |  |   | 58,624 |  |  |        | 4.00 |   |       |   | 73,280  |  |  |  | 5.00  |  
|                                       |  |        |         |  |                             | 
|At December 31, 2009                   |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Total capital to risk-weighted assets  |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  | $      | 93,298  |  |                             |  | 8.25  | %                                                             |  | $ | 90,426 |  |  |        | 8.00 | % |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 93,013  |  |                             |  | 8.22  |                                                               |  |   | 90,518 |  |  |        | 8.00 |   |       | $ | 113,147 |  |  |  | 10.00 | %
|Tier 1 capital to risk-weighted assets |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  |        | 79,046  |  |                             |  | 6.99  |                                                               |  |   | 45,213 |  |  |        | 4.00 |   |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 78,745  |  |                             |  | 6.96  |                                                               |  |   | 45,259 |  |  |        | 4.00 |   |       |   | 67,888  |  |  |  | 6.00  |  
|Tier 1 leverage ratio                  |  |        |         |  |                             |  |       |                                                               |  |   |        |  |  |        |      |   |       |   |         |  |  |  |       |  
|Company                                |  |        | 79,046  |  |                             |  | 5.55  |                                                               |  |   | 56,951 |  |  |        | 4.00 |   |       |   | n/a     |  |  |  | n/a   |  
|Bank                                   |  |        | 78,745  |  |                             |  | 5.52  |                                                               |  |   | 57,042 |  |  |        | 4.00 |   |       |   | 71,302  |  |  |  | 5.00  |  



Recent Regulatory Developments



The Company and the Bank are subject to periodic examination by various regulatory agencies. In November 2009, the FDIC and the State
Board conducted their annual joint examination of the Bank. Beginning in October 2009, the Companys Board of Directors and the Regulatory Oversight Committee of the Board of Directors met periodically with the FDIC to receive status reports on
their examination, and the Board received the final report of examination in April 2010. Effective June 10, 2010, the Bank agreed to the issuance of a Consent Order. The Consent Order includes requirements regarding the Banks capital
position and other requirements, including that the Bank:



| |  |  | Achieve and maintain, within 120 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted
assets and Tier 1 capital at least equal to 8% of total assets;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Determine, within 30 days of the last day of the calendar quarter, its capital ratios. If any capital measure falls below the established minimum,
within 30 days provide a written plan to the supervisory authorities describing the means and timing by which the Bank shall increase such ratios to or in excess of the established minimums;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Establish, within 30 days from the effective date of the Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored
by the Banks Board of Directors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Develop, within 60 days from the effective date of the Consent Order, a written analysis and assessment of the Banks management and staffing
needs;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



| |  |  | Notify the supervisory authorities in writing of the resignation or termination of any of the Banks directors or senior executive officers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Eliminate, within 10 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified
Loss and 50% of those assets classified Doubtful;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its policy to ensure the adequacy of the Banks allowance for loan
and lease losses, which must provide for a review of the Banks allowance for loan and lease losses at least once each calendar quarter;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce classified assets, which shall include, among other
things, a reduction of the Banks risk exposure in relationships with assets in excess of $1,000,000 which are criticized as Substandard, Doubtful, or Special Mention;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Revise, within 60 days from the effective date of the Consent Order, its policies and procedures for managing the Banks Adversely Classified
Other Real Estate Owned;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in
whole or in part, Loss or Doubtful and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or
in part, Substandard or Special Mention and is uncollected, unless the Banks board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the
Bank;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Perform, within 90 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Banks Concentrations of
Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review, within 60 days from the effective date of the Consent Order and annually thereafter, the Banks loan policies and procedures for adequacy
and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Banks lending functions and ensure their implementation;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adopt, within 60 days from the effective date of the Consent Order, an effective internal loan review and grading system to provide for the periodic
review of the Banks loan portfolio in order to identify and categorize the Banks loans, and other extensions of credit which are carried on the Banks books as loans, on the basis of credit quality;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its written profit plan to ensure the Bank has a realistic,
comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the Bank, the major areas in and means by which the Bank will seek to improve the
Banks operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and
adequately support major projected income and expense components of the plan, and coordination of the Banks loan, investment, and operating policies and budget and profit planning with the funds management policy;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review and update, within 60 days from the effective date of the Consent Order, its written plan addressing liquidity, contingent funding, and asset
liability management;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Eliminate, within 30 days from the effective date of the Consent Order, all violations of law and regulation or contraventions of policy set forth in
the FDICs safety and soundness examination of the Bank in November 2009;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



| |  |  | Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Limit asset growth to 10% per annum;
| | - |  | ------------------------------------



| |  |  | Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the
prior approval of the supervisory authorities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Not offer an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on its website unless
otherwise specifically permitted by the FDIC. On April 1, 2010 the Bank was notified by the FDIC that it had determined that the geographic areas in which it operates were considered high-rate areas. Accordingly, the Bank is able to offer
interest rates on deposits up to 75 basis points over the prevailing interest rates in its geographic areas. The FDIC informed the Company that this high-rate determination is also effective for calendar year 2011; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Furnish, by within 30 days from the effective date of the Consent Order and within 30 days of the end of each quarter thereafter, written progress
reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company intends to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof the
Company has submitted all documentation required as of this date to the FDIC and State Board. There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of the Companys
compliance will be made by the FDIC and the State Board. However, the Company believes it is currently in compliance with all provisions of the Consent Order except for the requirement to reduce the total amount of its criticized assets at
September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first date being December 7, 2010 when a 25% ($56.7 million)
reduction in criticized assets was required. The Company reduced its criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. The Companys next incremental deadline, June 5, 2011, stipulates a 45%
($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of February 22, 2011, the Company has reduced its criticized assets by 53.2% ($114.9 million). Failure to meet the requirements of the Consent Order
could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC. In addition, the Supervisory Authorities may amend the Consent Order based on the results of their ongoing
examinations.



|22. |  | Related Party Transactions
|--- |  | --------------------------



Intercompany Transactions



Intercompany transactions include activities between the Company and the Bank, as well as between the Bank, Palmetto Capital, and other
subsidiaries. The former includes transactions described in Note 20, Holding Company Condensed Financial Information. During 2010 and 2009, the Banks trust department also managed certain of the assets of the Companys employee benefit
plans.



Related Party Transactions



Certain directors, executive officers, and
their related interests are loan customers of the Bank. All such loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions. The total loans
outstanding to these related parties aggregated approximately $2.2 million and $12.3 million at December 31, 2010 and 2009, respectively.



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



Of the loans to related parties at December 31, 2009, $9.3 million related to
individuals whose status as members of the Companys Board of Directors terminated during 2010. Accordingly, those loans are no longer considered related party balances at December 31, 2010. In addition, during 2010 net paydowns on related
party loans were $773 thousand.



|23. |  | Quarterly Financial Data (Unaudited)
|--- |  | ------------------------------------



The following tables summarize selected financial data regarding results of operations for the periods indicated (in thousands, except per
share data). Certain amounts previously presented in the Consolidated Statements of Income (Loss) for prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods net
income (loss) as previously reported.



|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------- | - | ------- | ------------ |  | - | ------------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                              |  | For the year ended December 31, 2010 |       
|                                                              |  | Firstquarter                         |        |   | Secondquarter |   |         | Thirdquarter |  |   | Fourthquarter |   |  | Total |        
|Interest income                                               |  | $                                    | 14,879 |   |               | $ | 14,450  |              |  | $ | 13,856        |   |  | $     | 13,442  |   |  | $ | 56,627  |  
|Interest expense                                              |  |                                      | 4,080  |   |               |   | 3,716   |              |  |   | 3,888         |   |  |       | 3,682   |   |  |   | 15,366  |  
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net interest income                                           |  |                                      | 10,799 |   |               |   | 10,734  |              |  |   | 9,968         |   |  |       | 9,760   |   |  |   | 41,261  |  
|Provision for loan losses                                     |  |                                      | 10,750 |   |               |   | 12,750  |              |  |   | 13,100        |   |  |       | 10,500  |   |  |   | 47,100  |  
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net interest income (expense) after provision for loan losses |  |                                      | 49     |   |               |   | (2,016  | )            |  |   | (3,132        | ) |  |       | (740    | ) |  |   | (5,839  | )
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Investment securities gains                                   |  |                                      | 8      |   |               |   |        |              |  |   | 1             |   |  |       | 1       |   |  |   | 10      |  
|Other noninterest income                                      |  |                                      | 4,741  |   |               |   | 3,864   |              |  |   | 4,186         |   |  |       | 4,800   |   |  |   | 17,591  |  
|Noninterest expense                                           |  |                                      | 13,132 |   |               |   | 15,174  |              |  |   | 22,414        |   |  |       | 22,586  |   |  |   | 73,306  |  
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net loss before benefit for income taxes                      |  |                                      | (8,334 | ) |               |   | (13,326 | )            |  |   | (21,359       | ) |  |       | (18,525 | ) |  |   | (61,544 | )
|Provision (benefit) for income taxes                          |  |                                      | (3,042 | ) |               |   | (4,793  | )            |  |   | (7,580        | ) |  |       | 14,073  |   |  |   | (1,342  | )
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net loss                                                      |  | $                                    | (5,292 | ) |               | $ | (8,533  | )            |  | $ | (13,779       | ) |  | $     | (32,598 | ) |  | $ | (60,202 | )
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Common and per share data                                     |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net lossbasic                                                |  | $                                    | (0.82  | ) |               | $ | (1.32   | )            |  | $ | (2.13         | ) |  | $     | (0.74   | ) |  | $ | (3.78   | )
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net lossdiluted                                              |  |                                      | (0.82  | ) |               |   | (1.32   | )            |  |   | (2.13         | ) |  |       | (0.74   | ) |  |   | (3.78   | )
|                                                              |  |                                      |        |   |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  



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PALMETTO BANCSHARES, INC. AND SUBSIDIARY



Notes To Consolidated Financial
Statements(Continued)



|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------------------------ | ------ |  | ------------- | - | ------- | ------------ |  | - | ------------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                              |  | For the year ended December 31, 2009 |       
|                                                              |  | Firstquarter                         |        |  | Secondquarter |   |         | Thirdquarter |  |   | Fourthquarter |   |  | Total |        
|Interest income                                               |  | $                                    | 17,566 |  |               | $ | 15,890  |              |  | $ | 17,046        |   |  | $     | 15,708  |   |  | $ | 66,210  |  
|Interest expense                                              |  |                                      | 5,188  |  |               |   | 5,622   |              |  |   | 5,530         |   |  |       | 5,099   |   |  |   | 21,439  |  
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net interest income                                           |  |                                      | 12,378 |  |               |   | 10,268  |              |  |   | 11,516        |   |  |       | 10,609  |   |  |   | 44,771  |  
|Provision for loan losses                                     |  |                                      | 2,175  |  |               |   | 30,000  |              |  |   | 24,000        |   |  |       | 17,225  |   |  |   | 73,400  |  
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net interest income (expense) after provision for loan losses |  |                                      | 10,203 |  |               |   | (19,732 | )            |  |   | (12,484       | ) |  |       | (6,616  | ) |  |   | (28,629 | )
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Investment securities gains                                   |  |                                      | 2      |  |               |   |        |              |  |   |              |   |  |       |        |   |  |   | 2       |  
|Other noninterest income                                      |  |                                      | 4,015  |  |               |   | 4,767   |              |  |   | 4,254         |   |  |       | 4,393   |   |  |   | 17,429  |  
|Noninterest expense                                           |  |                                      | 11,103 |  |               |   | 12,807  |              |  |   | 13,709        |   |  |       | 13,396  |   |  |   | 51,015  |  
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net income (loss) before provision (benefit) for income taxes |  |                                      | 3,117  |  |               |   | (27,772 | )            |  |   | (21,939       | ) |  |       | (15,619 | ) |  |   | (62,213 | )
|Provision (benefit) for income taxes                          |  |                                      | 1,123  |  |               |   | (9,921  | )            |  |   | (7,764        | ) |  |       | (5,566  | ) |  |   | (22,128 | )
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net income (loss)                                             |  | $                                    | 1,994  |  |               | $ | (17,851 | )            |  | $ | (14,175       | ) |  | $     | (10,053 | ) |  | $ | (40,085 | )
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Common and per share data                                     |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net income (loss)basic                                       |  | $                                    | 0.31   |  |               | $ | (2.77   | )            |  | $ | (2.20         | ) |  | $     | (1.55   | ) |  | $ | (6.21   | )
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  
|Net income (loss)diluted                                     |  |                                      | 0.31   |  |               |   | (2.77   | )            |  |   | (2.20         | ) |  |       | (1.55   | ) |  |   | (6.21   | )
|                                                              |  |                                      |        |  |               |   |         |              |  |   |               |   |  |       |         |   |  |   |         |  



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##### Table of Contents

|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------



None.



ITEM 9A.CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



An evaluation of the Companys
disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of the Companys Chief Executive Officer and Chief Financial
Officer, and several other members of the Companys senior management as of December 31, 2010. The Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures were
effective as of December 31, 2010 in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934 is (i) accumulated and communicated to management
(including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and is (ii) recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms.



See Item 8. Financial Statements and Supplementary Data,
which includes managements report on internal control over financial reporting and the attestation report thereon issued by Elliott Davis, LLC.



Fourth Quarter Internal Control Changes



During the fourth quarter of 2010, the Company did not make any changes in its internal controls over financial reporting that has materially impacted or
is reasonably likely to materially impact those controls.



ITEM 9B.OTHER INFORMATION



None.



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##### Table of Contents

PART III



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------



The information required by this item is set forth in the
definitive Proxy Statement of the Company filed in connection with its 2011 Annual Meeting of the Shareholders, which is incorporated herein by reference.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



The information required by this item is set forth in the definitive Proxy Statement of the Company filed in connection with its 2011
Annual Meeting of the Shareholders, which is incorporated herein by reference.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



A portion of the information required by this item is set
forth in Item 5 of this Annual Report on Form 10-K. Additional information required by this item is set forth in the definitive Proxy Statement of the Company filed in connection with its 2011 Annual Meeting of Shareholders, which is
incorporated herein by reference.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------



The information required by this item is set forth in the
definitive Proxy Statement of the Company filed in connection with its 2011 Annual Meeting of the Shareholders, which is incorporated herein by reference.



|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- | --------------------------------------



The information required by this item is set forth in the
definitive Proxy Statement of the Company filed in connection with its 2011 Annual Meeting of the Shareholders, which is incorporated herein by reference.



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##### Table of Contents

PART IV



|ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|-------- | ---------------------------------------



| | (a) |  | (1) All Financial Statements
| | --- |  | ----------------------------



See Item 8. Financial Statements and Supplementary Data



| | (2) |  | Financial Statement Schedules
| | --- |  | -----------------------------



All schedules to the Consolidated Financial Statements required by Article 9 of Regulation S-X and all other schedules to the financial
statements of the Company required by Article 5 of Regulation S-X are not required under the related instructions or are inapplicable and, therefore, have been omitted, or the required information is contained in the Consolidated Financial
Statements or the notes thereto, which are included in Item 8 hereof.



| | (3) |  | Listing of Exhibits
| | --- |  | -------------------



|            |  |                                                                                                                                                                                                                                                                                                 
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                     
|3.1.1       |  | Amended and Restated Articles of Incorporation filed on December 21, 2009 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 3.1 of
the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on December 21, 2009
|            | 
|3.1. 2      |  | Articles of Amendment filed on August 11, 2010 in the office of the Secretary of State of South Carolina: Incorporated by reference to Exhibit 3.1 of the Companys Current
Report on Form 8-K, filed with the Securities and Exchange Commission on October 7, 2010                            
|            | 
|3.2. 1      |  | Amended and Restated Bylaws dated December 15, 2009: Incorporated by reference to Exhibit 3.2 of the Companys Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 21, 2009                                                                                
|            | 
|4.1         |  | Articles of Incorporation of the Registrant: Included in Exhibits 3.1.1  3.1.2                                                                                                                                                                                                                 
|            | 
|4.2         |  | Bylaws of the Registrant: Included in Exhibit 3.2.1                                                                                                                                                                                                                                             
|            | 
|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                                                         
|            | 
|10.1*       |  | 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                                             
|            | 
|10.2*       |  | The Palmetto Bank Officer Incentive Compensation Plan: Incorporated by reference to Exhibit 10.3 to the Companys Annual Report on Form 10-K for the year ended December 31,
2000                                                                                                               
|            | 
|10.3.1*     |  | Palmetto Bancshares, Inc. 1997 Stock Compensation Plan, as amended to date: Incorporated by reference to Exhibit 10.1 to the Companys Annual Report on Form 10-K for the
year ended December 31, 1997                                                                                          
|            | 
|10.3.2*     |  | Amendment to the Palmetto Bancshares, Inc.s 1997 Stock Compensation Plan: Incorporated by reference to Exhibit 10.4.1 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2003                                                                                         
|            | 
|10.4*       |  | Palmetto Bancshares, Inc. 2008 Restricted Stock Plan: Incorporated by reference to Appendix A to Companys Proxy Statement on Schedule 14A, filed with the Securities and
Exchange Commission on March 17, 2008                                                                                 
|            | 
|10.5        |  | Lease Agreement dated as of May 2, 2007 between The Palmetto Bank and Charles E. Howard and Doris H. Howard: Incorporated by reference to Exhibit 10.1 to the Companys
Current Report on Form 8-K filed on June 26, 2007                                                                       



185



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##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                                                                                               
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                   
|10.6*       |  | Employment Agreement by and between Palmetto Bancshares, Inc. and Samuel L. Erwin, dated December 15, 2009: Incorporated by reference to Exhibit 10.1 of the Companys
Current Report on Form 8-K filed with the Securities and Exchange Commission on December 21, 2009                                                                                                      
|            | 
|10.7*       |  | Employment Agreement by and between Palmetto Bancshares, Inc. and Lee S. Dixon, dated December 15, 2009: Incorporated by reference to Exhibit 10.2 of the Companys Current
Report on Form 8-K filed with the Securities and Exchange Commission on December 21, 2009                                                                                                         
|            | 
|10.8        |  | Stock Purchase Agreement by and among Palmetto Bancshares, Inc. and the investors named therein dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 of the
Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 1, 2010                                                                                             
|            | 
|10.9        |  | Registration Rights Agreement by and among Palmetto Bancshares, Inc. and the investors named therein dated as of May 25, 2010: Incorporated by reference to Exhibit 10.2 of the
Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 1, 2010                                                                                        
|            | 
|10.10       |  | Amendment No. 1 dated June 8, 2010 to Stock Purchase Agreement and Registration Rights Agreement by and among Palmetto Bancshares, Inc. and each of the other investors named
therein, each dated as of May 25, 2010: Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 11, 2010
|            | 
|10.11       |  | Amendment No. 2 dated September 22, 2010 to Stock Purchase Agreement by and among Palmetto Bancshares, Inc. and each of the other investors named therein: Incorporated by
reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on September 24, 2010                                                      
|            | 
|10.12       |  | Consent Order, effective June 10, 2010, between the FDIC, the South Carolina State Board of Financial Institutions, and The Palmetto Bank: Incorporated by reference to Exhibit
10.2 of the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on June 11, 2010                                                                           
|            | 
|10.13       |  | Form of Subscription Agreement by and among Palmetto Bancshares, Inc. and each Institutional Investors participating in the Institutional Shareholders Offering dated as of
January 28, 2011: Incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on February 3, 2011                     
|            | 
|21.1^       |  | List of Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                                                                        
|            | 
|23.1^       |  | Consent of Elliott Davis, LLC                                                                                                                                                                                                                                                                                                                                                 
|            | 
|31.1^       |  | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                     
|            | 
|31.2^       |  | Roy D. Jones Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                         
|            | 
|32^         |  | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                      



|* |  | Management contract or compensatory plan or arrangement
|- |  | -------------------------------------------------------

|^ |  | Filed with this Annual Report on Form 10-K
|- |  | ------------------------------------------



Copies of exhibits are available upon written request to Corporate Secretary, Palmetto Bancshares, Inc., 306 East North Street,
Greenville, SC 20601



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##### Table of Contents

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/    SAMUEL L.
ERWINSamuel L. Erwin
Chief Executive Officer Palmetto Bancshares, Inc./s/    ROY D.
JONESRoy D. Jones Chief Financial Officer Palmetto Bancshares,
Inc.




Date: February 28, 2011



KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Samuel L. Erwin, his true and lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.



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/    LEE S. DIXON
Lee S. Dixon                 |  | Director Chief Operating Officer Chief Risk Officer
Palmetto Bancshares, Inc. |  | February 28, 2011
|                                                 |  |                                                                              
|/s/    SAMUEL L. ERWIN
Samuel L. Erwin           |  | Director Chief Executive Officer Palmetto Bancshares, Inc.                    |  | February 28, 2011
|                                                 |  |                                                                              
|/s/    MICHAEL D. GLENN
Michael D. Glenn         |  | Director                                                                      |  | February 28, 2011
|                                                 |  |                                                                              
|/s/    ROBERT B. GOLDSTEIN
Robert B. Goldstein   |  | Director                                                                      |  | February 28, 2011
|                                                 |  |                                                                              
|/s/    JOHN D. HOPKINS,
JR. John D. Hopkins, Jr. |  | Director                                                                      |  | February 28, 2011



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##### Table of Contents

|                                                 |  |                                                   |  |                  
|------------------------------------------------ |  | ------------------------------------------------- |  | -----------------
|Signature                                        |  | Title                                             |  | Date             
|                                                 |  |                                                  
|/s/    ROY D. JONES
Roy D. Jones                 |  | Chief Financial Officer Palmetto Bancshares, Inc. |  | February 28, 2011
|                                                 |  |                                                  
|/s/    JAMES J. LYNCH
James J. Lynch             |  | Director                                          |  | February 28, 2011
|                                                 |  |                                                  
|/s/    L. LEON PATTERSON
L. Leon Patterson       |  | Chairman of the Board of Directors                |  | February 28, 2011
|                                                 |  |                                                  
|/s/    JANE S. SOSEBEE
Jane S. Sosebee           |  | Director                                          |  | February 28, 2011
|                                                 |  |                                                  
|/s/    L. STEWART SPINKS
L. Stewart Spinks       |  | Director                                          |  | February 28, 2011
|                                                 |  |                                                  
|/s/    JOHN P. SULLIVAN
John P. Sullivan         |  | Director                                          |  | February 28, 2011
|                                                 |  |                                                  
|/s/    J. DAVID WASSON,
JR. J. David Wasson, Jr. |  | Director                                          |  | February 28, 2011



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EXHIBIT INDEX



|            |      |  |             |                                                                                          
|----------- | ---- |  | ----------- | -----------------------------------------------------------------------------------------
|Exhibit No. |      |  | Description
|            | 21.1 |  |             | List of Subsidiaries of the Registrant                                                   
|            |     
|            | 23.1 |  |             | Consent of Elliott Davis, LLC                                                            
|            |     
|            | 31.1 |  |             | Samuel L. Erwins Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|            |     
|            | 31.2 |  |             | Roy D. Jones Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    
|            |     
|            | 32   |  |             | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                 



189