**U. S. SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

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

 

For the quarterly period ended September 30, 2007

 

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.)** |
|                                                                                             |                                                 |
| **301 Hillcrest Drive, Laurens, South Carolina**                             | **29360 **                                      |
| **(Address of principal executive offices)**                                      | **(Zip Code)**                                  |
|                                                                                                  |                                                 |
| **(864) 984–4551**                                                                          | **www.palmettobank.com**                             |
| **(Registrant's telephone number)**                                                         | **(Registrant's web site)**                |

 

        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 filingrequirements for the past 90 days. Yes X   No __

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, ora non-accelerated filer.  See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. 

 

Large accelerated filer [ ]       Accelerated filer [x]      Non-accelerated filer [ ]

 

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

 

        Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

| Class                                             | Outstanding at November 6, 2007 |
|---------------------------------------------------|-----------------------------------------------------|
| -----------------------------                     | -------------------------------                     |
| Common stock, $5.00 par value | 6,400,260                                           |

 

----

 

| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY** |
|------------------------------------------------------------------|
| **Table of Contents**                                  |
|                                                             |   |   | Page |   |   |
|                                                             |   |   |   |   |   |
|                                                             |   |   |   |   |   |
| PART I - FINANCIAL INFORMATION               |   |   |   |
|                                                             | Item 1. | Financial Statements | 3 |   |   |
|                                                             | Item 2. | Management's Discussion and Analysis of Financial Condition and | 23 |   |   |
|                                                             |   |      Results of Operations |   |   |   |
|                                                             | Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 51 |   |   |
|                                                             | Item 4. | Controls and Procedures | 52 |   |   |
|                                                             |   |   |   |   |   |
| PART II - OTHER INFORMATION                  |   |   |   |
|                                                             | Item 1. | Legal Proceedings | 53 |   |   |
|                                                             | Item 6. | Exhibits |   |   |   |
|                                                             |   |   |   |   |   |
| SIGNATURES                                                       | 54 |   |   |
|                                                             |   |   |   |   |   |

 

2

----

**PART I - FINANCIAL INFORMATION**

**Item 1. Financial Statements**

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                          |
|------------------------------------------------------------------------|
| **Consolidated  Balance Sheets**                                       |
| **(dollars in  thousands, except common and per share data)**          |
|                                                                   |   |   |   |   |   |   |   |   |
| ** **                                                             |   |   |   |   |   | **September 30,** |   | **December 31,** |
|                                                                   |   |   |   |   |   | **2007** | ** ** | **2006** |
|                                                                   |   |   |   |   |   | (unaudited) |   |   |
| Assets                                                                 |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |   |   |   |   |   |
|                                                                   | Cash and due from banks |   |   |  $ | 31,076  |   | 43,084  |
|                                                                   | Federal funds sold |   |   | 4,188  |   | 3,582  |
|                                                                   |   | Total cash and cash equivalents |   | 35,264  |   | 46,666  |
|                                                                   |   |   |   |   |   |   |   |   |
| Federal Home Loan Bank ("FHLB") stock, at cost               |   | 3,157  |   | 2,599  |
| Investment securities available for sale, at fair market  value        | 96,287  |   | 116,567  |
| Mortgage loans held for sale                                           |   |   | 1,435  |   | 1,675  |
|                                                                   |   |   |   |   |   |   |   |   |
| Loans                                                                  |   |   |   |   | 1,005,872  |   | 945,913  |
|                                                                   | Less: allowance for loan losses |   |   | (8,280) |   | (8,527) |
|                                                                   |   | Loans, net |   |   | 997,592  |   | 937,386  |
|                                                                   |   |   |   |   |   |   |   |   |
| Premises and equipment, net                                            |   |   | 24,476  |   | 24,494  |
| Goodwill                                                               |   |   |   |   | 3,691  |   | 3,691  |
| Other intangible assets                                                |   |   | 90  |   | 126  |
| Accrued interest receivable                                            |   |   | 6,421  |   | 6,421  |
| Other                                                                  |   |   |   |   | 20,437  |   | 13,511  |
|                                                                   |   |   | Total assets |   |   |  $ | 1,188,850  |   | 1,153,136  |
|                                                                   |   |   |   |   |   |   |   |   |
| Liabilities and Shareholders' Equity                                   |   |   |   |   |   |
| Liabilities                                                            |   |   |   |   |   |   |   |
| Deposits                                                               |   |   |   |   |   |   |   |
|                                                                   | Noninterest-bearing |   |   |  $ | 136,990  |   | 133,623  |
|                                                                   | Interest-bearing |   |   | 859,505  |   | 859,958  |
|                                                                   |   | Total deposits |   |   | 996,495  |   | 993,581  |
|                                                                   |   |   |   |   |   |   |   |   |
| Retail repurchase agreements                                           |   |   | 10,130  |   | 14,427  |
| Commercial paper (Master notes)                                        |   |   | 30,636  |   | 20,988  |
| Other short-term borrowings                                            |   |   | 33,000  |   | 6,000  |
| Long-term borrowings                                                   |   |   | -    |   | 10,000  |
| Accrued interest payable                                               |   |   | 1,518  |   | 1,584  |
| Other                                                                  |   |   |   |   | 8,140  |   | 6,180  |
|                                                                   |   | Total liabilities |   |   | 1,079,919  |   | 1,052,760  |
|                                                                   |   |   |   |   |   |   |   |   |
| Commitments and contingencies (Note 14)                                |   |   |   |   |
|                                                                   |   |   |   |   |   |   |   |   |
| Shareholders' Equity                                                   |   |   |   |   |   |
| Common stock - par value $5.00 per share;  authorized  10,000,000 |   |   |   |
|                                                                   | shares; issued and outstanding 6,400,260 and 6,367,450 |   |   |   |
|                                                                   | at September 30, 2007 and December 31, 2006, respectively | 32,001  |   | 31,837  |
| Capital surplus                                                        |   |   |   | 1,527  |   | 1,102  |
| Retained earnings                                                      |   |   | 76,211  |   | 68,132  |
| Accumulated other comprehensive loss, net of tax                       |   | (808) |   | (695) |
|                                                                   |   | Total shareholders' equity |   |   | 108,931  |   | 100,376  |
|                                                                   |   |   |   |   |   |   |   |   |
|                                                                   |   |   | Total liabilities and shareholders' equity |  $ | 1,188,850  |   | 1,153,136  |
|                                                                   |   |   |   |   |   |   |   |   |
|                                                                   |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements.               |

** **

3

----

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                 |
|---------------------------------------------------------------|
| **Consolidated  Statements of Income**                        |
| **(dollars in  thousands, except common and per share data)** |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   | **For the three  month periods ended September 30,** |
|                                                          |   |   |   |   |   |   | **2007** | ** ** | **2006** | ** ** |
|                                                          |   |   |   |   |   |   | (unaudited) | ** ** |
| Interest income                                               |   |   |   |   |   |   |   |   |
|                                                          | Interest and fees on loans |   |   |  $ | 20,012  |   | 18,033  |   |
|                                                          | Interest on investment securities available for sale: |   |   |   |   |
|                                                          |   | Government-sponsored enterprises (taxable) | 322  |   | 458  |   |
|                                                          |   | State and municipal (nontaxable) |   | 464  |   | 512  |   |
|                                                          |   | Mortgage-backed securities (taxable) | 299  |   | 212  |   |
|                                                          | Interest on federal funds sold |   |   | 149  |   | 317  |   |
|                                                          | Dividends on FHLB stock |   |   | 47  |   | 45  |   |
|                                                          |   |   | Total interest income |   | 21,293  |   | 19,577  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Interest expense                                              |   |   |   |   |   |   |   |
|                                                          | Interest on deposits |   |   | 7,663  |   | 6,680  |   |
|                                                          | Interest on retail repurchase agreements |   | 149  |   | 213  |   |
|                                                          | Interest on commercial paper   |   | 312  |   | 247  |   |
|                                                          | Interest on other short-term borrowings |   | 414  |   | 5  |   |
|                                                          | Interest on long-term borrowings |   | -    |   | 97  |   |
|                                                          |   |   | Total interest expense |   | 8,538  |   | 7,242  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income |   | 12,755  |   | 12,335  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Provision for loan losses                                     |   |   | 400  |   | 275  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income after provision for loan losses | 12,355  |   | 12,060  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Noninterest income                                            |   |   |   |   |   |   |   |
|                                                          | Service charges on deposit accounts |   | 2,001  |   | 1,995  |   |
|                                                          | Fees for trust and brokerage services |   | 736  |   | 817  |   |
|                                                          | Mortgage-banking income |   |   | 468  |   | 182  |   |
|                                                          | Investment securities gains |   |   | -    |   | -    |   |
|                                                          | Other |   |   |   |   | 1,407  |   | 810  |   |
|                                                          |   |   | Total noninterest income |   | 4,612  |   | 3,804  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Noninterest expense                                           |   |   |   |   |   |   |   |
|                                                          | Salaries and other personnel |   |   | 7,040  |   | 5,772  |   |
|                                                          | Occupancy |   |   |   | 375  |   | 398  |   |
|                                                          | Premises, furniture, and equipment leases and rentals | 321  |   | 341  |   |
|                                                          | Premises, furniture, and equipment depreciation | 492  |   | 506  |   |
|                                                          | Other furniture and equipment |   |   | 482  |   | 473  |   |
|                                                          | Loss on disposition of premises, furniture, and equipment | 346  |   | -    |   |
|                                                          | Marketing |   |   |   | 208  |   | 479  |   |
|                                                          | Amortization of core deposit intangibles |   | 12  |   | 12  |   |
|                                                          | Other |   |   |   |   | 2,115  |   | 2,044  |   |
|                                                          |   |   | Total noninterest expense |   | 11,391  |   | 10,025  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income before provision for income taxes | 5,576  |   | 5,839  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Provision for income taxes                                    |   |   | 1,680  |   | 2,038  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income |   |   |  $ | 3,896  |   | 3,801  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| Common and per share data                                     |   |   |   |   |   |   |
|                                                          | Net income - basic |   |   |  $ | 0.61  |   | 0.60  |   |
|                                                          | Net income - diluted |   |   | 0.60  |   | 0.59  |   |
|                                                          | Cash dividends |   |   |   | 0.19  |   | 0.18  |   |
|                                                          | Book value |   |   |   | 17.02  |   | 15.29  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
|                                                          | Weighted average common shares outstanding - basic | 6,392,721  |   | 6,356,656  |   |
|                                                          | Weighted average common shares outstanding - diluted | 6,500,962  |   | 6,432,546  |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements.      |

4

----

| **PALMETTO BANCSHARES,  INC. AND SUBSIDIARY**                 |
|---------------------------------------------------------------|
| **Consolidated  Statements of Income**                        |
| **(dollars in  thousands, except common and per share data)** |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   | **For the nine  month periods ended September 30,** |
|                                                          |   |   |   |   |   |   | **2007** | ** ** | **2006** |
|                                                          |   |   |   |   |   |   | (unaudited) |
| Interest income                                               |   |   |   |   |   |   |   |
|                                                          | Interest and fees on loans |   |   |  $ | 58,079  |   | 51,601  |
|                                                          | Interest on investment securities available for sale: |   |   |   |
|                                                          |   | Government-sponsored enterprises (taxable) | 1,138  |   | 1,497  |
|                                                          |   | State and municipal (nontaxable) |   | 1,340  |   | 1,505  |
|                                                          |   | Mortgage-backed securities (taxable) | 908  |   | 644  |
|                                                          | Interest on federal funds sold |   |   | 600  |   | 903  |
|                                                          | Dividends on FHLB stock |   |   | 122  |   | 144  |
|                                                          |   |   | Total interest income |   | 62,187  |   | 56,294  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Interest expense                                              |   |   |   |   |   |   |
|                                                          | Interest on deposits |   |   | 22,327  |   | 17,943  |
|                                                          | Interest on retail repurchase agreements |   | 425  |   | 564  |
|                                                          | Interest on commercial paper   |   | 839  |   | 591  |
|                                                          | Interest on other short-term borrowings |   | 497  |   | 119  |
|                                                          | Interest on long-term borrowings |   | 173  |   | 479  |
|                                                          |   |   | Total interest expense |   | 24,261  |   | 19,696  |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income |   | 37,926  |   | 36,598  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Provision for loan losses                                     |   |   | 1,200  |   | 1,325  |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net interest income after provision for loan losses | 36,726  |   | 35,273  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Noninterest income                                            |   |   |   |   |   |   |
|                                                          | Service charges on deposit accounts |   | 5,900  |   | 6,023  |
|                                                          | Fees for trust and brokerage services |   | 2,258  |   | 2,445  |
|                                                          | Mortgage-banking income |   |   | 987  |   | 679  |
|                                                          | Investment securities gains |   |   | -    |   | 3  |
|                                                          | Other |   |   |   |   | 3,164  |   | 2,533  |
|                                                          |   |   | Total noninterest income |   | 12,309  |   | 11,683  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Noninterest expense                                           |   |   |   |   |   |   |
|                                                          | Salaries and other personnel |   |   | 19,234  |   | 17,256  |
|                                                          | Occupancy |   |   |   | 1,124  |   | 1,152  |
|                                                          | Premises, furniture, and equipment leases and rentals | 946  |   | 987  |
|                                                          | Premises, furniture, and equipment depreciation | 1,478  |   | 1,528  |
|                                                          | Other furniture and equipment |   |   | 1,385  |   | 1,408  |
|                                                          | Loss on disposition of premises, furniture, and equipment | 346  |   | -    |
|                                                          | Marketing |   |   |   | 695  |   | 1,217  |
|                                                          | Amortization of core deposit intangibles |   | 36  |   | 36  |
|                                                          | Other |   |   |   |   | 6,160  |   | 6,592  |
|                                                          |   |   | Total noninterest expense |   | 31,404  |   | 30,176  |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income before provision for income taxes | 17,631  |   | 16,780  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Provision for income taxes                                    |   |   | 5,909  |   | 5,598  |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   | Net income |   |   |  $ | 11,722  |   | 11,182  |
|                                                          |   |   |   |   |   |   |   |   |   |
| Common and per share data                                     |   |   |   |   |   |
|                                                          | Net income - basic |   |   |  $ | 1.84  |   | 1.76  |
|                                                          | Net income - diluted |   |   | 1.81  |   | 1.74  |
|                                                          | Cash dividends |   |   |   | 0.57  |   | 0.54  |
|                                                          | Book value |   |   |   | 17.02  |   | 15.29  |
|                                                          |   |   |   |   |   |   |   |   |   |
|                                                          | Weighted average common shares outstanding - basic | 6,385,625  |   | 6,351,646  |
|                                                          | Weighted average common shares outstanding - diluted | 6,484,293  |   | 6,427,536  |
|                                                          |   |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements.      |

 5

----

**  **

| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY**                                                   |
|------------------------------------------------------------------------------------------------|
| ** Consolidated Statements of Changes in Shareholders'  Equity and Comprehensive Income** |
| **(dollars in thousands, except common and per share  data)**                                  |
| (unaudited)                                                                                    |
|                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** |   |   |
|                                                                                           | **Shares of** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **other** | ** ** | ** ** |
|                                                                                           | **common** | ** ** | **Common** | ** ** | **Capital** |   | ** Retained** |   | **comprehensive** | ** ** | ** ** |
|                                                                                           | **stock** | ** ** | **stock** | ** ** | **surplus** |   | **earnings**			 
**gain(loss), net**

** **

**Total**

Balance at December 31, 2005

6,331,335  

 

 $

31,656  

 

 $

659  

 

 $

57,532  

 

 $

(906)

 

 $

88,941  

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

11,182  

 

 

 

11,182  

Other comprehensive income,  net of tax:

 

 

 

 

 

 

 

 

 

 

 

     Unrealized holding gains  arising during period, net

 

 

 

 

 

 

 

 

 

 

 

          of tax effect of  $26

 

 

 

 

 

 

 

 

42  

 

 

     Plus:  reclassification  adjustment included

 

 

 

 

 

 

 

 

 

 

 

          in net income, net  of tax effect of $1

 

 

 

 

 

 

 

 

(2)

 

 

     Net unrealized gains on  securities

 

 

 

 

 

 

 

 

 

 

40  

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

11,222  

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared and  paid ($0.54 per share)

 

 

 

 

 

 

(3,431)

 

 

 

(3,431)

Compensation expense related  to stock options

 

 

 

 

99  

 

 

 

 

 

99  

Exercise of stock options

25,450  

 

128  

 

228  

 

 

 

 

 

356  

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30,  2006

6,356,785  

 

 $

31,784  

 

 $

986  

 

 $

65,283  

 

 $

(866)

 

 $

97,187  

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2006

6,367,450  

 

 $

31,837  

 

 $

1,102  

 

 $

68,132  

 

 $

(695)

 

 $

100,376  

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

11,722  

 

 

 

11,722  

Other comprehensive income,  net of tax:

 

 

 

 

 

 

 

 

 

 

 

     Unrealized holding losses arising during period, net

 

 

 

 

 

 

 

 

 

 

 

          of tax effect of  $71

 

 

 

 

 

 

 

 

(113)

 

 

     Plus:  reclassification  adjustment included

 

 

 

 

 

 

 

 

 

 

 

          in net income, net  of tax effect of $0

 

 

 

 

 

 

 

 

-    

 

 

     Net unrealized losses on  securities

 

 

 

 

 

 

 

 

 

 

(113)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

11,609  

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared and  paid ($0.57 per share)

 

 

 

 

 

 

(3,643)

 

 

 

(3,643)

Compensation expense related  to stock options

 

 

 

 

99  

 

 

 

 

 

99  

Exercise of stock options

32,810  

 

164  

 

326  

 

 

 

 

 

490  

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30,  2007

6,400,260  

 

 $

32,001  

 

 $

1,527  

 

 $

76,211  

 

 $

(808)

 

 $

108,931  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 6
****
** **

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Statements of Cash Flows**

**(in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the nine month periods ended September 30,**

 

 

 

 

 

 

**2007**

** **

**2006**

 

 

 

 

 

 

(unaudited)

Cash flows from operating  activities

 

 

 

 

Net income

 

 

 $

11,722  

 

11,182  

 

Adjustments to reconcile net  income to net cash 

 

 

 

 

 

provided by operating  activities

 

 

 

 

 

 

Depreciation, amortization,  and accretion, net

1,687  

 

1,562  

 

 

 

Investment securities gains

-    

 

(3)

 

 

 

Provision for loan losses

1,200  

 

1,325  

 

 

 

Origination of mortgage  loans held for sale

(48,991)

 

(28,721)

 

 

 

Proceeds from sale of  mortgage loans held for sale

49,832  

 

32,578  

 

 

 

Gain on sale of mortgage  loans

(614)

 

(370)

 

 

 

Compensation expense related  to stock options granted

99  

 

99  

 

 

 

Loss on disposition of  premises and equipment

346  

 

-    

 

 

 

Loss on disposition of real estate acquired in			settlement of loans

545  

 

1,337  

 

 

 

Increase of other assets,  net

(982)

 

(962)

 

 

 

Increase (decrease) of other  liabilities, net

1,965  

 

(642)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by  operating activities

16,809  

 

17,385  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing  activities

 

 

 

 

Purchase of investment  securities available for sale

(23,979)

 

(14,832)

 

Maturities, redemption,  calls, and principal repayment of investment securities available for sale

43,902  

 

17,223  

 

Proceeds from sales of  investment securities available for sale

-    

 

4,131  

 

Redemption of FHLB stock

72  

 

1,345  

 

Purchase of FHLB stock

(630)

 

(158)

 

Origination of loans, net

(67,508)

 

(65,210)

 

Proceeds on sale of  real estate acquired in			settlement of loans

(374)

 

(1,150)

 

Purchases of premises and  equipment

(1,806)

 

(3,183)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing  activities

(50,323)

 

(61,834)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing  activities

 

 

 

 

Deposits, net

 

 

2,914  

 

76,274  

 

(Decrease) increase of  retail repurchase agreements, net

(4,297)

 

740  

 

Increase in commercial  paper, net

9,648  

 

3,972  

 

Increase (decrease) of other  short-term borrowings, net

27,000  

 

(17,900)

 

Repayment of long-term  borrowings

(10,000)

 

(13,000)

 

Other common stock activity

490  

 

356  

 

Cash dividends paid on  common stock

(3,643)

 

(3,431)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by  financing activities

22,112  

 

47,011  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) of  cash and cash equivalents

(11,402)

 

2,562  

Cash and cash equivalents,  beginning of the period

46,666  

 

37,976  

 

 

 

 

 

 

 

 

 

Cash and cash equivalents,  end of the period

 $

35,264  

 

40,538  

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Data

 

 

 

 

Cash paid during the period  for:

 

 

 

 

 

Interest expense

 $

24,327  

 

19,457  

 

 

Income taxes 

 

6,018  

 

5,925  

 

Significant noncash  investing and financing activities

 

 

 

 

 

(Decrease) increase of  unrealized loss on investment securities available for sale, pretax

 $

184  

 

(67)

 

 

Loans transferred to real estate acquired in			settlement of loans, at fair market value 

6,115  

 

154  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial  Statements.

 

 

 

 

 

 

 

 

 

** **

 7

**PALMETTOBANCSHARES, INC. AND SUBSIDIARY**

**Notes To ConsolidatedInterim Financial Statements**

**(unaudited)**

** **

***1.       Summaryof Significant Accounting Policies***

 

The significant accounting policies followed by the Companyfor interim financial reporting are consistent with the accounting policiesfollowed for annual financial reporting.  The unaudited ConsolidatedInterim Financial Statements and footnotes are presented in accordance with theinstructions for the Quarterly Report on Form 10-Q.  The informationcontained in the footnotes included in the Company’s latest Annual Report onForm 10-K should be referred to in connection with the reading of theseunaudited Consolidated Interim Financial Statements.  

 

*Principles of Consolidation*

*** ***

The accompanying ConsolidatedFinancial Statements include the accounts of Palmetto Bancshares, Inc. (the“Company”), which includes its wholly owned subsidiary, The Palmetto Bank (the“Bank”), and the Bank's wholly owned subsidiary, Palmetto Capital, Inc.("Palmetto Capital").  In management’s opinion, all significant intercompany accounts andtransactions have been eliminated in consolidation, and all adjustmentsnecessary for a fair presentation of the financial condition and results ofoperations for periods presented have been included. Any such adjustments areof a normal and recurring nature.  Assets held by the Company or itssubsidiary in a fiduciary or agency capacity for customers are not included inthe Company’s Consolidated FinancialStatements as such items do not represent assets of the Company or itssubsidiary.

 

*Use of Estimates*

* *

The accounting and reporting policies of the Company conformto accounting principles generally accepted in the United States of America andto general practices within the banking industry. In preparing its Consolidated Financial Statements, the Company’smanagement makes estimates and assumptions that impact the reported amounts ofassets and liabilities and the disclosure of contingent assets and liabilitiesas of the date of the Consolidated Financial Statements for the periodspresented. Actual results could differ from these estimates andassumptions. As such, the results of operations for the three and nine monthperiods ended September 30, 2007 are not necessarily indicative of the resultsof operations that may be expected in future periods.

 

Reclassifications

* *

Certain amounts previously presented in the Company’s Consolidated Financial Statements forprior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on prior period net income or retainedearnings as previously reported. 

 

During the second half of 2006, the Company made thefollowing reclassifications in the Consolidated Statements of Income:

 
- Certain accounts related to service charges on deposit     accounts in the Other Noninterest Income and Other Noninterest Expense     line items were reclassified to the Service Charges on Deposit Accounts     line item. 

 
- Certain accounts in the Occupancy line item and the     Furniture and Equipment line item were reclassified to the Premises and Equipment     Leases and Rentals line item and the Premises and Equipment Depreciation     line item.

 
- Certain accounts in the Other Noninterest Expense line     item were reclassified to the Amortization of Core Deposit Intangibles     line item.

 
- Certain accounts in the Marketing line item were deemed     to, more often than not, include expenses applicable to general branch     operations instead of expenses for creating, communicating, and delivering     value to customers and for managing customer relationships, so the Company     began classifying this account in the Other Noninterest Expense line item.

8

 

The following table summarizes the Company’s Consolidated Statementsof Income for the three and nine month periods ended September 30, 2006 asreported prior to these reclassifications (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

**For the three**

 

**For the nine**

 

 

 

 

**month period ended**

 

**month period ended**

 

 

 

 

**9/30/2006**

 

**9/30/2006**

Noninterest income

 

 

 

 

Service charges on deposit accounts

$

2,228 

 

6,333 

 

Fees for trust and brokerage services

817 

 

2,445 

 

Mortgage-banking income

182 

 

679 

 

Investment securities gains

- 

 

3 

 

Other

 

909 

 

2,738 

 

 

Total noninterest income

4,136 

 

12,198 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

Salaries and other personnel

5,772 

 

17,256 

 

Net occupancy

733 

 

2,124 

 

Furniture and equipment

986 

 

2,952 

 

Marketing and advertising

488 

 

1,284 

 

Postage and supplies

350 

 

1,086 

 

Telephone

180 

 

575 

 

Professional services

210 

 

690 

 

Other

 

1,638 

 

4,724 

 

 

Total noninterest expense

10,357 

 

30,691 

 

 

 

 

 

 

 

 

 

Net noninterest expense

$

6,221 

 

18,493 

 

 

 

 

 

 

 

* *

*Intangible Assets*

* *

Intangible assets, included in Other Assets on the ConsolidatedBalance Sheets, include goodwill and other identifiable assets, such ascustomer lists, resulting from acquisitions.  Goodwill, in this context, is theexcess of the purchase price in an acquisition transaction over the fair marketvalue of the net assets acquired. Customer list intangibles are amortized on ahybrid double-declining, straight-line basis over such asset’s estimated usefullife.  In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”goodwill is not amortized but is tested annually for impairment or at any timean event occurs, or circumstances change, that may trigger a decline in thevalue of the reporting unit. Such impairment testing calculations includeestimates. Furthermore, the determination of which intangible assets havefinite lives is subjective as is the determination of the amortization periodfor such intangible assets. The Company tests for goodwill impairment bydetermining the fair market value for each reporting unit and comparing thefair market value to the carrying amount of the applicable reporting unit. Ifthe carrying amount exceeds fair market value, the potential for impairmentexists, and a second step of impairment testing is performed. In the secondstep, the fair market value of the reporting unit’s goodwill is determined byallocating the reporting unit’s fair market value to all of its assets(recognized and unrecognized) and liabilities as if the reporting unit had beenacquired in a business combination at the date of the impairment test. If theimplied fair market value of reporting unit goodwill is less than its carryingamount, goodwill is impaired and is written-down to its fair market value. Theloss recognized is limited to the carrying amount of goodwill.  Once animpairment loss is recognized, future increases in fair market value will notresult in the reversal of previously recognized losses. The Company performsits annual impairment testing as of June 30 by applying the above process toits reportable operating segment of banking. The Company’s impairment testingas of June 30, 2007 indicated that no impairment charge was required as of thatdate.

 

See Note 7 for further discussion regarding the Company’sintangible assets.

 

*Recently Issued Accounting Pronouncements*

* *

The Company is aware of noaccounting standards that have been issued or proposed by the FASB or otherstandards-setting bodies that are applicable to the Company’s business.

* *

*Recently Adopted Accounting Pronouncements*

* *

Accounting standards issued by the FASB or otherstandards-setting bodies may have become effective during the period covered bythis report but were determined not to be applicable to the Company’s businessand, therefore, did not have a material impact on the Company’s financialposition, results of operations or cash flows.

 

9

 

***2.       Cash and CashEquivalents***

 

The following table summarizes the composition of cash and cashequivalents at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

 

**2007**

**2006**

 

Cash working funds

$

7,994 

9,190 

 

Noninterest-earning demand deposits

in other banks

14,842 

23,511 

 

In-transit funds

8,240 

10,383 

 

Interest-earning federal funds sold

4,188 

3,582 

 

 

Total cash and cash equivalents

$

35,264 

46,666 

 

 

 

 

 

 

 

The following table summarizesfederal funds sold information, all of which were obtained through thecorrespondent banks,****at and for theperiods indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

**2007**

 

**2006**

 

**2007**

 

**2006**

Interest-earning federal funds sold

 

 

 

 

 

 

 

 

Amount outstanding at period end

$

4,188 

 

6,662 

 

4,188 

 

6,662 

 

Average amount outstanding during period

10,117 

 

23,083 

 

15,517 

 

23,941 

 

Maximum amount outstanding at any period end

10,254 

 

29,571 

 

33,840 

 

29,571 

 

Rate paid at period end

4.64 

%

5.34 

 

4.64 

 

5.34 

 

Weighted average rate paid during the period

5.84 

 

5.45 

 

5.17 

 

5.04 

 

 

 

 

 

 

 

 

 

 

The Company is required to maintain average reserve balances computed by applying prescribed percentages to its various types of deposits.  At September 30, 2007, the Federal Reserve required that the Company maintain $9.6 million in reserve balances.  Due to the Company’s levels of vault cash, no reserves were required to be maintained with Bank of America, however, $1.0 million was required to be maintained with the Federal Reserve Bank of Richmond.

 

***3.       InvestmentSecurities Available for Sale***

 

The following tables summarize the amortized cost, gross unrealizedgains, gross unrealized losses, and fair market values of investment securitiesavailable for sale at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair**

**market**

**value**

 

Government-sponsored enterprises

$

20,702 

60 

(20)

20,742 

 

State and municipal

52,763 

18 

(1,029)

51,752 

 

Mortgage-backed

24,136 

16 

(359)

23,793 

 

 

Total investment securities

available for sale

$

97,601 

94 

(1,408)

96,287 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2006**

 

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair**

**market**

**value**

 

Government-sponsored enterprises

$

42,554 

- 

(171)

42,383 

 

State and municipal

48,780 

56 

(822)

48,014 

 

Mortgage-backed

26,362 

72 

(264)

26,170 

 

 

Total investment securities

available for sale

$

117,696 

128 

(1,257)

116,567 

 

 

 

 

 

 

 

 

10

The following table summarizes the gross unrealized losses, fair market value,and the number of securities in each category of investment securities availablefor sale, aggregated by investment category and length of time that individualsecurities have been in a continuous unrealized loss position, at September 30,2007 and December 31, 2006 (dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

- 

$

- 

$

- 

 

1 

3,469 

20 

 

1 

3,469 

20 

State and municipal

22 

8,038 

120 

 

101 

39,078 

909 

 

123 

47,116 

1,029 

Mortgage-backed

3 

6,949 

85 

 

22 

12,389 

274 

 

25 

19,338 

359 

 

Total investment securities

available for sale

25 

$

14,987 

$

205 

 

124 

54,936 

1,203 

 

149 

69,923 

1,408 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2006**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

3 

$

2,980 

$

3 

 

10 

39,402 

168 

 

13 

42,382 

171 

State and municipal

10 

4,898 

52 

 

91 

34,437 

770 

 

101 

39,335 

822 

Mortgage-backed

- 

- 

- 

 

30 

16,327 

264 

 

30 

16,327 

264 

 

Total investment securities

available for sale

13 

$

7,878 

$

55 

 

131 

90,166 

1,202 

 

144 

98,044 

1,257 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management believes that the above summarized unrealizedlosses are due to interest rate changes, rather than credit quality, oninvestments that the Company classifies to indicate that sale is a possibilitybut also for which the Company has the ability to hold until maturity.  Ifliquidity is needed, the Company does not automatically chose an impaired orthe most impaired security to sell to provide needed liquidity, but ratherconsiders many factors including, but not limited to, asset – liabilitymanagement. Since the Company has the ability and intent to hold theseinvestments until a market price recovery or maturity, management does notconsider these investments to be other-than-temporarily impaired. 

 

The following table summarizes the percentage of theapplicable investment segments of the investment securities available for saleby Moody’s credit ratings based on fair market value at September 30, 2007.

 

 

 

 

 

 

 

 

 

**State and**

 

**Mortgage-**

 

 

 

**municipal**

 

**backed**

 

A1

 

1 

%

 

A3

 

2 

 

- 

 

Aa1

4 

 

- 

 

Aaa

77 

 

100 

 

Not rated

16 

 

- 

 

 

Total

100 

%

100 

 

 

 

 

 

 

 

 

Of the state and municipal investment securities not ratedby Moody’s at September 30, 2007, 97% of the securities were rated AAA byStandard and Poor’s while 3% were rated AA+.

 

The following tables summarize the gross realized gains and losses ofinvestment securities available for sale at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

**For the nine month**

 

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

 

**2007**

**2006**

 

**2007**

**2006**

 

Realized gains

$

- 

- 

 

- 

25 

 

Realized losses

- 

- 

 

- 

(22)

 

 

Net unrealized gains (losses)

$

- 

- 

 

- 

3 

 

 

 

 

 

 

 

 

 

Public funds are bank depositsof state and local municipalities and typically require that the Bank pledgeinvestment grade securities to the accounts to ensure repayment.  Approximately82% of the investment securities portfolio was pledged to secure publicdeposits as of September 30, 2007 as compared with 62% at December 31, 2006 and60% at September 30, 2006.  

 

Concentrations of Credit Risk. The Company’s investment portfolio consists principally ofsecurities issued by government-sponsored enterprises, and securities issued bystates and municipalities within the United States. The Company hasconcentrations in securities issued by government-sponsored enterprises,defined as securities of issuersthat, in the aggregate, exceed ten percent of shareholders’ equity, atSeptember 30, 2007.  Although most government sponsored enterprisessecurities are not backed by the full faith and credit of the federalgovernment, the Company believes that such securities have negligible creditrisk. Because of the importance of the agencies in promoting public policy, theCompany believes that the federal government would prevent a governmentsponsored enterprises from defaulting on its debt obligations. As a result,management believes that such securities provide enjoy what is commonlydescribed as an “implied guarantee.”

 

11

 

***4.       Loans***

 

The following table summarizesloans, by loan purpose, excluding those mortgage loans held for sale, byclassification at the dates indicated (dollars in thousands). 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Commercial business

$

130,292 

13.0 

%

112,264 

12.0 

Commercial real estate

626,555 

62.7 

 

593,377 

63.2 

Installment

24,213 

2.4 

 

22,139 

2.4 

Installment real estate

71,679 

7.2 

 

66,161 

7.0 

Indirect

41,824 

4.2 

 

43,634 

4.6 

Credit line

1,943 

0.2 

 

1,982 

0.2 

Prime access

51,906 

5.2 

 

53,883 

5.7 

Residential mortgage

39,956 

4.0 

 

35,252 

3.7 

Bankcards

11,841 

1.2 

 

11,813 

1.3 

Business manager

336 

- 

 

370 

- 

Other

1,607 

0.2 

 

1,793 

0.2 

 

Loans, unadjusted gross

1,002,152 

100.3 

 

942,668 

100.3 

 

 

 

 

 

 

 

Loans in process

2,922 

0.3 

 

2,587 

0.3 

Deferred loans fees and costs

798 

0.1 

 

658 

0.1 

 

Loans, adjusted gross

1,005,872 

100.7 

 

945,913 

100.7 

 

 

 

 

 

 

 

Mortgage loans held for sale

1,435 

0.1 

 

1,675 

0.2 

 

Total loans, gross

1,007,307 

100.8 

 

947,588 

100.9 

 

 

 

 

 

 

 

Allowance for loan losses

(8,280)

(0.8)

 

(8,527)

(0.9)

 

Total loans, net

$

999,027 

100.0 

%

939,061 

100.0 

 

 

 

 

 

 

 

 

Loans included in the table arenet of participations sold and mortgage loans sold and serviced for others. Mortgage loans serviced for the benefit of others amounted to $339.4 million,$325.1 million, and $310.0 million at September 30, 2007, December 31, 2006,and September 30, 2006, respectively. SeeNote 6 for further discussion regarding the Company’s mortgage-servicing rights portfolio. Netgains on the sale of mortgage loans included in Mortgage Banking Income in theCompany’s Consolidated Statements of Income totaled $279 thousand and $80thousand for the three month periods ended September 30, 2007 and 2006,respectively. Net gains on the sale of mortgage loans totaled $614 thousand and$370 thousand for the nine month periods ended September 30, 2007 and 2006,respectively. 

 

The following table summarizes nonaccrual loans and loans past due 90days and still accruing interest at the dates indicated (in thousands).

 

 

 

 

 

 

 

**September 30,**

**December 31,**

**September 30,**

 

**2007**

**2006**

**2006**

Nonaccrual loans

$

7,043 

6,999 

6,921 

Loans past due 90 days and still accruing (1)

210 

260 

94 

 

$

7,253 

7,259 

7,015 

 

 

 

 

(1) Substantially all of these loans are bankcard loans

 

 

 

12

 

The following table summarizes the activity impacting theallowance for loan losses (“Allowance”) for the periods indicated (inthousands).

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

**ended September 30,**

 

**ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Allowance, beginning of period

$

8,515 

8,879 

 

8,527 

8,431 

Provision for loan losses

400 

275 

 

1,200 

1,325 

 

 

 

 

 

 

 

Loans charged-off

(706)

(454)

 

(1,696)

(1,166)

Loan recoveries

71 

24 

 

249 

134 

 

Net loans charged-off

(635)

(430)

 

(1,447)

(1,032)

 

 

 

 

 

 

 

Allowance, end of period

$

8,280 

8,724 

 

8,280 

8,724 

 

 

 

 

 

 

 

 

Troubled debt restructurings entered into by the Companyduring the three month periods ended September 30, 2007 were reviewed by theCompany to ensure loan classifications were in accordance with applicableregulations.  Any specific allocations identified during the review based onprobable losses have been included in the Company’s Allowance for theapplicable period. 

 

The Company makes contractualcommitments to extend credit that are legally binding agreements to lend moneyto customers at predetermined interest rates for a specific period of time. The Company also provides standby letters of credit.  See Note 14 for further discussion regarding the Company’scommitments.

 

At September 30, 2007, of its approximately $95.3 millionqualifying loans available to serve as collateral against borrowings andletters of credit from the FHLB, the Company pledged as collateral $93.0million. 

 

***5.       Premisesand Equipment, Net***

 

The following table summarizes the Company’s premises andequipment balances at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

**2007**

**2006**

Land

$

6,761 

6,305 

Buildings

17,809 

17,124 

Leasehold improvements

2,156 

2,847 

Furniture and equipment

17,799 

17,762 

Software

3,260 

3,194 

Bank automobiles

909 

859 

 

Premises and equipment, gross

48,694 

48,091 

 

 

 

 

Accumulated depreciation and amortization

(24,218)

(23,597)

 

Premises and equipment, net

$

24,476 

24,494 

 

 

 

 

 

At September 30, 2007, the Company had thirty-twofull-service banking offices in the Upstate region of South Carolina in thefollowing counties: Laurens County (4), Greenville County (10), SpartanburgCounty (6), Greenwood County (5), Anderson County (3), Cherokee County (2),Pickens County (1), and Oconee County (1) in addition to two Palmetto Capitaloffices independent of banking office locations, 39 automatic teller machine(“ATM”) locations (including nine in nonbanking office locations), and fivelimited service banking offices located in retirement centers in the Upstate.  One principal banking office is located in each of the following counties:Laurens, Greenville, Spartanburg, Greenwood, and Anderson.   

 

During the first nine months of 2007, the Bank completed itspurchase of real estate on which to construct and relocate its existingPendleton banking office in Anderson County. Ground was broken on this site inJuly 2007.  Additionally, during the first nine months of 2007, the Bankcompleted the renovation of its Montague banking office in Greenwood County,completed the upfit of, and relocated to, its temporary downtown Greenvillebanking office to be used during the construction of the Company’s newcorporate headquarters, added a new nonbanking office ATM location at BatesvillePlaza Shopping Center in Greenville County, and executed a ground leasecontract for a nonretail office ATM location at Woodmont Village ShoppingCenter on Highway 25 in Moonville, South Carolina.  The Company plans to havethis location in service by January 2008.  

 

13

 

The table set forth below summarizes the activity impactingaccumulated depreciation for the periods indicated (in thousands). Depreciationbalances were impacted during the period by the activity discussed herein.

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

 

**ended September 30,**

 

**ended September 30,**

 

 

 

**2007**

**2006**

 

**2007**

**2006**

Accumulated depreciation, beginning of period

$

24,510 

22,710 

 

23,597 

21,759 

 

 

 

 

 

 

 

 

Depreciation

 

 

 

 

 

 

Buildings

141 

111 

 

361 

344 

 

Leasehold improvements

26 

42 

 

99 

124 

 

Furniture and equipment

234 

247 

 

717 

743 

 

Software

47 

62 

 

163 

197 

 

Bank automobiles

44 

44 

 

138 

120 

 

 

Total depreciation

492 

506 

 

1,478 

1,528 

 

 

 

 

 

 

 

 

Disposals

(784)

(119)

 

(857)

(190)

 

 

 

 

 

 

 

 

Accumulated depreciation, end of period

$

24,218 

23,097 

 

24,218 

23,097 

 

 

 

 

 

 

 

 

 

The table set forth below summarizes the premises andequipment written-off during the third quarter (in thousands) in conjunctionwith the demolition of the current downtown Greenville banking office.  

 

 

 

 

 

 

 

 

 

 

**For the three and nine**

 

 

 

 

**month periods ended**

 

 

 

 

**September 30, 2007**

 

Assets written-off, gross

 

 

 

Leasehold improvements

$

715 

 

 

Furniture and equipment

396 

 

 

 

Total assets written-off, gross

1,111 

 

 

 

 

 

 

Accumulated depreciation		written-off

 

 

 

Leasehold improvements

(384)

 

 

Furniture and equipment

(381)

 

 

 

Total accumulated depreciation		written-off

(765)

 

 

 

 

 

 

 

 

Loss on disposition of premises, furniture, and equipment

$

346 

 

 

 

 

 

 

 

***6.       Mortgage-Servicing Rights***

 

The Company sells a portion of its originated fixed-rate andadjustable-rate mortgage loans servicing retained. All of the Company’s loansales have been without recourse. Mortgage loans serviced for the benefit ofothers amounted to $339.4 million, $325.1 million, and $310.0 million atSeptember 30, 2007, December 31, 2006, and September 30, 2006, respectively.Mortgage loans serviced for the benefit of others are held by the Company orits subsidiary in a fiduciary or agency capacity for customers and, as such,are not included in the Company’s ConsolidatedFinancial Statements as such items do not represent assets of theCompany or its subsidiary.

 

14

 

The following table summarizesthe changes in the Company’s mortgage-servicing rights portfolio for theperiods indicated (dollars in thousands). 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

**For the nine month periods**

 

 

 

**ended September 30,**

 

**ended September 30,**

 

 

 

**2007**

 

**2006**

 

**2007**

**2006**

Mortgage-servicing rights portfolio, net of valuation

 

 

 

 

 

 

 

allowance, beginning of period

$

2,722 

 

2,673 

 

2,648 

2,626 

 

 

Capitalized mortgage-servicing rights

252 

 

68 

 

662 

387 

 

 

Mortgage-servicing rights portfolio amortization

(61)

 

(165)

 

(398)

(570)

 

 

Change in mortgage-servicing rights portfolio valuation allowance

1 

 

9 

 

2 

142 

Mortgage-servicing rights portfolio, net of valuation

 

 

 

 

 

 

 

allowance, end of period

$

2,914 

 

2,585 

 

2,914 

2,585 

 

 

 

 

 

 

 

 

 

 

Mortgage-servicing rightsamortization and valuation allowances are included in Mortgage-Banking Incomeon the Consolidated Statements of Income.

 

Theaggregate fair market value of the Company’s mortgage-servicing rightsportfolio at September 30, 2007, December 31, 2006, and September 30, 2006 was$4.0 million, $3.6 million, and$3.5 million , respectively.

 

The following table summarizes the activity impacting thevaluation allowance for impairment of the mortgage-servicing rights portfoliofor the periods indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

**ended September 30,**

 

**ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Valuation allowance, beginning of period

$

3 

15 

 

4 

148 

 

Aggregate additions charged and reductions credited to operations

(1)

(9)

 

(2)

(142)

Valuation allowance, end of period

$

2 

6 

 

2 

6 

 

 

 

 

 

 

 

 

See Consolidated Statements of Cash Flows for a further discussion of theactivity impacting the Company’s mortgage-servicing rights portfolio.

 

***7.      IntangibleAssets***

** **

The following table summarizes intangible assets,which are included in Other Assets on the Consolidated Balance Sheets, net ofaccumulated amortization, at the dates indicated (in thousands). 

** **

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

**2007**

**2006**

Goodwill

$

3,691 

3,691 

Customer list intangibles

90 

126 

 

Total intagible assets

$

3,781 

3,817 

 

 

 

 

 

Thefollowing table summarizes theactivity of intangible assets with finite lives, which are comprised ofcustomer list intangibles, and the related amortization, which is included inOther Noninterest Expense in the Consolidated Statements of Income, for theperiods indicated (in thousands).  

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

**ended September 30,**

 

**ended September 30,**

 

**2007**

**2006**

 

**2007**

**2006**

Balance, at beginning of period

$

102 

151 

 

126 

175 

     Less: amortization

(12)

(12)

 

(36)

(36)

Balance, at end of period

$

90 

139 

 

90 

139 

 

 

 

 

 

 

 

Thefollowing table summarizes thegross carrying amount and accumulated amortization of intangible assets withfinite lives at the dates indicated (in thousands).

 

 

 

 

 

 

 

**September 30,**

**December 31,**

**September 30,**

 

**2007**

**2006**

**2006**

Customer list intangibles, gross

$

1,779 

1,779 

1,779 

     Less: accumulated amortization

(1,689)

(1,653)

(1,640)

Customer list intangibles, net

$

90 

126 

139 

 

 

 

 

 

15

 

In its Annual Report on Form10-K for the year ended December 31, 2006, theCompany estimated amortization expense related to intangible assets with finite lives of $48thousand for the year ended December 31, 2007, $45 thousand for the year endedDecember 31, 2008, and $34 thousand for the year ended December 31, 2009.  Managementis aware of no material events or uncertainties that would cause amortizationexpense related to the Company’s intangibleassets with finite lives not to be indicative of future financialcondition or results of operations or that would cause future financialcondition or results of operations to differ materially from these projections.

 

The Company’s intangible assets with infinite lives (goodwill) are subject to periodic impairment tests that areperformed by the Company as of June 30 annually, or more often, if events orcircumstances indicate that there may be impairment. The valuation as of June30, 2007 indicated that no impairment charge was required as of that date. Managementis aware of no material events or uncertainties that have occurred since September 30, 2007 that would indicate that theremight be impairment. 

 

**8.       *RealEstate and Personal Property Acquired in Settlement of Loans***

 

The following table summarizes real estate andpersonal property acquired in settlement of loans for the periods indicated (in thousands).                          

 
		 **September 30,****December 31,****September 30,**
 

**2007**

**2006**

**2006**

Real estate acquired in settlement of loans

$

6,170 

600 

771 

Repossessed automobiles acquired in settlement of loans

295 

319 

347 

     Total property acquired in settlement of loans

$

6,465 

919 

1,118 

 

 

 

 

 

The following table summarizes the changes in theCompany’s real estate acquired in settlement of loans, including the balance atthe beginning and end of each period, provision charged to expense, and lossescharged to the Allowance related to the Company’s real estate acquired insettlement of loans for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

**periods ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Real estate acquired in settlement of loans, beginning of period

$

717 

728 

 

600 

1,954 

 

Add: New real estate acquired in settlement of loans

5,533 

72 

 

6,115 

154 

 

Less: Sales / recoveries of real estate acquired in settlement of loans

(80)

(29)

 

(374)

(1,150)

 

Less: Provision charged to expense

- 

- 

 

(171)

(187)

Real estate acquired in settlement of loans, end of period

$

6,170 

771 

 

6,170 

771 

 

 

 

 

 

 

 

 

Based on the Company’s regularreview of fair market values of real estate acquired in settlement of loans andwritedowns taken as a result of those reviews, management believes that theproperties within the portfolio were properly valued at September 30, 2007. 

 

***9.       Deposits***

 

Thefollowing table summarizesthe Company’s deposit composition at the dates indicated (in thousands).

 

 

 

 

 

 

 

 

**September 30,**

**December 31,**

 

 

**2007**

**2006**

Transaction deposit accounts

$

518,492 

447,236 

Money market deposit accounts

115,470 

124,874 

Savings deposit accounts

39,380 

41,887 

Time deposit accounts

323,153 

379,584 

 

Total deposit accounts

$

996,495 

993,581 

 

 

 

 

 

At September 30, 2007, $625 thousand of overdrawntransaction deposit accounts had been reclassified as loan balances comparedwith $606 thousand at December 31, 2006.

 

16

 

The table set forth below summarizes the Company’s interestexpense on deposit accounts costs for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

 

**ended September 30,**

 

**ended September 30,**

 

 

 

**2007**

**2006**

 

**2007**

**2006**

Transaction and money market deposit accounts

$

3,861 

2,684 

 

10,488 

6,429 

Savings deposit accounts

36 

39 

 

106 

112 

Time deposit accounts

3,766 

3,957 

 

11,733 

11,402 

 

Total interest expense on deposit accounts

$

7,663 

6,680 

 

22,327 

17,943 

 

 

 

 

 

 

 

 

 

***10.    Short-TermBorrowings***

 

The following tablesummarizes the Company’s borrowings composition at the dates indicated (dollarsin thousands). Borrowings as a percentage of total liabilities wereapproximately 6.8% and 4.9% at September 30, 2007 and December 31, 2006,respectively.

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Retail repurchase agreements

$

10,130 

		13.7 

%

14,427 

34.8 

Commercial paper

30,636 

41.5 

 

20,988 

50.7 

Other short-term borrowings

33,000 

44.8 

 

6,000 

14.5 

 

Total borrowings

$

73,766 

100.0 

%

41,415 

100.0 

 

 

 

 

 

 

 

 

 

If needed, funding sources have been arranged throughfederal funds lines at correspondent banks, the Federal Reserve DiscountWindow, and the FHLB.  

 

At September 30, 2007, the Company had additional fundingsources at correspondent banks totaling $50 million that were accessible at theCompany’s option of which $9.0 million had been utilized. Due to the maturityterms of such sources, utilized borrowed funds are considered to be short-term.During April 2007, Nexity Bank extended the Bank a federal funds accommodationin the amount of $10 million for a period beginning on April 25, 2007 andending April 30, 2008 subject to specified terms and conditions. Advances underthis accommodation are advances of federal funds with a maturity of the nextBanking Day (the next day other than Saturday or Sunday on which bankingbusiness is conducted in South Carolina). This additional federal fundsaccommodation in the amount of $10 million increased the Company’s accessiblefunding sources from $40 million to $50 million.  

 

At September 30, 2007, of its approximately $95.3 millionavailable credit based on qualifying loans to serve as collateral againstborrowings and letters of credit from the FHLB, the Company employed $24.0million in borrowings, all of which was determined to be short-term when employed,and employed $69.0 million in a letter of credit used to secure public depositsas required or permitted by law.  FHLB letters of credit provide an attractivealternative to using traditional collateral for various transactions.Advantages of FHLB letters of credit include enhancing member liquidity(substituting letter of credit for securities as collateralization of publicunit deposits) and utilization of residential mortgage loans as collateral forthe letters of credit. However, the utilization of FHLB letters of creditreduces the Company’s available credit based on qualifying loans to serve ascollateral.  The Company uses the FHLB letter of credit for collateralizationof public deposits. At September 30, 2007, the Company had approximately $2.3million available credit based on qualifying loans to serve as collateralagainst short-term borrowings, long-term borrowings, and / or letters of creditfrom the FHLB.

 

***11.    Long-TermBorrowings***

*** ***

Long-term borrowings are those having maturities greater thanone year when executed. The Company’s remaining $10.0 million in long-term FHLBborrowings matured on June 14, 2007. These $10.0 million in long-term FHLBborrowings were outstanding at December 31, 2006.

 

As noted above with regard to short-term borrowings, atSeptember 30, 2007, of its approximately $95.3 million available credit basedon qualifying loans to serve as collateral against borrowings and letters ofcredit from the FHLB, the Company employed $24.0 million in borrowings, all ofwhich was determined to be short-term when employed, and employed $69.0 millionin a letter of credit used to secure public deposits as required or permittedby law.  At September 30, 2007, the Company had approximately $2.3 millionavailable credit based on qualifying loans to serve as collateral againstshort-term borrowings, long-term borrowings, and / or letters of credit fromthe FHLB.

 

17

***12.    EmployeeBenefit Plans***

 

*Postretirement Benefits*

 

Current Cost of Benefit Plan. The following table summarizes the combined net postretirementbenefit expense components for the Company’s defined benefit pension plan,which is included in Salaries and Other Personnel Expense on the ConsolidatedStatements of Income, at and for the periods indicated (in thousands). 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

 

**ended September 30,**

 

**ended September 30,**

 

 

 

**2007**

**2006**

 

**2007**

**2006**

Service cost

$

195 

141 

 

585 

423 

Interest cost

229 

165 

 

686 

495 

Expected return on plan assets

(318)

(229)

 

(953)

(687)

Amortization of prior service cost

4 

3 

 

12 

9 

Amortization of loss

28 

20 

 

83 

60 

 

Postretirement benefit expense, net

$

138 

100 

 

413 

300 

 

 

 

 

 

 

 

 

 

PlanAssets.  In September 2006, the FASBissued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plans,” which amends SFAS No. 87 and SFAS No. 106 torequire recognition of the overfunded or underfunded status of pension andother postretirement benefit plans on the balance sheet. Under SFAS No. 158,gains and losses, prior service costs and credits, and any remaining transitionamounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognizedthrough net periodic benefit cost will be recognized in accumulated othercomprehensive income, net of tax effects, until they are amortized as acomponent of net periodic cost. The measurement date — the date at which thebenefit obligation and plan assets are measured — is required to be thecompany’s fiscal year end. The recognition and disclosure provisions of SFASNo. 158 differ for an employer that is anissuer of publicly traded equity securities (as defined by the Standard)and an employer that is not. As theCompany does not meet the definition of anissuer of publicly traded equity securities (as defined by SFAS No. 158) for purposes of this Standard, the Company was not required to recognize the funded status of a defined benefitpostretirement plan and to provide the required disclosures until the end ofthe fiscal year ending after June 15, 2007with the exception of the provisions for the measurement date which areeffective for fiscal years ending after December 15, 2008. Management estimatesthe adjustment to the Consolidated Balance Sheets during the fourth quarter of2007 to properly reflect the funded status at December 31, 2006 to be $6.5million.  Management does not currently have an estimate of the adjustmentnecessary to properly reflect any fluctuations in this funded status during theyear ended December 31, 2007.  

 

Expected Current Contributions. Contributions to theCompany’s defined benefit pension plan assets totaling $1.1 million areexpected during fiscal year 2007. Contributions during the third quarter of2007 totaled $275 thousand compared with $308 thousand during the third quarterof 2006. Contributions during the first nine months of 2007 totaled $824thousand compared with $925 thousand during the same period of 2006. 

 

*Stock Option Plans*

 

At September 30, 2007, there were no remaining optionsavailable for grant under the Palmetto Bancshares, Inc. 1997 Stock CompensationPlan. 

 

Determining Fair Value. The following tablesummarizes the stock-based awards granted by the Company, the fair market value of each award grantedas estimated on the date of grant using the Black-Scholes option-pricing model,and the weighted average assumptions used for such grants for the grant datesindicated. 

 

18

 

 

 

 

 

 

 

 

 

 

 

 

**Stock-based awards granted during the**

 

 

 

**nine month period ended September 30,**

 

 

**2007**

 

**2006**

Grant Date

1/16/2007

 

6/20/2006

 

1/17/2006

 

 

 

 

 

 

 

 

 

Stock option awards granted

800 

 

5,000 

 

10,000 

 

 

 

 

 

 

 

 

 

Option price

$

30.40 

 

27.30 

 

27.30 

 

 

 

 

 

 

 

 

 

Fair market value of stock option awards

$

6.24 

 

4.79 

 

3.39 

 

 

 

 

 

 

 

 

 

Expected dividend yields

2.5 

%

2.7 

 

2.7 

 

Expected volatility

13 

%

5 

 

5 

 

Risk-free interest rate

5 

%

5 

 

4 

 

Expected term (years)

10 

 

10 

 

10 

 

Vesting period (years)

5 

 

5 

 

5 

 

 

Stock Option CompensationExpense. The compensation cost  related to stock options that was charged against pretax net incomeduring the third quarter of 2007 was $33 thousandcompared with $45 thousand during the third quarter of 2006.  Expense duringthe first nine months of 2007 and 2006 totaled $99 thousand. 

 

At September 30, 2007, based onoptions outstanding at that time, the total compensation cost related tononvested stock option awards granted under the Company’s stock option plansbut not yet recognized was $222 thousand. Stock option compensation expense isrecognized on a straight-line basis over the vesting period of the option. TheCompany expects to recognize this cost over a remaining period ending inDecember 2011. 

 

Stock Option Activity.The following table summarizes stockoption activity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Planfor the periods indicated.

 

 

 

 

 

 

 

 

 

 

**Stock options**

**outstanding**

**Weighted-**

**average**

**exercise**

**price**

Outstanding at December 31, 2005

252,785 

$

16.63 

 

Granted

15,000 

27.30 

 

Exercised

(25,450)

13.97 

Outstanding at September 30, 2006

242,335 

$

17.57 

 

 

 

 

 

Outstanding at December 31, 2006

251,670 

$

18.67 

 

Granted

800 

30.40 

 

Exercised

(32,810)

14.92 

Outstanding at September 30, 2007

219,660 

$

19.28 

 

 

 

 

 

 

No stock options were forfeitedduring the nine month periods ended September 30, 2007 or 2006.  Cash receivedfrom stock option exercises under the Company’s stock option plan for the ninemonth periods ended September 30, 2007 and 2006 was $490 thousand and $356thousand, respectively. 

 

*401(k) Retirement Plan*

 

Matching Contributions. During the three monthperiods ended September 30, 2007 and 2006, the Company made matchingcontributions to employee 401(k) retirement plans totaling $85 thousand and $73thousand, respectively. During the nine month periods ended September 30, 2007and 2006, the Company made matching contributions to employee 401(k) retirementplans totaling $234 thousand, and $207 thousand, respectively.

 

Other. During 2007, in conjunction with the audit ofthe Company’s 401(k) Retirement Plan (the “Plan”), an administrative error wasdiscovered that had resulted in participants being denied the opportunity tofully defer the appropriate amount of compensation under the plan.  During the third quarter of 2007, the Company calculated and accruedthe denied deferral amount and the resulting employer match, including missedearnings, and believes such amounts total approximately $1.3 million through December31, 2006. As such, the Company accrued this amount within Salaries and OtherPersonnel Expense on the Consolidated Statements of Income for the three andnine month periods ended September 30, 2007.  The Company is currentlycalculating such amounts for the period since December 31, 2006.  The Company’smanagement intends to contribute these amounts to each participant’s accountduring the fourth quarter of 2007 by correcting the error under guidelinesestablished by the Internal Revenue Service.  

*** ***

19

***13.    NetIncome per Common Share***

 

The following table summarizes the Company’s reconciliationof the numerators and denominators of the basic and diluted net income percommon share computations for the periods indicated.

 

** **

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

**ended September 30,**

 

**ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Weighted average common shares outstanding - basic

6,392,721 

6,356,656 

 

6,385,625 

6,351,646 

 

Dilutive impact resulting from potential common share issuances

108,241 

75,890 

 

98,668 

75,890 

Weighted average common shares outstanding - diluted

6,500,962 

6,432,546 

 

6,484,293 

6,427,536 

 

 

 

 

 

 

 

Per Share Data

 

 

 

 

 

 

Net income - basic

$

0.61 

0.60 

 

1.84 

1.76 

 

Net income - diluted

0.60 

0.59 

 

1.81 

1.74 

 

At September 30, 2007, all outstanding options were includedin the calculation of diluted net income per common share because the exerciseprice of all options was lower than the average market price as determined byan independent valuation of common shares.

 

The Company paid cash dividends of $0.19 and $0.18 per sharefor the three month periods ended September 30, 2007 and 2006, respectively andcash dividends of $0.57 and $0.54 per share for the nine month periods endedSeptember 30, 2007 and 2006, respectively.  

 

As reported in its Annual Report on Form 10-K for the yearended December 31, 2006, historically, there has been no established publictrading market for the Company’s stock.  Instead, the Company’s Secretaryfacilitates stock trades of the Company’s common stock by matching willingbuyers and sellers that contact her.  However, trades can be and are made thatare not facilitated through the Secretary between willing buyers and sellers ofwhich the Company may have no transaction details.  Additionally, the Companybelieved that many of these transactions did not constitute arm's lengthtransactions as many of the transactions are between buyers and sellers withrelationships that may lead to a sale at a price other than fair market value. Because of these factors, the Company did not believe that the prices at whichthe trades recorded by its Secretary occurred could be considered fair marketvalue, and, as a result, annually, a third party fair market valuation wasperformed by an external third party. During 2007, management determined thatan average trading price valuation method, based on the last five known tradesof the stock, was a more appropriate estimate of the fair value of the stock. Management's determination was based upon the emergence of a more established,although still limited, trading market in the stock.  As a result, the Companychanged the method used to value company stock held from the annual independentstock appraisal method to the average trading price method prospectively,beginning in April 2007, at which time the average price of the last five knowntrades of the stock was $40 per share.

 

***14.    Commitmentsand Contingencies***

 

Legal Proceedings

 

The Company is currently subject to various legalproceedings and claims that have arisen in the ordinary course of its business.In the opinion of management, based on consultation with external legalcounsel, any reasonably foreseeable outcome of such current litigation wouldnot materially impact the Company's financial condition or results ofoperations. 

 

Lease Agreements

 

During the second quarter of 2007, the Company signed abuild-to-suit lease agreement with regard to the relocation of its corporateheadquarters to Greenville, South Carolina.  Under the terms of this agreement,the Company’s new headquarters will be constructed on the site of the Company’scurrent downtown Greenville banking office that is leased from the same lessor.The lease provides for an initial term of fifteenyears and five options to extend the term after the initial term expirationdate, of five years each.  In conjunction with the demolition of thecurrent downtown Greenville banking office, the Company wrote off $346 thousandin leasehold improvements during the third quarter of 2007.  The Companyanticipates construction completion during late 2008 / early 2009 and iscurrently analyzing the accounting treatment of this lease agreement. TheCompany filed a Current Report on Form 8-K on June 26, 2007 to announce itsentry into this material definitive agreement.

 

20

 

During the second quarter of 2007, the Company executed aground lease contract on which to put in service a nonretail office ATMlocation at Woodmont Village Shopping Center on Highway 25 in Moonville, SouthCarolina.  The Company plans to have this location in service by January 2008. 

 

Lending Commitments

 

The Company’s contractual commitments to extend credit increasedslightly from $265.8 million at December 31, 2006 to $284.4 million atSeptember 30, 2007.

 

The following table summarizes the Company’s contractualcommitments to extend credit, bycollateral type, at September 30, 2007 (in thousands).

 

 

 

 

 

Commercial and industrial

$

32,873 

Real estate

184,900 

Credit line

7,716 

Bankcards

46,654 

Others

12,291 

 

Total contractual commitments to extend credit

$

284,434 

 

 

 

* *

*Guarantees*

* *

AtSeptember 30, 2007, the Company recorded no liability for the current carryingamount of the obligation to perform as a guarantor, and no contingent liabilitywas considered necessary as such amounts were not considered material.  Themaximum potential amount of undiscounted future payments related to standbyletters of credit at September 30, 2007 was $10.3 million compared with $8.3million at December 31, 2006.  Past experience indicates that these standbyletters of credit will expire unused. However, through its various sources ofliquidity, the Company believes that it has the necessary resources availableto meet these obligations should the need arise.  Additionally, the Companydoes not believe that the current fair market value of such guarantees wasmaterial at September 30, 2007.

 

*Other Off-Balance Sheet Arrangements*

 

At September 30, 2007, the Companyengaged in no transactions, agreements, or other contractual arrangements towhich an entity unconsolidated with the Company is a party, under which theCompany has:

 
- Any obligation under a     guarantee contract;

 
- A retained or contingent     interest in assets transferred to an unconsolidated entity or similar     arrangement that serves as credit, liquidity or market risk support to     such entity for such assets;

 
- Any obligation under a     contract that would be accounted for as a derivative instrument     considering exceptions; or

 
- Any obligation arising out of     a variable interest in an unconsolidated entity that is held by, and     material to, the Company, where such entity provides financing, liquidity,     market risk or credit risk support to, or engages in leasing, hedging or     research and development services with, the Company.

 

***15.    DerivativeFinancial Instruments and Hedging Activities***

 

At September 30, 2007, the Company’s derivative instrumentsconsisted of forward sales commitments relating to the Company’s commitments tooriginate certain residential loans held for sale.

 

21

 

Outstanding commitments on mortgage loans not yet closed(primarily single-family loan commitments) amounted to approximately $6.6million at September 30, 2007 compared to approximately $3.8 million at December31, 2006.  The fair market value of derivative assets related to commitments tooriginate such residential loans held for sale was not significant at September30, 2007.  The fair market value of derivative assets related to forward salescommitments did not significantly differ from the carrying amount at September30, 2007. 

 

***16.    RegulatoryCapital Requirements***

 

AtSeptember 30, 2007, the most recent notification from federal banking agenciescategorized the Company and the Bank as well capitalized under United Statesfederal banking regulations. To be categorized as well capitalized, minimumtotal risk-based capital, Tier 1 capital, and Tier 1 leverage ratiosmust be maintained as set forth in the following table (dollars in thousands).Since September 30, 2007, there have been no events or conditions thatmanagement believes would change these categories.

 

* *

 

 

 

 

 

 

 

 

 

 

 

 

**Actual**

**For capital adequacy**

**purposes**

**To be well capitalized**

**under prompt**

**corrective action**

**provisions**

 

 

 

**amount**

**ratio**

**amount**

**ratio**

**amount**

**ratio**

At September 30, 2007

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

$

113,947 

10.39% 

			87,734 

8.00 

n/a 

n/a 

 

Bank

 

113,683 

			10.37 

			87,737 

8.00 

109,671 

10.00 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

105,667 

9.64 

			43,867 

4.00 

n/a 

n/a 

 

Bank

 

105,403 

9.61 

			43,868 

4.00 

65,803 

6.00 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to average assets*

 

 

 

 

 

 

 

Company

 

105,667 

8.90 

47,469 

4.00 

n/a 

n/a 

 

Bank

 

105,403 

8.89 

47,407 

4.00 

			59,258 

5.00 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At September 30, 2006

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

$

102,688 

10.12% 

81,137 

8.00 

n/a 

n/a 

 

Bank

 

101,468 

10.00 

81,137 

8.00 

101,422 

10.00 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

93,964 

9.26 

40,569 

4.00 

n/a 

n/a 

 

Bank

 

92,744 

9.14 

40,569 

4.00 

60,853 

6.00 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to average assets*

 

 

 

 

 

 

 

Company

 

93,964 

8.41 

44,715 

4.00 

n/a 

n/a 

 

Bank

 

92,744 

8.29 

44,731 

4.00 

55,913 

5.00 

 

                               

22
****
Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

*Discussionsof certain matters contained in this Quarterly Report on Form 10-Q mayconstitute forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the Securitiesand Exchange Act of 1934, as amended, and as such, may involve risks anduncertainties. These forward-looking statements relate to, among other things,expectations of the business environment in which the Company operates,projections of future performance, perceived opportunities in the market, andstatements regarding the Company’s mission and vision. The Company cautionsreaders that a number of factors could cause actual results to differmaterially from the results expressed or implied in such forward-lookingstatements. For a discussion of some of the factors that might cause such adifference, see Part 1, Item 1A in the Company’s Annual Report on Form10-K for the year ended December 31, 2006 and Part II, Item IA in thisQuarterly Report on Form 10-Q for the quarter ended September 30, 2007. TheCompany does not undertake and specifically disclaims any obligation to updatesuch forward-looking statements to reflect occurrences or unanticipated eventsor circumstances after the date of such statements except as required by law.*

* *

The following discussion and analysis is presented to assistthe reader with understanding the financial condition and results of operationsof the Company.  The information presented in the following discussion resultsfrom the activities of the Company’s subsidiary, the Bank, which comprises themajority of the consolidated net income, revenues, and assets of the Company. This discussion should be read in conjunction with the Consolidated FinancialStatements and related notes and other financial data appearing in this reportas well as in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2006.  Results of operations for the three and nine month periodsended September 30, 2007 are not necessarily indicative of results that may beattained for any other period.  Percentage calculations contained herein havebeen calculated based on rounded results presented herein.

 

Throughout this report, the"Company" shall refer to Palmetto Bancshares, Inc. and itssubsidiary, The Palmetto Bank (the “Bank”), which includes Palmetto Capital, Inc.

*** ***

***BusinessStrategy Overview***

 

The Company’s mission as an independent Upstate financialinstitution is to achieve superior long-term shareholder value, exerciseexemplary corporate citizenship, and create an environment that promotes andrewards employee development and the consistent delivery of quality service toits customers.  One of the Company’s primary strategies employed to achievethis mission is to increase the number of products customers buy from us and toprovide all of the financial products that fulfill customers’ needs. Managementbelieves that the Company’s cross-sell strategy and diversified businessproduct offerings facilitate growth in strong and weak economic cycles, asgrowth can be achieved by expanding the number of products current customershave with the Company. Though the Company is striving for four or more productsper average retail banking household, currently the average retail bankinghousehold has approximately three products with the Company at a time when theindustry average is approximately 2.3 products per average retail bankinghousehold.  The Company strives to capitalize on potential demand from existingcustomers.  

 

Management believes it isimportant to maintain a well-controlled environment as we continue to grow theCompany. Credit risk is managed by setting what is believed are sound creditpolicies for underwriting, while continuously monitoring and reviewing theperformance of the loan portfolio. Management believes that the Companymaintains a diversified loan portfolio, measured by industry, geography andproduct type. Interest rate and market risks inherent in the Company’s assetsand liabilities are managed within ranges, that management believes areprudent, while ensuring adequate liquidity and funding. Management alsobelieves that shareholder value has increased over time due to customersatisfaction, strong financial results, investment in the Company, consistentexecution of the Company’s business model and the management of business risks.

 

**Financial and Operating Highlights**

 

The following tablessummarize the Company’s financial highlights at and for the dates indicated(dollars in thousands).

 

23

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands, except common and per share data)

 

 

 

 

 

 

 

 

 

 
		 		 **At and for the three month**		 		 		 		 
**At and for the nine month**		 		 		 		 		 **periods ended September 30,**
**Variance**		 
**periods ended September 30,**
**Variance**
 

 

**2007**

 

**2006**

**$**

 

**%**

 

**2007**

**2006**

**$**

 

**%**

 

 

(unaudited)

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RESULTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

Interest income

$

21,293 

 

19,577 

1,716 

8.8 

%

62,187 

56,294 

5,893 

10.5 

Interest expense

8,538 

 

7,242 

1,296 

17.9 

 

24,261 

19,696 

4,565 

23.2 

 

Net interest income

12,755 

 

12,335 

420 

3.4 

 

37,926 

36,598 

1,328 

3.6 

Provision for loan losses

400 

 

275 

125 

45.5 

 

1,200 

1,325 

(125)

(9.4)

 

Net interest income after provision for loan losses

12,355 

 

12,060 

295 

2.4 

 

36,726 

35,273 

1,453 

4.1 

Noninterest income

4,612 

 

3,804 

808 

21.2 

 

12,309 

11,683 

626 

5.4 

Noninterest expense

11,391 

 

10,025 

1,366 

13.6 

 

31,404 

30,176 

1,228 

4.1 

 

Income before provision for income taxes

5,576 

 

5,839 

(263)

(4.5)

 

17,631 

16,780 

851 

5.1 

Provision for income taxes

1,680 

 

2,038 

(358)

(17.6)

 

5,909 

5,598 

311 

5.6 

 

     Net income

$

3,896 

 

3,801 

95 

2.5 

%

11,722 

11,182 

540 

4.8 

 

 

 

 

 

 

 

 

 

 

 

 

COMMON SHARE DATA

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.61 

 

0.60 

0.01 

1.7 

%

1.84 

1.76 

0.08 

4.5 

 

Diluted

0.60 

 

0.59 

0.01 

1.7 

 

1.81 

1.74 

0.07 

4.0 

Cash dividends

0.19 

 

0.18 

0.01 

5.6 

 

0.57 

0.54 

0.03 

5.6 

Book value

17.02 

 

15.29 

1.73 

11.3 

 

17.02 

15.29 

1.73 

11.3 

Outstanding shares

6,400,260 

 

6,356,785 

43,475 

0.7 

 

6,400,260 

6,356,785 

43,475 

0.7 

Weighted average outstanding - basic

6,392,721 

 

6,356,656 

36,065 

0.6 

 

6,385,625 

6,351,646 

33,979 

0.5 

Weighted average outstanding - diluted

6,500,962 

 

6,432,546 

68,416 

1.1 

 

6,484,293 

6,427,536 

56,757 

0.9 

Dividend payout ratio

31.21 

%

30.10 

1.11 

3.7 

 

31.08 

30.69 

0.39 

1.3 

 

 

 

 

 

 

 

 

 

 

 

 

PERIOD-END BALANCES

 

 

 

 

 

 

 

 

 

 

Assets

$

1,188,850 

 

1,132,732 

56,118 

5.0 

%

1,188,850 

1,132,732 

56,118 

5.0 

Investment securities available for sale, at fair market value

96,287 

 

119,538 

(23,251)

(19.5)

 

96,287 

119,538 

(23,251)

(19.5)

Loans (1)

1,007,307 

 

931,539 

75,768 

8.1 

 

1,007,307 

931,539 

75,768 

8.1 

Deposits and borrowings

1,070,261 

 

1,029,012 

41,249 

4.0 

 

1,070,261 

1,029,012 

41,249 

4.0 

Shareholders' equity

108,931 

 

97,187 

11,744 

12.1 

 

108,931 

97,187 

11,744 

12.1 

 

 

 

 

 

 

 

 

 

 

 

 

AVERAGE BALANCES

 

 

 

 

 

 

 

 

 

 

Assets

$

1,188,923 

 

1,121,939 

66,984 

6.0 

%

1,170,757 

1,108,037 

62,720 

5.7 

Interest-earning assets

1,114,362 

 

1,050,577 

63,785 

6.1 

 

1,099,343 

1,033,776 

65,567 

6.3 

Investment securities available for sale, at fair market value

102,154 

 

117,062 

(14,908)

(12.7)

 

107,744 

121,312 

(13,568)

(11.2)

Loans (1)

999,044 

 

907,834 

91,210 

10.0 

 

973,358 

885,480 

87,878 

9.9 

Interest-bearing liabilities

936,439 

 

884,765 

51,674 

5.8 

 

923,192 

874,566 

48,626 

5.6 

Shareholders' equity

107,704 

 

95,837 

11,867 

12.4 

 

105,036 

93,584 

11,452 

12.2 

 

 

 

 

 

 

 

 

 

 

 

 

CREDIT QUALITY RATIOS

 

 

 

 

 

 

 

 

 

 

Classified assets as a percentage of loans (2)

1.81 

%

1.86 

(0.05)

(2.7)

%

1.81 

1.86 

(0.05)

(2.7)

Nonperforming loans as a percentage of loans (2)

0.70 

 

0.74 

(0.04)

(5.4)

 

0.70 

0.74 

(0.04)

(5.4)

Total nonperforming assets as a percentage of total assets

1.14 

 

0.71 

0.43 

60.6 

 

1.14 

0.71 

0.43 

60.6 

Net loans charged-off as a percentage of average loans (2)

0.25 

 

0.19 

0.06 

31.6 

 

0.20 

0.16 

0.04 

25.0 

Allowance for loan losses as a		percentage of ending loans (2)

0.82 

 

0.94 

(0.12)

(12.8)

 

0.82 

0.94 

(0.12)

(12.8)

Allowance for loan losses to nonperforming loans

1.18 

x

1.26 

(0.08)

(6.3)

 

1.18 

1.26 

(0.08)

(6.3)

 

 

 

 

 

 

 

 

 

 

 

 

SIGNIFICANT OPERATING RATIOS BASED ON EARNINGS

 

 

 

 

 

 

 

 

 

 

Return on average assets

1.30 

%

1.34 

(0.04)

(3.0)

%

1.34 

1.35 

(0.01)

(0.7)

Return on average shareholders' equity

14.35 

 

15.74 

(1.39)

(8.8)

 

14.92 

15.98 

(1.06)

(6.6)

Net interest margin

4.54 

 

4.66 

(0.12)

(2.6)

 

4.61 

4.73 

(0.12)

(2.5)

 

 

 

 

 

 

 

 

 

 

 

 

(1) Calculated using loans including mortgage loans held for sale, net of unearned, excluding the allowance for loan losses

(2) Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the allowance for loan losses

 

 

Net interest income for the third quarterof 2007 was $12.8 million, an increase of 3.4% compared to the third quarter of2006. The following table summarizes the dollar amount of changes in interestincome and interest expense attributable to changes in volume and the amountattributable to changes in rate when comparing the three month period endedSeptember 30, 2007 to the three month period ended September 30, 2006 (inthousands).  

 

 

 

 

 

 

 

 

 

 

 

 

 

**Volume**

 

**Rate**

 

**Total**

 

Total interest-earning assets

$

1,475 

 

241 

 

1,716 

 

Total interest-bearing liabilities

133 

 

1,163 

 

1,296 

 

 

Net interest income

$

1,342 

 

(922)

 

420 

 

 

 

 

 

 

 

 

 

The Federal Open Market Committee’s 50 basis point reductionin the federal funds rate during September 2007 directly influences othershort-term interest rates, such as deposits, loans, credit card interest rates,and adjustable-rate mortgages. However, because the cut occurred near the endof the third quarter, management does not believe that the rate cut had amaterial impact on third quarter results.  Management believes that consumerswill start feeling, and the Company’s results of operations will fullyrecognize, the impact of the federal rate cut during the fourth quarter of2007.   As discussed in Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk, management’s evaluation of its netinterest income simulation prepared as of September 30, 2007 indicated that theCompany’s balance sheet is liability sensitive. A liability sensitive balancesheet suggests that in falling interest rate environment, net interest marginwould be positively impacted.

 

24

 

Asset Growth

 

Loans represent the mostsignificant component of the Company’s interest-earning assets with averageloans accounting for 90.0% of average interest-earning assets during the threemonth period ended September 30, 2007. Total loans, including mortgage loansheld for sale, increased $59.7 million, during the first nine months of 2007. Management believes that this increase is primarily attributed to the Company’sintroduction of business credit scoring and its emphasis on small commercialloans partially offset by a decline in loan mix within the commercial realestate portfolio as a result of the Company’s tightened underwriting standardsin an effort to limit its exposure to commercial limited-service properties.

 

Asset Growth Funding

 

Deposit accounts, retail repurchase agreements, andcommercial paper increased $8.3 million, or 0.8%, during the first nine monthsof 2007.  The combination of increasing competition and alternative investmentoptions has made it increasingly difficult to grow deposits. Savers havenumerous alternatives to the retail deposit programs provided by the Bank. Inother words, there has been increasing competition for a shrinking traditionaldeposit market. As expected, these factors have adversely impacted deposit,retail repurchase agreements, and commercial paper cash flows. Over the shortrun, management has employed proceeds from maturing short-term taxablesecurities issued by government-sponsored enterprises to fund loan growth andrepay borrowings.  Ultimately, insufficient deposit growth requiredmanagement to obtain otherfunding sources such as wholesale funding. Management does not currently consider acquisitions andbuilding new branches to be possible solutions to correct insufficient depositgrowth, as they can be expensive and difficult to execute as funding needsarise. 

 

Public funds are bank depositsof state and local municipalities and typically require that the Bank pledgeinvestment grade securities to the accounts to ensure repayment.  Approximately82% of the investment securities portfolio was pledged to secure publicdeposits as of September 30, 2007 as compared with 62% at December 31, 2006 and60% at September 30, 2006.  Of the Company’s $96.3 million available for saleinvestment securities balance at September 30, 2007, $17.3 million wasunpledged and, therefore, available as a liquidity source.  The fluctuation inpledged securities between these periods was the result of a diversification ofassets pledged to secure public deposits, securities sold under agreements torepurchase, and for other purposes as required or permitted by law as further discussedin Part I, Item 1. Financial Statements, Note10 and Note 11 contained herein andBorrowing Activities below with regard to theCompany’s borrowings from the FHLB.

 

The Company has found wholesale funding to be a logicalanswer to its insufficient deposit growth. Wholesale funding possibilities thatthe Company employs and / or considers include federal funds lines and FederalHome Loan Bank (FHLB) advances as such funding provides it with the ability toaccess the exact type of funding needed, at the exact time, in the exactquantity, and at market rates. This provides the Company with the flexibilityto tailor borrowings to its specific needs. Historically, the Company has notconsidered or employed brokered certificate of deposit accounts. Due to theinsufficient deposit growth, total wholesale funding, which includes othershort-term borrowings and long-term borrowings increased $17.0 million, or$106.3 during the first nine months of 2007.  This fluctuation takes intoaccount the Company’s remaining $10.0 million in long-term FHLB borrowings thatmatured on June 14, 2007. 

 

During April 2007, NexityBank extended to the Bank a federal funds accommodation in the amount of $10million for a period beginning on April 25, 2007 and ending on April 30, 2008subject to specified terms and conditions. Advances under this accommodationare advances of federal funds with a maturity of the next Banking Day (the nextday other than Saturday or Sunday on which banking business is conducted inSouth Carolina). This additional federal funds accommodation in the amount of$10 million increased the Company’s accessible funding sources from $40 millionto $50 million of which $9.0 million was utilized at September 30, 2007.

 

At September 30, 2007, ofits approximately $95.3 million available credit based on qualifying loans toserve as collateral against borrowings and letters of credit from the FHLB, theCompany employed $24.0 million in borrowings, all of which was determined to beshort-term when employed, and employed $69.0 million in a letter of credit usedto secure public deposits as required or permitted by law.  At September 30,2007, the Company had approximately $2.3 million available credit based onqualifying loans to serve as collateral against short-term borrowings,long-term borrowings, and / or letters of credit from the FHLB.

 

25

 

Managementbelieves that the correct mix of funding for the Company is between retaildeposits and wholesale funding that provides the overall lowest cost of totalfunds but provides the flexibility to manage the liquidity and interest rateposition of the balance sheet. Although the Company has traditionally relied oncustomer deposits to fund asset growth, with new trends of loan assets beingfixed rate for at least three to five years and depositors wanting to keepmaturities short, there is little ability for a bank to effectively managetheir interest rate risk position and net interest margins.  As a result, theCompany needs the ability to acquire funding that is not only cost effective,but also has the maturity characteristics that best meet the interest ratecharacteristics of its balance sheet. Wholesale funding in the current yieldcurve environment can meet these requirements.  As such, management believesthat the Company will continue to employ a mix of retail deposits and wholesalefunding to fund asset growth.  

 

Credit Quality

 

The allowance for loanlosses (the “Allowance”) decreased from $8.5 million at December 31, 2006 to$8.3 million at September 30, 2007 representing 0.90% and 0.82% of loans,respectively, calculated using loans excluding mortgage loans held for sale andthe Allowance, net of unearned income. Management believes that the decliningtrend of the Allowance as a percentage of ending loans results from severalfactors including, but not limited to, management’s conservative philosophyregarding its lending mix which impacts risk grades assigned at loanorigination, the ongoing management of asset quality, and growth within theportfolio being primarily loans secured by real estate which generally involveless risk than other types of lending, all of which impact Allowanceallocations. 

 

Subprime Lending Crisis.  The subprime mortgage financial crisis, which has yet to beresolved, is the result of the sharp rise in foreclosures in the subprimemortgage market that began in the United States in 2006 and that has become aglobal financial crisis in 2007. Management believes that rising interest rates,which  increased the monthly payments on newly popular adjustable ratemortgages, together with declines in property value from the demise of the United States housing bubble, left manyhomeowners unable or unwilling to meet financial commitments and lenderswithout a means to recoup their losses. Many observers believe this hasresulted in a severe credit crunch, threatening the solvency of a number ofprivate banks and other financial institutions.

 

Although the Company does offer adjustable rate mortgages,the majority of such loans are sold on the secondary market.  Additionally, theCompany does not participate in a subprime lending program.  As such, theCompany does not anticipate a negative impact on its earnings as a result ofthe subprime lending crisis.  These factors, however, cannot always safeguardthe Company against fraudulent reporting by borrowers on loan applications.  Asa result, the Company cannot guarantee that a negative impact on its earningswill not occur related to such fraudulent applications.  However, managementdoes not anticipate such losses to be material.

 

Net Loans Charged-Off. During the three and nine month periods ended September 30, 2007, net loanscharged-off increased by $205 thousand and $415 thousand, respectively. Management believes that the increase in net loans charged-off over bothperiods has been largely confined to a group of residential rentalproperty loans in which the borrowers admitted they defrauded seven banks byusing false mortgage information.  During the second quarter of 2007, theindividuals were sentenced to five years plus three months in prison andordered to pay restitution. Management believes that these credit losses duringthe periods were a result of inherent losses associated with all normal lendingoperations and / or loans where the Borrower defrauded the Bank (as notedabove).  Management does not believe that losses within the loan portfolio were the result of subprime lendingpractices.  

 

Real Estate Acquired In Settlement Of Loans. Realestate acquired in settlement of loans increased $5.6 million from December 31,2006 to September 30, 2007 primarily as the result of two loans secured byother real estate for which foreclosure proceedings were completed with regardto the securing real estate collateral during July 2007.  Both properties wereplaced into the Bank’s real estate acquired in settlement of loans portfolio inJuly at fair market value, approximately $5.3 million.  Management expects thatthe sale of the collateral securing these loans will fully cover the Company’sinvestment as well as a portion of the foregone interest. Excluding the impactof these loans, virtually all other nonperforming comparisons remainedrelatively unchanged from December 31, 2006 to September 30, 2007.  

 

26

 

Other Highlights

 

On September 21, 2006, theCompany announced its plan to relocate its corporate headquarters to downtownGreenville in 2008. Project construction of the new leased facility beganduring 2007 with a projected completion date in 2008.  In conjunction with thedemolition of the current downtown Greenville banking office, the Company wroteoff $346 thousand in leasehold improvements during the third quarter of 2007. 

 

During the second quarter of 2007, the Company executed aground lease contract for a nonretail office ATM location at Woodmont VillageShopping Center on Highway 25 in Moonville, South Carolina.  The Company plansto have this location in service by January 2008.  

 

As reported in the Company’s Annual Report on Form 10-K forthe Year Ended December 31, 2006, during February 2007, the Bank purchased realestate in Anderson County on which to construct and relocate its existingPendleton banking office.  Ground was broken on this site in July 2007, andGrand Opening is planned for the first quarter of 2008.

 

During the second quarter of 2007, the Company contracted topurchase property at the intersection of West Wade Hampton Boulevard andMiddleton Way in Greenville County on which to construct and relocate itsexisting Greer banking office.  The Company expects to close on this propertyduring the fourth quarter of 2007.**

 

**Critical Accounting Policies**

 

TheCompany’s accounting and financial reporting policies are in conformity withgenerally accepted accounting principles (“GAAP”).  The preparation offinancial statements in conformity with such principles requires management tomake estimates and assumptions that impact the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities during thereporting period, and the reported amounts of revenue and expense during thereporting period.  The Company’ssignificant accounting policies are discussed in Item 8, Note 1 to theConsolidated Financial Statements of the Annual Report on Form 10-K for theyear ended December 31, 2006.  Ofthese significant accounting policies, the Company believes that the accountingfor its Allowance, pension plan, mortgage-servicing rights portfolio, pastacquisitions, and income taxes are its most critical accounting policies due tothe valuation techniques used and the sensitivity of these financial statementamounts to the methods, assumptions, and estimates underlying these balances.Accounting for these critical areas requires a significant degree of judgmentthat could be subject to revision as newer information becomes available. Inorder to determine the Company’s critical accounting policies, managementconsiders if the accounting estimaterequires assumptions about matters that were highly uncertain at the time theaccounting estimate was made and if different estimates that reasonably couldhave been used in the current period or changes in the accounting estimate thatare reasonably likely to occur from period to period would have a materialimpact on the presentation of financial condition, changes in financialcondition, or results of operations. In conjunction with the filing of theCompany’s Annual Report on Form 10-K for the year ended December 31, 2006, management and the Company’s independent registeredpublic accounting firm discussed the development and selection of the criticalaccounting estimates discussed herein with the Audit Committee of the Company’sBoard of Directors. 

*** ***

***Other Information***

* *

*Impact of Inflation*

 

The Consolidated Financial Statements andrelated financial data presented herein have been prepared in accordance withgenerally accepted accounting principles.  These principles require themeasurement of financial condition and results of operations in terms ofhistorical dollars without considering changes in relative purchasing powerover time due to inflation.  

 

27

 

***Financial Condition*****

* *

The following information isintended to supplement any information relating to the Consolidated BalanceSheets contained within Part I, Item 1 of this Quarterly Report on Form10-Q.    

 

*Overview*

* *

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated Balance Sheets**

 

**(dollars in thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

**Variance**

 

 

 

 

 

 

 

**2007**

 

**2006**

 

**$**

 

 

**%**

 

 

 

 

 

 

 

		(unaudited)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

$

31,076 

 

43,084 

 

(12,008)

 

(27.9)

%

 

Federal funds sold

 

 

4,188 

 

3,582 

 

606 

 

16.9 

 

 

 

Total cash and cash equivalents

 

35,264 

 

46,666 

 

(11,402)

 

(24.4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal Home Loan Bank ("FHLB") stock, at cost

 

3,157 

 

2,599 

 

558 

 

21.5 

 

Investment securities available for sale, at fair market value

96,287 

 

116,567 

 

(20,280)

 

(17.4)

 

Mortgage loans held for sale

 

 

1,435 

 

1,675 

 

(240)

 

(14.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

 

 

 

1,005,872 

 

945,913 

 

59,959 

 

6.3 

 

 

Less: allowance for loan losses

 

(8,280)

 

(8,527)

 

247 

 

(2.9)

 

 

 

Loans, net

 

 

997,592 

 

937,386 

 

60,206 

 

6.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

24,476 

 

24,494 

 

(18)

 

(0.1)

 

Goodwill

 

 

 

 

3,691 

 

3,691 

 

- 

 

- 

 

Other intangible assets

 

 

90 

 

127 

 

(37)

 

(29.1)

 

Accrued interest receivable

 

 

6,421 

 

6,421 

 

- 

 

- 

 

Other

 

 

 

 

20,437 

 

13,510 

 

6,927 

 

51.3 

 

 

 

 

Total assets

 

 

$

1,188,850 

 

1,153,136 

 

35,714 

 

3.1 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing

 

 

$

136,990 

 

133,623 

 

3,367 

 

2.5 

%

 

Interest-bearing

 

 

859,505 

 

859,958 

 

(453)

 

(0.1)

 

 

 

Total deposits

 

 

996,495 

 

993,581 

 

2,914 

 

0.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

10,130 

 

14,427 

 

(4,297)

 

(29.8)

 

Commercial paper (Master notes)

 

30,636 

 

20,988 

 

9,648 

 

46.0 

 

Other short-term borrowings

 

 

33,000 

 

6,000 

 

27,000 

 

450.0 

 

Long-term borrowings

 

 

- 

 

10,000 

 

(10,000)

 

(100.0)

 

Accrued interest payable

 

 

1,518 

 

1,584 

 

(66)

 

(4.2)

 

Other

 

 

 

 

8,140 

 

6,180 

 

1,960 

 

31.7 

 

 

 

Total liabilities

 

 

1,079,919 

 

1,052,760 

 

27,159 

 

2.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

32,001 

 

31,837 

 

164 

 

0.5 

 

Capital surplus

 

 

1,527 

 

1,102 

 

425 

 

38.6 

 

Retained earnings

 

 

76,211 

 

68,132 

 

8,079 

 

11.9 

 

Accumulated other comprehensive loss, net of tax

 

(808)

 

(695)

 

(113)

 

16.3 

 

 

 

Total shareholders' equity

 

108,931 

 

100,376 

 

8,555 

 

8.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,188,850 

 

1,153,136 

 

35,714 

 

3.1 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lending Activities

 

General.  Loans represent the most significantcomponent of the Company’s interest-earning assets with average loansaccounting for 90.0% and 86.4% of average interest-earning assets during thethree month periods ended September 30, 2007 and September 30, 2006,respectively and 88.5% and 85.7% of average interest-earning assets during thenine month periods ended September 30, 2007 and September 30, 2006,respectively. The following tablesummarizes the Company’s loan portfolio, by collateral type, at thedates indicated (dollars in thousands).

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Commercial and industrial

$

79,287 

7.9 

%

126,742 

13.4 

 

 

 

 

 

 

 

Real estate - 1 - 4 family

208,339 

20.7 

 

171,828 

18.1 

Real estate - construction

48,166 

4.8 

 

19,959 

2.1 

Real estate - other

580,739 

57.6 

 

540,869 

57.1 

 

Total loans secured by real estate

837,244 

83.1 

 

732,656 

77.3 

 

 

 

 

 

 

 

General consumer

72,798 

7.2 

 

70,502 

7.4 

Credit line

5,062 

0.5 

 

4,868 

0.5 

Bankcards

11,841 

1.2 

 

11,813 

1.3 

Others

1,075 

0.1 

 

1,007 

0.1 

 

Total loans, gross

$

1,007,307 

100.0 

%

947,588 

100.0 

 

 

 

 

 

 

 

 

During the first nine months of2007, in order to adequately monitor and properly report for regulatorypurposes segments of the loan portfolio, the Company reviewed itsstratifications within the loan portfolio using parameters including, but notlimited to, loan type, loan purpose, geographic distribution, and collateral,if applicable. As a result of this process, management deemed it necessary toadjust various stratification identifiers resulting in fluctuations within loanoutstanding balances. These reclassifications impact the comparability of 2006and 2007 balances. Management is currently exploring ways in which to improvethe comparability of these numbers in the future.

 

28

 

The following table summarizesloans by loan purpose at the dates indicated (dollars in thousands). 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Commercial business

$

130,292 

13.0 

%

112,264 

12.0 

Commercial real estate

626,555 

62.7 

 

593,377 

63.2 

Installment

24,213 

2.4 

 

22,139 

2.4 

Installment real estate

71,679 

7.2 

 

66,161 

7.0 

Indirect

41,824 

4.2 

 

43,634 

4.6 

Credit line

1,943 

0.2 

 

1,982 

0.2 

Prime access

51,906 

5.2 

 

53,883 

5.7 

Residential mortgage

39,956 

4.0 

 

35,252 

3.7 

Bankcards

11,841 

1.2 

 

11,813 

1.3 

Business manager

336 

- 

 

370 

- 

Other

1,607 

0.2 

 

1,793 

0.2 

 

Loans, unadjusted gross

1,002,152 

100.3 

 

942,668 

100.3 

 

 

 

 

 

 

 

Loans in process

2,922 

0.3 

 

2,587 

0.3 

Deferred loans fees and costs

798 

0.1 

 

658 

0.1 

 

Loans, adjusted gross

1,005,872 

100.7 

 

945,913 

100.7 

 

 

 

 

 

 

 

Mortgage loans held for sale

1,435 

0.1 

 

1,675 

0.2 

 

Total loans, gross

1,007,307 

100.8 

 

947,588 

100.9 

 

 

 

 

 

 

 

Allowance for loan losses

(8,280)

(0.8)

 

(8,527)

(0.9)

 

Total loans, net

$

999,027 

100.0 

%

939,061 

100.0 

 

 

 

 

 

 

 

 

During 2006, the Companyintroduced business credit scoring and began placing an emphasis on smallcommercial loans.  Management believes that these changes continue to result inincreases in commercial business loans as a percentage of the total portfolio. 

 

Management believes that theaggressive commercial real estate building in recent years may indicate anupcoming period of oversupply.  In order to avoid an excess supply ofcommercial limited-service properties, the Company has tightened underwritingstandards with regard to such loans resulting in little change in commercialreal estate loans as a percentage of the total portfolio.

 

The increase in residential mortgage loans and the slightdecrease in mortgage loans held for sale during the first nine months was due,in part, to the Company’s decision to retain more residential loans in itsin-house portfolio during the period. 

 

See Part I, Item 1. FinancialStatements, Note 4 contained herein for further discussion regarding theCompany’s loan portfolio.

 

29

 

Credit Quality.  Thefollowing table summarizes the composition of the Company’s classified assets, bycollateral type, at the dates indicated (in thousands). 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

 

**Special**

**mention**

**Substandard**

**Doubtful**

**Loss**

**Total**

Commercial and industrial

$

117 

859 

929 

- 

1,905 

Real estate

586 

14,745 

659 

- 

15,990 

General consumer

15 

246 

28 

- 

289 

Credit line

4 

66 

1 

- 

71 

 

Total classified loans

$

722 

15,916 

1,617 

- 

18,255 

 

 

 

 

 

 

 

 

Total classified loans as a percentage of total loans (1)

1.8% 

 

 

 

 

 

 

 

 

 

**December 31, 2006**

 

 

**Special**

**mention**

**Substandard**

**Doubtful**

**Loss**

**Total**

Commercial and industrial

$

301 

1,098 

839 

- 

2,238 

Real estate

1,063 

12,398 

942 

- 

14,403 

General consumer

2 

321 

36 

- 

359 

Credit line

6 

47 

1 

- 

54 

 

Total classified loans

$

1,372 

13,864 

1,818 

- 

17,054 

 

 

 

 

 

 

 

 

Total classified loans as a percentage of total loans (1)

1.8% 

 

 

 

 

 

 

 

(1)

Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the Allowance.

 

 

 

 

 

 

 

 

The following table summarizes trends in problem assets andother asset quality indicators at the dates indicated (dollars in thousands). Thecomposition of nonaccrual loans is based on loan collateral type.

 

 

 

 

 

 

 

 

		 

		 
		 		 
**September 30,**		 
**December 31,**
 

 

**2007**

 

**2006**

 

 

 

 

 

Commercial and industrial

$

684 

 

549 

Real estate

6,224 

 

6,271 

General consumer / credit line

135 

 

179 

 

Total nonaccrual loans

		7,043 

 

		6,999 

 

 

 

 

 

Real estate acquired in settlement of loans

6,170 

 

600 

Repossessed automobiles

295 

 

319 

 

Total nonperforming assets

$

		13,508

 

		7,918 

 

 

 

 

 

Loans past due 90 days and still accruing (1)

$

210 

 

260 

 

 

 

 

 

Ending loans (2)

$

1,005,872 

 

945,913 

Nonaccrual loans as a percentage of loans (2)

		0.70 

%

		0.74 

Nonperforming assets as a percentage of

 

 

 

 

total assets

		1.14 

%

0.69 

Allowance for loan losses to nonaccrual

 

 

 

 

loans

		1.18 

x

		1.22 

 

 

 

 

 

(1)

Substantially all of these loans are bankcard loans

 

 

(2)

Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the Allowance

 

 

 

 

 

 

During July 2007, the Company completed foreclosureproceedings with regard to the real estate collateral securing two loans thathad been previously classified as nonaccrual.  Both properties, totaling $5.3million, were placed into the Bank’s real estate in settlement of loansportfolio in July at fair market value. The Company has a current contract withregard to one of the properties and anticipates sale, fully covering itsprincipal investment, during December 2007.  With regard to the secondproperty, one of the parties that submitted a Letter of Intent has requestedconversion to a contract. A copy of this proposed contract has been submittedand is awaiting the approval of their institutional investor.  If contractedfor the proposed amount, the Company should recover all principal and a portionof the foregone interest.  Management does not currently believe it is feasiblefor expect a sale prior to year end.  Excluding the impact of these loans,virtually all other nonperforming comparisons remained relatively unchangedfrom December 31, 2006 to September 30, 2007.  In its consideration ofcollectibility of nonaccrual loans, management takes into consideration, amongother factors, that 88.4% of nonaccrual loans at September 30, 2007 weresecured by real estate. In the event of foreclosure, any losses would be offsetby funds received through the liquidation of the underlying real estatecollateral.  

 

30

 

Also included within nonaccrual loans at both December 31,2006 and September 30, 2007 was a loan secured by other real estate placed innonaccrual during the fourth quarter of 2005.  In accordance with the Bank’sLending Policy, the loan was downgraded to“substandard” at that time.  At both December 31, 2006 and September 30,2007, the principal balance of this loan totaled $3.9 million.  The Companyincreased the loan balance specifically reserved from $878 thousand at December31, 2006 to $1.2 million at September 30, 2007. A hearing is scheduled in theUnited States Bankruptcy Court on November 14, 2007 at which time managementanticipates a sale of the property. The Company, in addition to the lead bankand the other participants, believes it will be granted a position as a creditbidder.  Management anticipates that those parties will become owners of thereal estate allowing for preparation of the sale of the property.  

 

Troubled debt restructurings entered into by the Companyduring the three month period ended September 30, 2007 were reviewed by theCompany to ensure loan classifications were in accordance with applicableregulations.  Any specific allocations identified during the review based onprobable losses have been included in the Company’s Allowance for theapplicable period. 

 

As of September 30, 2007, management was aware of no otherpotential problem loans that were not already categorized as nonaccrual, pastdue, or restructured, or that had borrower credit problems causing managementto have serious doubt as to the ability of the borrower to comply with thepresent loan repayment terms.  

 

The Company regularly reviews its loan portfolio andmanagement determines whether any loans require classification in accordancewith applicable regulations.  The Company’sbelieves that its loans are appropriately classified. 

 

The following table summarizes the changes in theCompany’s real estate acquired in settlement of loans, including the balance atthe beginning and end of each period, provision charged to expense, and lossescharged to the Allowance related to the Company’s real estate acquired in settlementof loans for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

**periods ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Real estate acquired in settlement of loans, beginning of period

$

717 

728 

 

600 

1,954 

 

Add: New real estate acquired in settlement of loans

5,533 

72 

 

6,115 

154 

 

Less: Sales / recoveries of real estate acquired in settlement of loans

(80)

(29)

 

(374)

(1,150)

 

Less: Provision charged to expense

- 

- 

 

(171)

(187)

Real estate acquired in settlement of loans, end of period

$

6,170 

771 

 

6,170 

771 

 

 

 

 

 

 

 

 

 Real estate acquired in settlement of loans increased $5.4million from December 31, 2006 to September 30, 2007 primarily as the result oftwo loans secured by other real estate for which foreclosure proceedings werecompleted with regard to the securing real estate collateral during July 2007. Both properties were placed into the Bank’s real estate acquired in settlementof loans portfolio in July at fair market value of approximately $5.3 million. The Company has a current contract with regard to one of the properties andanticipates sale, fully covering its principal investment, during December2007.  With regard to the second property, one of the parties that submitted aLetter of Intent has requested conversion to a contract. A copy of thisproposed contract has been submitted and is awaiting the approval of theirinstitutional investor.  If contracted for the proposed amount, the Company shouldrecover all principal and a portion of the foregone interest.  Management doesnot currently believe it is feasible for expect a sale prior to year end.  Exclusiveof these two loans, the real estate acquired in settlement of loans portfolioincreased $97 thousand from December 31, 2006 to September 30, 2007. Management believes that real estate acquired in settlement of loans iseffectively managed by the Company considering the increasing industry trendswith regard to foreclosure, but believes that there will always remain a corelevel of delinquent loans and real estate and personal property acquired insettlement of loans from normal lending operations. Sales and recoveries fromthe portfolio were down over both comparison periods due primarily to themarketability of the properties within the portfolio due to the real estatemarket decline of recent years.  Management does not believe that the lowersales from the portfolio are an indication of the properties within theportfolio but rather an indication of the current real estate market. As such,management believes that as the market begins a rebound, compounded with otherrecent positive economic indicators, sales from the portfolio will increase. 

* *

Allowance. TheAllowance totaled $8.7 million, $8.5 million, and $8.3 million at September 30,2006, December 31, 2006, and September 30, 2007, respectively representing0.94%, 0.90%, and 0.82% of loans, calculated using loans excluding mortgageloans held for sale and the Allowance, net of unearned income.

 

31

 

The following table summarizes activity within the Allowanceat the dates and for the periods indicated (dollars in thousands). Losses andrecoveries are charged or credited to the Allowance at the time realized. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

 

**periods ended September 30**

 

**periods ended September 30**

 

 

 

**2007**

 

**2006**

 

**2007**

 

**2006**

Allowance balance, beginning of period

$

8,515 

 

8,879 

 

8,527 

 

8,431 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

400 

 

275 

 

1,200 

 

1,325 

 

 

 

 

 

 

 

 

 

 

Loans charged-off

 

 

 

 

 

 

 

 

Commercial and industrial

72 

 

104 

 

210 

 

318 

 

Real estate - 1 - 4 family

149 

 

107 

 

361 

 

147 

 

Real estate - construction

- 

 

- 

 

- 

 

- 

 

Real estate - other

236 

 

44 

 

394 

 

144 

 

General consumer / credit line

249 

 

199 

 

731 

 

557 

 

 

Total loans charged-off

706 

 

454 

 

1,696 

 

1,166 

 

 

 

 

 

 

 

 

 

 

Recoveries

 

 

 

 

 

 

 

 

Commercial and industrial

30 

 

2 

 

51 

 

31 

 

Real estate - 1 - 4 family

2 

 

1 

 

35 

 

14 

 

Real estate - construction

- 

 

- 

 

- 

 

- 

 

Real estate - other

9 

 

2 

 

12 

 

5 

 

General consumer / credit line

30 

 

19 

 

151 

 

84 

 

 

Total recoveries

71 

 

24 

 

249 

 

134 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off

635 

 

430 

 

1,447 

 

1,032 

 

 

 

 

 

 

 

 

 

 

Allowance balance, end of period

$

8,280 

 

8,724 

 

8,280 

 

8,724 

 

 

 

 

 

 

 

 

 

 

Average loans (1)

$

997,301 

 

905,222 

 

970,999 

 

882,357 

 

 

 

 

 

 

 

 

 

 

Ending loans (1)

1,005,872 

 

930,205 

 

1,005,872 

 

930,205 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off as		a percentage of average loans (1)

0.25 

%

0.19 

 

0.20 

 

0.16 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses as		a percentage of ending loans (1)

0.82 

 

0.94 

 

0.82 

 

0.94 

 

 

 

 

 

 

 

 

 

 

(1)

Calculated using loans excluding mortgage loans held for sale, net of unearned income, excluding allowance for loan losses.

 

 

In evaluating the adequacy of the Allowance and determiningthe related provision for loan losses, if any, management considers, amongother things, historical loss experience and change in the size and mix of theoverall portfolio composition, specific allocations based on probable lossesidentified during the review of the portfolio, delinquency trends in the portfolioand the composition of nonperforming loans, including the percent ofnonperforming loans with supplemental mortgage insurance or secured by realestate, and subjective factors, including local and general economic businessfactors and trends, industry and interest rate trends, new lending products,changes in underwriting criteria, and portfolio concentrations. Management iscurrently using a five year lookback period when computing historical lossrates to determine the allocated component of the Allowance.  

 

During the three and nine month periods ended September 30, 2007, netloans charged-off increased by $205 thousand and $415 thousand, respectively. Comparisons of fluctuations of net loans charged-off by collateral loan type,as summarized by the table above, are difficult due to the tasks performedduring the first nine months of 2007 in order to comply with commercialreal estate regulatory reporting requirements, as previously discussed. Thesereclassifications may impact the comparability of 2006 and 2007 balances.Management is currently exploring ways in which to improve the comparability ofthese numbers in the future.

 

Management believes that the increase in net loans charged-off over bothperiods has been largely confined to a group of residential rentalproperty loans in which the borrowers admitted they defrauded seven banks byusing false mortgage information.  During the second quarter of 2007, theindividuals were sentenced to five years plus three months in prison andordered to pay restitution. Management believes that these credit losses duringthe periods were a result of inherent losses associated with all normal lendingoperations and / or loans where the Borrower defrauded the Bank (as notedabove).  Management does not believe that losses within the loan portfolio were the result of subprime lendingpractices.  

 

32

 

The subprime mortgage financial crisis, which has yet to beresolved, is the result of the sharp rise in foreclosures in the subprimemortgage market that began in the United States in 2006 and that has become aglobal financial crisis in 2007. Management believes that rising interest rates,which  increased the monthly payments on newly popular adjustable ratemortgages, together with declines in property value from the demise of the United States housing bubble, left manyhomeowners unable or unwilling to meet financial commitments and lenderswithout a means to recoup their losses. Many observers believe this hasresulted in a severe credit crunch, threatening the solvency of a number ofprivate banks and other financial institutions.

 

Although the Company does offer adjustable rate mortgages,the majority of such loans are sold on the secondary market.  Additionally, theCompany does not participate in a subprime lending program.  As such, theCompany does not anticipate a negative impact on its earnings as a result ofthe subprime lending crisis.  These factors, however, cannot always safeguardthe Company against fraudulent reporting by borrowers on loan applications.  Asa result, the Company cannot guarantee that a negative impact on its earningswill not occur related to such fraudulent applications.  However, managementdoes not anticipate such losses to be material.

 

Management believes thatthe declining trend of the Allowance as a percentage of ending loans resultsfrom several factors including, but not limited to, management’s conservativephilosophy regarding its lending mix which impacts risk grades assigned at loanorigination, the ongoing management of asset quality, and growth within theportfolio being primarily loans secured by real estate which generally involveless risk that other types of lending, all of which impact Allowanceallocations. 

 

The following table indicates management’s breakdown of theAllowance losses by loan category and the percentage of loans in each categoryto gross loans at the dates indicated (dollars in thousands). Managementbelieves that the Allowance can be allocated by category only on an approximatebasis.  The allocation of the Allowance to each category is not necessarilyindicative of future losses and does not restrict the use of the Allowance toabsorb losses in other categories. 

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

 

**2007**

 

**2006**

 

 

**Total**

**allowance**

**% of**

**loans**

**to total**

**loans**

 

**Total**

**allowance**

**% of**

**loans**

**to total**

**loans**

Commercial and industrial

$

922 

7.9 

%

1,167 

13.4 

Real estate - 1 - 4 family

1,542 

20.7 

 

1,344 

18.1 

Real estate - construction

49 

4.8 

 

20 

2.1 

Real estate - other

3,190 

57.6 

 

2,745 

57.1 

General consumer

1,181 

7.2 

 

1,860 

7.4 

Credit line

166 

0.5 

 

162 

0.5 

Bankcards

365 

1.2 

 

382 

1.3 

Others

865 

0.1 

 

847 

0.1 

 

Total

$

8,280 

100.0 

%

8,527 

100.0 

 

 

 

 

 

 

 

 

As previously discussed, thefluctuations in outstanding balances during the first nine months of 2007 werea result of the Company’s review of stratifications within the loan portfolioand the resulting adjustments made to various stratification identifiers. Thesereclassifications impact the comparability of 2006 and 2007 balances.Management is currently exploring ways in which to improve the comparability ofthese numbers in the future.

 

The increase in allowance of theAllowance to the loan portfolio secured by other real estate was due primarilyto an increase in classified assets over the periods presented of approximately$1.9 million.  The decrease in allocationof the Allowance to the loan portfolio secured by general consumer collateralwas due primarily to a decrease in the historical loss percentage with regardto this category.

 

Based on the currenteconomic environment and other factors that impact the assessment of theCompany’s Allowance as discussed above, management believes that the Allowanceat September 30, 2007 was maintained at a level adequate to provide forestimated probable losses in the loan portfolio.  However, assessing theadequacy of the Allowance is a process that requires considerable judgment.Management's judgments are based on numerous assumptions about current eventsbelieved to be reasonable but which may or may not be valid. Thus, there can beno assurance that loan losses in future periods will not exceed the currentAllowance or that future increases in the Allowance will not be required. Noassurance can be given that management's ongoing evaluation of the loan portfolio,in light of changing economic conditions and other relevant circumstances, willnot require future additions to the Allowance, thus adversely impacting theresults of operations of the Company.

 

33

 

*AssetGrowth Funding*

 

Deposit Activities. Although the Bank has historicallydirectly competed for deposits with commercial banks and other financialinstitutions, in recent years, money market, stock, and fixed income mutualfunds have attracted an increasing share of household savings.  Consequently, theCompany considers these funds to be competitors of the Bank. Competition amongvarious financial institutions is based on interest rates offered on depositaccounts, service charges, the quality of service rendered, and the convenienceof banking offices. The Bank feels that it sets itself apart from itscompetitors by providing superior personal service and a full range of highquality financial products and services.  

 

The following tablesummarizes the Company’s deposit composition at the dates indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30,**

 

**December 31,**

 

 

**2007**

 

**2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Noninterest-bearing transaction deposit accounts

$

136,990 

13.7 

%

133,623 

13.4 

Interest-bearing transaction deposit accounts

381,502 

38.3 

 

313,613 

31.6 

 

Transaction deposit accounts

518,492 

52.0 

 

447,236 

45.0 

 

 

 

 

 

 

 

Money market deposit accounts

115,470 

11.6 

 

124,874 

12.6 

Savings deposit accounts

39,380 

4.0 

 

41,887 

4.2 

Time deposit accounts

323,153 

32.4 

 

379,584 

38.2 

 

Total traditional deposit accounts

$

996,495 

100.0 

%

993,581 

100.0 

 

 

 

 

 

 

 

 

The Company experienced an increase of $2.9 million intraditional deposit accounts during the first nine months of 2007 as a resultof an increase in transaction deposit accounts totaling $71.3 million offset bydeclines in money market, savings, and time deposit accounts.  The increase intransaction deposit accounts resulted from the Company’s continued ability toattract deposits through pricing adjustments, expansion of its geographicmarket area, quality customer service, and reputation in the communitiesserved. Additionally, the Company has made efforts to enhance its deposit mix byworking to attract transaction deposit accounts which generally have a lowercost than other traditional deposit accounts.  The Company believes that the growth in traditional deposit accountscontinues to be enhanced by the introduction, continuation, andenhancement of product programs and promotions.  

 

Money market deposit accounts decreased $9.4 million, or7.5% during the first nine months of 2007.  During 2006, the Company reported$14 million of growth within money market deposit accounts related to temporarypublic funds from one entity. During the first nine months of 2007,approximately $8 million of the public funds were transferred from the Bank.The decline was partially offset by an increase of money market funds of theBank’s trust department totaling $7.8 million.  Also impacting the decline inmoney market deposit accounts from December 31, 2006 to September 30, 2007 werecustomer funds transfers primarily to the Palmetto Index account, includedwithin interest-bearing transaction deposit accounts summarized above.

 

Savings deposit accounts declined slightly during the firstnine months of 2007.  The combination of increasing competition and alternativeinvestment options has made the task of growing savings deposits difficult.Savers have numerous alternatives to the retail deposit programs provided bythe Bank. In other words, there has been increasing competition for a shrinkingsavings deposit market. As expected, these factors have adversely impactedgrowth in savings deposit accounts. 

 

Time deposit accounts decreased by $56.4 million, or 14.9% during thefirst nine months of 2007. Approximately $144 million in certificate ofdeposit accounts offered by the Company matured during the first nine months of2007. The Company was able to retain approximately 70% of these maturing fundsin certificate of deposit products.  The remaining 30% of these maturing fundswere either withdrawn or transferred to another product, primarily the PalmettoIndex account, included within interest-bearing transaction deposit accountssummarized above.

 

34

 

The table set forth below summarizes the Company’s weightedaverage deposit costs for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

**For the nine month**
		 		 		 
**periods ended September 30,**		 
**periods ended September 30,**
 

 

 

**2007**

 

**2006**

 

**2007**

 

**2006**

Average cost of core deposit accounts

2.92 

%

2.42 

 

2.79 

 

2.06 

Average cost of time deposit accounts

4.47 

 

4.07 

 

4.39 

 

3.89 

Average cost of total traditional deposit accounts

3.52 

 

3.18 

 

3.45 

 

2.94 

 

 

 

 

 

 

 

 

 

 

 

The table set forth below summarizes the Company’s interestexpense on deposit accounts costs for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

**For the nine month periods**

 

 

**ended September 30,**

 

**ended September 30,**

 

 

**2007**

**2006**

 

**2007**

**2006**

Transaction deposit accounts

$

2,804 

1,584 

 

7,536 

3,557 

Money market deposit accounts

1,057 

1,100 

 

2,952 

2,872 

Savings deposit accounts

36 

39 

 

106 

112 

 

Total interest expense on core deposit accounts

3,897 

2,723 

 

10,594 

6,541 

 

 

 

 

 

 

 

 

Interest expense on time deposit accounts

3,766 

3,957 

 

11,733 

11,402 

 

 

 

 

 

 

 

 

Total interest expense on traditional deposit accounts

$

7,663 

6,680 

 

22,327 

17,943 

 

 

 

 

 

 

 

 

As summarized in Earnings Review for the applicable period,the increase in interest expense on deposit accounts when comparing both thethree and nine month periods ended September 30, 2007 over the same periods of2006 was attributable primarily to changes in rate.

 

Investment Activities. Insufficient deposit growthhas necessitated going outside of current traditional deposit gathering marketsto obtain other funding sources. In recent years, management has employedproceeds from maturing short-term taxable securities issued bygovernment-sponsored enterprises to fund loan growth and repay borrowings.  AtDecember 31, 2004, 2005, and 2006, investment securities available for saletotaled $143.7 million, $126.0 million, and $116.6 million, respectively.  AtSeptember 30, 2007, investment securities available for sale totaled $96.3million.  

 

Utilization. Thefollowing table summarizes the composition of the Company’s investmentsecurities available for sale portfolio at the dates indicated (dollars inthousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Government-sponsored enterprises

$

20,742 

21.6% 

 

42,383 

36.4 

State and municipal

51,752 

53.7 

 

48,014 

41.2 

Mortgage-backed

23,793 

24.7 

 

26,170 

22.4 

 

Total investment securities

available for sale

$

96,287 

100.0% 

 

116,567 

100.0 

 

 

 

 

 

 

 

 

At September 30, 2007, theinvestment security portfolio represented 8.1% of total assets, a decline from10.1% at December 31, 2006. The decline in the total investment securitiesportfolio from December 31, 2006 to September 30, 2007 resulted primarily fromshort-term taxable securities issued by government-sponsored enterprises(“GSEs”) not being reinvested but instead being used to fund loan growth andrepay borrowings during the six month period ended September 30, 2007.

 

See Part I, Item 1. FinancialStatements, Consolidated Statements of Cash Flows contained herein for further discussion regardinghow purchases of and proceeds from the sale, maturities, and / or callsof investment securities as well as principal paydowns of mortgage-backedsecurities impacted the investment securities available for sale portfolioduring the nine month period ended September 30, 2007.

 

35

 

The following tables summarize the amortized cost and fair marketvalues of investment securities available for sale at the dates indicated (inthousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

 

**Amortized**

**cost**

**Fair**

**market**

**value**

 

**Amortized**

**cost**

**Fair**

**market**

**value**

 

Government-sponsored enterprises

$

20,702 

20,742 

 

42,554 

42,383 

 

State and municipal

52,763 

51,752 

 

48,780 

48,014 

 

Mortgage-backed

24,136 

23,793 

 

26,362 

26,170 

 

 

Total investment securities

available for sale

$

97,601 

96,287 

 

117,696 

116,567 

 

 

 

 

 

 

 

 

 

Availability. The Company'sinvestment portfolio can provide liquidity through any of three ways includingthe maturity of a security, the sale of securities for cash, or the use ofsecurities as collateral in a repurchase agreement or other borrowing. TheCompany considers an investment security to be saleable if it is notencumbered, i.e., the security cannot be sold under a repurchase agreement orpledged or used as collateral, and it is marketable. 

 

Public funds are bank depositsof state and local municipalities and typically require that the Bank pledgeinvestment grade securities to the accounts to ensure repayment.  Although thefunds are usually a low-cost, relatively stable source of funding for the Bank,availability depends on the particular government's fiscal policies and cashflow needs. 

 

Approximately 82% of the $96.3million investment securities portfolio was pledged to secure public depositsas of September 30, 2007, and $17.3 million was unpledged and, therefore,available as a liquidity source. 62% of the investment securities portfolio waspledged to secure public deposits at December 31, 2006 compared with 60% atSeptember 30, 2006.  The fluctuation in pledged securities between theseperiods was the result of a diversification of assets pledged to secure publicdeposits, securities sold under agreements to repurchase, and for otherpurposes as required or permitted by law as further discussed in Part I, Item1. Financial Statements, Note 10 andNote 11 contained herein andBorrowing Activities below with regard to theCompany’s borrowings from the FHLB.

 

See Part I, Item1. Financial Statements, Note 3 containedherein for further discussion regarding the Company’s investment securities portfolio.

 

As noted above, in the event that the Company considers theneed for liquidity provided through the investment portfolio, the security mustbe considered saleable.  Management believes that the portfolio’s unrealizedlosses are due to interest rate changes, rather than credit quality, oninvestments that the Company classifies to indicate that sale is a possibilitybut also for which the Company has the ability to hold until maturity.  Ifliquidity is needed, the Company does not automatically chose an impaired orthe most impaired security to sell to provide needed liquidity, but ratherconsiders many factors including, but not limited to, asset – liabilitymanagement. The following table summarizes the gross unrealized losses, fairmarket value, and the number of securities in each category of investmentsecurities available for sale, aggregated by investment category and length oftime that individual securities have been in a continuous unrealized lossposition, at September 30, 2007 (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

- 

$

- 

$

- 

 

1 

3,469 

20 

 

1 

3,469 

20 

State and municipal

22 

8,038 

120 

 

101 

39,078 

909 

 

123 

47,116 

1,029 

Mortgage-backed

3 

6,949 

85 

 

22 

12,389 

274 

 

25 

19,338 

359 

 

Total investment securities

available for sale

25 

$

14,987 

$

205 

 

124 

54,936 

1,203 

 

149 

69,923 

1,408 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Borrowing Activities. General. The Company’s reliance onliability liquidity has increased during the first nine months of 2007, as netfunds provided through traditional deposit accounts have remained relativelyunchanged. Although deposit accounts are the Company’s primary funding sourcefor asset growth, the Company generally has ready access to borrowed funds andgenerally finds that such borrowings are an economical way to meet short-termor unanticipated loan demand or deposit withdrawals. Management believes thatby locking in term funding, liquidity risk can be reduced.

 

36

 

Utilization. In additionto the funds employed from the decline in the investment securityportfolio and the net growth in traditional deposit accounts, borrowingsincreased $22.4million during the first nine months of 2007 primarily to fund assetgrowth. Borrowings as a percentage of total liabilities were approximately 6.8%and 4.9% at September 30, 2007 and December 31, 2006, respectively. The following table summarizes the Company’sborrowings composition at the dates indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

**December 31, 2006**

 

 

**Total**

**% of Total**

 

**Total**

**% of Total**

Retail repurchase agreements

$

10,130 

13.7 

%

14,427 

28.1 

Commercial paper

30,636 

41.5 

 

20,988 

40.8 

Other short-term borrowings

33,000 

44.8 

 

6,000 

11.7 

Long-term borrowings

- 

- 

 

10,000 

19.4 

 

Total borrowings

$

73,766 

100.0 

%

51,415 

100.0 

 

 

 

 

 

 

 

 

The Company offers commercial paper as an alternativeinvestment tool for its commercial customers.  Through a master notearrangement between the holding company and the Bank, Palmetto Master Notes areissued for commercial sweep accounts.  These master notes are unsecured but arebacked by the full faith and credit of the holding company.  The commercialpaper is issued only in conjunction with the automated sweep account customeragreement on deposits at the Bank level.

 

Other short-term borrowings include federal funds activitiesthat are the day-to-day unsecured lending of excess reserve funds betweenbanks. If a bank needs funds to meet either its reserve requirements or otherobligations, it can purchase the excess reserves of another bank. The primaryfederal funds market is overnight, but maturities may extend a few days orweeks. 

 

The Company has found wholesale funding to be a logicalanswer to its insufficient deposit growth. Wholesale funding possibilities thatthe Company employs and / or considers include federal funds lines and FHLBadvances as such funding provides it with the ability to access the exact typeof funding needed, at the exact time, in the exact quantity, and at market rates.This provides the Company with the flexibility to tailor borrowings to itsspecific needs. Wholesale funding utilization may be categorized as eitherother short-term borrowings or long-term borrowings depending on maturityterms.  Long-term borrowings are those having maturities greater than one yearwhen executed. Short-term borrowings are those having maturities less than oneyear when executed.  

 

The following table summarizesshort-term borrowing utilization****atand for the periods indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

**2007**

 

**2006**

 

**2007**

 

**2006**

Retail repurchase agreements

 

 

 

 

 

 

 

 

Amount outstanding at period end

$

10,130 

 

17,468 

 

10,130 

 

17,468 

 

Average amount outstanding during period

14,187 

 

19,059 

 

13,502 

 

18,492 

 

Maximum amount outstanding at any period end

12,790 

 

18,497 

 

12,790 

 

23,344 

 

Rate paid at period end

3.13 

%

3.63 

 

3.13 

 

3.63 

 

Weighted average rate paid during the period

4.17 

 

4.43 

 

4.21 

 

4.08 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 

 

 

 

 

 

 

Amount outstanding at period end

$

30,636 

 

21,887 

 

30,636 

 

21,887 

 

Average amount outstanding during period

29,421 

 

22,402 

 

26,185 

 

19,630 

 

Maximum amount outstanding at any period end

30,636 

 

21,887 

 

30,636 

 

22,104 

 

Rate paid at period end

3.31 

%

3.81 

 

3.31 

 

3.81 

 

Weighted average rate paid during the period

4.21 

 

4.37 

 

4.28 

 

4.03 

 

 

 

 

 

 

 

 

 

Other short-term borrowings

 

 

 

 

 

 

 

 

Amount outstanding at period end

$

33,000 

 

- 

 

33,000 

 

- 

 

Average amount outstanding during period

29,885 

 

667 

 

11,932 

 

3,445 

 

Maximum amount outstanding at any period end

33,000 

 

- 

 

33,000 

 

13,900 

 

Rate paid at period end

5.49 

%

- 

 

5.49 

 

- 

 

Weighted average rate paid during the period

5.50 

 

2.97 

 

5.57 

 

4.62 

 

 

 

 

 

 

 

 

 

*

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

 

 

 

 

 

 

 

 

 

 

Of the $33.0 million othershort-term borrowings utilized at September 30, 2007,  $9.0 million wasborrowed through federal funds lines with correspondent banks and $24.0 millionwas borrowed from the FHLB.

 

37

 

Long-term borrowings are those having maturities greater thanone year when executed. The Company’s remaining $10.0 million in long-term FHLBborrowings matured on June 14, 2007. The followingtable summarizes long-term borrowing information, all of which wereobtained through the FHLB,****at andfor the periods indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

**At and for the nine month**

 

 

**periods ended September 30,**

 

**periods ended September 30,**

 

 

**2007**

 

**2006**

 

**2007**

 

**2006**

Long-term FHLB borrowings

 

 

 

 

 

 

 

 

Amount outstanding at period end

$

- 

 

10,000 

 

- 

 

10,000 

 

Average amount outstanding during period

- 

 

10,000 

 

6,044 

 

17,810 

 

Maximum amount outstanding at any period end

- 

 

10,000 

 

10,000 

 

23,000 

 

Rate paid at period end

- 

%

3.85 

 

- 

 

3.85 

 

Weighted average rate paid during the period

- 

 

3.85 

 

3.83 

 

3.60 

 

 

 

 

 

 

 

 

 

 

Availability. If needed, fundingsources have been arranged through federal funds lines at correspondent banks,the Federal Reserve Discount Window, and the FHLB.  

 

During April 2007, NexityBank extended to the Bank a federal funds accommodation in the amount of $10million for a period beginning on April 25, 2007 and ending on April 30, 2008subject to specified terms and conditions. Advances under this accommodationare advances of federal funds with a maturity of the next Banking Day (the nextday other than Saturday or Sunday on which banking business is conducted inSouth Carolina). This additional federal funds accommodation in the amount of$10 million increased the Company’s accessible funding sources from $40 millionto $50 million of which $9.0 million was utilized at September 30, 2007.

 

At September 30, 2007, ofits approximately $95.3 million available credit based on qualifying loans toserve as collateral against borrowings and letters of credit from the FHLB, theCompany employed $24.0 million in borrowings, all of which was determined to beshort-term when employed, and employed $69.0 million in a letter of credit usedto secure public deposits as required or permitted by law.  At September 30,2007, the Company had approximately $2.3 million available credit based onqualifying loans to serve as collateral against short-term borrowings,long-term borrowings, and / or letters of credit from the FHLB.

 

Federal Reserve advances,commonly referred to as “discount window borrowings,” are secured borrowingsfrom Federal Reserve Banks. A collateralized borrowing relationship with theFederal Reserve was in place for the Bank to meet emergency funding needs atSeptember 30, 2007, however, no borrowings were outstanding. The Bank has nothistorically utilized discount window borrowings from the Federal Reserve andhas no plans to do so in the near term. The Bank would typically only utilizethis funding source to meet emergency funding needs.

 

Managementbelieves that the correct mix of funding for the Company is between retaildeposits and wholesale funding that provides the overall lowest cost of totalfunds but provides the flexibility to manage the liquidity and interest rateposition of the balance sheet. Although the Company has traditionally relied oncustomer deposits to fund asset growth, with new trends of loan assets beingfixed rate for at least three to five years and depositors wanting to keepmaturities short, there is little ability for a bank to effectively managetheir interest rate risk position and net interest margins.  As a result, theCompany needs the ability to acquire funding that is not only cost effective,but also has the maturity characteristics that best meet the interest ratecharacteristics of its balance sheet. Wholesale funding in the current yieldcurve environment can meet these requirements.  As such, management believesthat the Company will continue to employ a mix of retail deposits and wholesalefunding to fund asset growth.  

 

*Capital Resources*****

 

Average shareholders’ equity was $107.7 million for thethree month period ended September 30, 2007, or 9.1% of average assets,compared with $95.8 million, or 8.5% of average assets, for the same period of2006.  For the nine month period ended September 30, 2007, averageshareholders’ equity was $105.0 million, or 9.0% of average assets, comparedwith $93.6 million, or 8.4% of average assets, for the same period of 2006. 

 

Total shareholders’equity increased from $100.4 million at December 31, 2006 to $108.9 million atSeptember 30, 2007. The Company’s capital ratio of total shareholders’ equityto total assets was 9.2% at September 30, 2007 compared with 8.7% at December31, 2006. During the first nine months of 2007, shareholders’ equity wasincreased through the retention of net income, stock option activity, andcompensation expense related to stock options granted.  These increases wereoffset by an increase in cash dividends and in accumulated other comprehensiveloss over the nine month period.  See Part I, Item 1. Financial Statements, Consolidated Statements of Changes inShareholders’ Equity and Comprehensive Income contained herein for further discussion regarding the changes instockholders’ equity during the nine month period ended September 30, 2007.

 

38

 

Palmetto Bancshares and the Bank are required to meetregulatory capital requirements that currently include several measures ofcapital.  At September 30, 2007 and 2006, both were each categorized as wellcapitalized under the regulatory framework for prompt corrective regulatoryaction. See Part I, Item 1. Financial Statements, Note 16 contained hereinfor further discussion regarding the Bank’s and Palmetto Bancshares’ capitalregulatory requirements.  At September 30, 2007, there were noconditions or events of which management was aware that would materially changePalmetto Bancshares’ or the Bank’s capitalization status. 

 

For the third quarter of2007, the Company’s cash dividend payout ratio was 31.21% compared with apayout ratio of 30.1% during the same period of 2006. Cash dividends per commonshare during the third quarter of 2007 totaled $0.19, an increase of 5.6% overdividends per common share during the same period of 2006 of $0.18. For the ninemonth periods ended September 30, 2007 and 2006, respectively, the Company’scash dividend payout ratio was 31.08% and 30.69%.  During the same periods,cash dividends per common share totaled $0.57 and $0.54, an increase of 5.6%. Theamount of the dividends declared is dependent upon the Company’s earnings,financial condition, capital position, and such other factors the Board deemsrelevant.  South Carolina regulations restrict the amount of dividends that theBank can pay to the holding company and may require prior approval beforedeclaration and payment of any excess dividend. 

 

***Concentrations***

* *

InvestmentActivities. The following tablesummarizes the amortized cost and fair market value of the securities ofissuers that, in the aggregate, exceed ten percent of shareholders’ equity atSeptember 30, 2007 (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

**Amortized**

**Cost**

**% of**

**Shareholders**

**equity**

 

**Fair market**

**value**

**% of**

**Shareholders**

**equity**

Government-sponsored enterprises

 

 

 

 

 

 

FHLB

$

17,724 

16.3 

%

17,768 

16.3 

 

FNMA

989 

0.9 

 

983 

0.9 

 

 

$

18,713 

17.2 

%

18,751 

17.2 

 

 

 

 

 

 

 

 

 

**Amortized**

**Cost**

**% of**

**Shareholders**

**equity**

 

**Fair market**

**value**

**% of**

**Shareholders**

**equity**

Mortgage-backed

 

 

 

 

 

 

FNMA

		$

17,643 
16.2 

%

17,427 

16.0 

 

 

$

17,643 

16.2 

%

17,427 

16.0 

 

 

 

 

 

 

 

 

 

**Amortized**

**Cost**

**% of**

**Shareholders**

**equity**

 

**Fair market**

**value**

**% of**

**Shareholders**

**equity**

Total GSEs and MBSs

 

 

 

 

 

 

FHLB

$

17,724 

16.3 

%

17,768 

16.3 

 

FNMA

18,632 

17.1 

 

18,410 

16.9 

 

 

$

36,356 

33.4 

%

36,178 

33.2 

 

 

 

 

 

 

 

 

Although most governmentsponsored enterprises’ securities are not backed by the full faith and creditof the federal government, the Company believes that such securities havenegligible credit risk. Because of the importance of the agencies in promotingpublic policy, the Company believes that the federal government would prevent agovernment sponsored enterprises from defaulting on its debt obligations. As aresult, management believes that such securities provide what is commonlydescribed as an “implied guarantee.”

 

Lending Activities. Financial instruments, whichpotentially subject the Company to concentrations of credit risk, consistprincipally of loans, investment securities, federal funds sold and due frombank balances.

 

39

 

The Company makes loans toindividuals and small to medium-sized businesses for various personal andcommercial purposes primarily in Upstate, SouthCarolina.  The Company’s loan portfolio is not concentrated in loans to anysingle borrower or a relatively small number of borrowers.  Additionally,management is not aware of any concentrations of loans to classes of borrowersor industries that would be similarly impacted by economic conditions. Management has identified, and the following table summarizes at the datesindicated, concentrations of types of lending that it monitors (dollars inthousands).

 

 

 

 

 

 

 

 

 

 

 

 

**September 30, 2007**

 

 

**Outstanding**

**balance**

 

**As a percentage**

**of total equity**

 

**As a percentage of**

**total loans**

 

Loans secured by:

 

 

 

 

 

 

 

Commercial and industrial nonmortgage instruments

$

79,287 

 

75 

%

8 

%

 

1-4 family residential mortgage instruments

208,339 

 

198 

 

21 

 

 

Other residential mortgage instruments

580,739 

 

551 

 

58 

 

 

Construction mortgage instruments

48,166 

 

46 

 

5 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2006**

 

 

**Outstanding**

**balance**

 

**As a percentage**

**of total equity**

 

**As a percentage of**

**total loans**

 

Loans secured by:

 

 

 

 

 

 

 

Commercial and industrial nonmortgage instruments

$

126,742 

 

126 

%

13 

%

 

1-4 family residential mortgage instruments

171,828 

 

171 

 

18 

 

 

Other residential mortgage instruments

540,869 

 

539 

 

57 

 

 

Construction mortgage instruments

19,959 

 

20 

 

2 

 

 

 

 

 

 

 

 

 

 

As previously discussed, thefluctuations in outstanding balances during the first nine months of 2007 werea result of the Company’s review of stratifications within the loan portfolioand the resulting adjustments made to various stratification identifiers. Thesereclassifications may impact the comparability of 2006 and 2007 balances.Management is currently exploring ways in which to improve the comparability ofthese numbers in the future.

 

Management realizes that thereare inherent risks in all loan portfolios and that there is always riskassociated with a lack of diversification.  However, management believes thatrisks associated with the concentration of loans secured by nonresidentialmortgage instruments are mitigated through the analysis and underwriting of thecredit requests, the retention of adequate collateral, and the oversight ofdevelopment or construction processes, where applicable.  The collateralassociated with such loans ranges from income producing commercial propertiesto new residential or commercial development projects. Sources of repayment areanalyzed to determine the degree of risk related to each loan during theunderwriting process.  Additionally, although included in one reportingcategory, loans secured by nonresidential mortgage instruments are comprised ofmany types of loans to many types of borrowers located in many geographicalareas.  

 

In addition to monitoring potential concentrations of loansto particular borrowers or groups of borrowers, industries, geographic regions,and loan types, management monitors whether or not the Company has exposure tocredit risk from other lending practices such as loans that subject borrowersto substantial payment increases (e.g. principal deferral periods, loans withinitial interest-only periods, etc.) and loans with high loan-to-value ratios.  Management has determined that, at September 30, 2007,the Company has no concentrations in such loans, as the Company does nottypically engage in such lending practices.  

 

Additionally, there are industrypractices that could subject the Company to increased credit risk shouldeconomic conditions change over the course of a loan’s life.  For example, theCompany makes adjustable-rate loans and fixed-rate principal-amortizing loanswith maturities prior to the loan being fully paid (i.e. balloon-term loans). These loans are underwritten and monitored to manage the associated risks. Therefore, management believes that these particular practices do not subjectthe Company to unusual credit risk. 

 

***Off-Balance SheetArrangements***

 

In the normal course ofbusiness, the Company engages in a variety of financial transactions that, inaccordance with generally accepted accounting principles, are not recorded inits financial statements or are recorded in amounts that differ from thenotional amounts.  These transactions involve elements of credit, interestrate, and liquidity risk.  

 

The Company’soff-balance sheet arrangements principally include lending commitments,guarantees, and derivatives. 

 

40

 

Lending Commitments

 

In the normal course ofbusiness, the Company makes contractual commitments to extend credit that arelegally binding agreements to lend money to customers at predetermined interestrates for a specific period of time. The Company also provides standby lettersof credit. The Company’s credit policies and standards are applied when makingthese types of commitments. These instruments are not recorded until funds areadvanced under the commitments. TheCompany’s contractual commitments to extend credit increased slightlyfrom $265.8 million at December 31, 2006 to $284.4 million at September 30,2007 primarily within real estate and bankcard loans. The following table summarizes the Company’s contractualcommitments to extend credit, bycollateral type, at September 30, 2007 (in thousands).

 

 

 

 

 

Commercial and industrial

$

32,873 

Real estate

184,900 

Credit line

7,716 

Bankcards

46,654 

Others

12,291 

 

Total contractual commitments to extend credit

$

284,434 

 

 

 

* *

* Guarantees*

* *

At September30, 2007, the Company recorded no liability for the current carrying amount ofthe obligation to perform as a guarantor, and no contingent liability wasconsidered necessary as such amounts were not considered material.  The maximumpotential amount of undiscounted future payments related to standby letters ofcredit at September 30, 2007 was $10.3 million compared with $8.3 million atDecember 31, 2006.  Past experience indicates that these standby letters ofcredit will expire unused. However, through its various sources of liquidity,the Company believes that it has the necessary resources available to meetthese obligations should the need arise.  Additionally, the Company does notbelieve that the current fair market value of such guarantees was material atSeptember 30, 2007.

 

*Other Off-Balance Sheet Arrangements*

 

At September 30, 2007, theCompany engaged in no transactions, agreements, or other contractualarrangements to which an entity unconsolidated with the Company is a party,under which the Company has:

 
- Any obligation under a     guarantee contract;

 
- A retained or contingent     interest in assets transferred to an unconsolidated entity or similar     arrangement that serves as credit, liquidity or market risk support to     such entity for such assets;

 
- Any obligation under a     contract that would be accounted for as a derivative instrument     considering exceptions; or

 
- Any obligation arising out of     a variable interest in an unconsolidated entity that is held by, and     material to, the Company, where such entity provides financing, liquidity,     market risk or credit risk support to, or engages in leasing, hedging or     research and development services with, the Company.

 

Derivatives and Hedging Activities

 

At September 30, 2007, the Company’s derivative instrumentsconsisted of forward sales commitments relating to the Company’s commitments tooriginate certain residential loans held for sale.

 

Outstanding commitments on mortgage loans not yet closed(primarily single-family loan commitments) amounted to approximately $6.6million at September 30, 2007 compared to approximately $3.8 million atDecember 31, 2006.  The fair market value of derivative assets related tocommitments to originate such residential loans held for sale was notsignificant at September 30, 2007.  The fair market value of derivative assetsrelated to forward sales commitments did not significantly differ from thecarrying amount at September 30, 2007. 

 

41

 

***Earnings Review***

 

For the Three MonthPeriod Ended September 30, 2007

** **

Overview. The following information is intended to supplementany information relating to the Consolidated Statements of Income containedwithin Part I, Item 1 of this Quarterly Report on Form 10-Q.   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

 

**Consolidated Statements of Income**

 

**(dollars in thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods**

 

 

 

 

 

 

 

 

 

 

**ended September 30,**

 

**Variance**

 

 

 

 

 

 

**2007**

 

**2006**

 

**$**

 

 

**%**

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

20,012 

 

18,033 

 

1,979 

 

11.0 

 

Interest on investment securities available for sale

1,085 

 

1,182 

 

(97)

 

(8.2)

 

Interest on federal funds sold

 

149 

 

317 

 

(168)

 

(53.0)

 

Dividends on FHLB stock

 

47 

 

45 

 

2 

 

4.4 

 

 

 

Total interest income

 

21,293 

 

19,577 

 

1,716 

 

8.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

7,663 

 

6,680 

 

983 

 

14.7 

 

Interest on retail repurchase agreements

149 

 

213 

 

(64)

 

(30.0)

 

Interest on commercial paper

 

312 

 

247 

 

65 

 

26.3 

 

Interest on other short-term borrowings

414 

 

5 

 

409 

 

8,180.0 

 

Interest on long-term borrowings

- 

 

97 

 

(97)

 

(100.0)

 

 

 

Total interest expense

 

8,538 

 

7,242 

 

1,296 

 

17.9 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,755 

 

12,335 

 

420 

 

3.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

400 

 

275 

 

125 

 

45.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,355 

 

12,060 

 

295 

 

2.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

2,001 

 

1,995 

 

6 

 

0.3 

 

Fees for trust and brokerage services

736 

 

817 

 

(81)

 

(9.9)

 

Mortgage-banking income

 

468 

 

182 

 

286 

 

157.1 

 

Other

 

 

 

1,407 

 

810 

 

597 

 

73.7 

 

 

 

Total noninterest income

4,612 

 

3,804 

 

808 

 

21.2 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

Salaries and other personnel

 

7,040 

 

5,772 

 

1,268 

 

22.0 

 

Occupancy

 

 

375 

 

398 

 

(23)

 

(5.8)

 

Premises,		furniture, and equipment leases and rentals

321 

 

341 

 

(20)

 

(5.9)

 

Premises,		furniture, and equipment depreciation

492 

 

506 

 

(14)

 

(2.8)

 

		Other furniture and equipment

 

482 

 

473 

 

9 

 

1.9 

 

Loss on disposition of premises, furniture, and equipment

346 

 

- 

 

346 

 

100.0 

 

Marketing

 

 

208 

 

479 

 

(271)

 

(56.6)

 

Amortization of core deposit intangibles

12 

 

12 

 

- 

 

- 

 

Other

 

 

 

2,115 

 

2,044 

 

71 

 

3.5 

 

 

 

Total noninterest expense

11,391 

 

10,025 

 

1,366 

 

13.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

5,576 

 

5,839 

 

(263)

 

(4.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

1,680 

 

2,038 

 

(358)

 

(17.6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,896 

 

3,801 

 

95 

 

2.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common and per share data

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

0.61 

 

0.60 

 

0.01 

 

1.7 

 

Net income - diluted

 

0.60 

 

0.59 

 

0.01 

 

1.7 

 

Cash dividends

 

0.19 

 

0.18 

 

0.01 

 

5.6 

 

Book value

 

 

17.02 

 

15.29 

 

1.73 

 

11.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,392,721 

 

6,356,656 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,500,962 

 

6,432,546 

 

 

 

 

 

Net Interest Income. Net interest income is the difference betweeninterest and fees on interest-earning assets, primarily loans and investmentsecurities, and interest paid on interest-bearing deposits and otherinterest-bearing liabilities.  This measure represents the largest component ofearnings for the Company. The net interest margin measures how effectively theCompany manages the difference between the yield on interest-earning assets andthe rate paid on funds to support those assets. Balances of interest-earningassets and successful management of the net interest margin determine the levelof net interest income. Changes in interest rates earned on interest-earningassets and interest rates paid on interest-bearing liabilities, the rate ofgrowth of the asset and liability base, the ratio of interest-earning assets tointerest-bearing liabilities, and the management of interest rate sensitivityfactor into changes in net interest income.

*       *

42

The following table summarizes the Company’s average balancesheets and net interest income analysis for the periods indicated (dollars inthousands). The Company's yield on interest-earning assets and cost ofinterest-bearing liabilities shown in the table are derived by dividinginterest income and expense by the average balances of interest-earning assetsor interest-bearing liabilities. The following table does not include atax-equivalent adjustment to net interest income adjusting the yield forinterest-earning assets earning tax-exempt income to a comparable yield on ataxable basis.

 

 

 

 

 

For the three month periods ended September 30,

 

 

 

 

 

2007

 

2006

 

 

 

 

 

Average

Income/

Yield/

 

Average

Income/

Yield/

 

 

 

 

 

balance

expense

rate

 

balance

expense

rate

 

Assets

 

 

 

 

 

 

 

 

 

 

Interest-earnings assets

 

 

 

 

 

 

 

 

 

Loans, net of unearned (1)

$

999,044 

$

20,012 

7.95 

%

$

907,834 

$

18,033 

7.88 

%

 

Investment securities available for sale, nontaxable (2)

51,393 

464 

3.58 

 

56,255 

512 

3.61 

 

 

Investment securities available for sale, taxable (2)

50,761 

621 

4.85 

 

60,807 

670 

4.37 

 

 

Federal funds sold

10,117 

149 

5.84 

 

23,083 

317 

5.45 

 

 

FHLB stock

3,047 

47 

6.12 

 

2,598 

45 

6.87 

 

 

 

Total interest-earning assets

1,114,362 

21,293 

7.58 

 

1,050,577 

19,577 

7.39 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-earning assets

 

 

 

 

 

 

 

 

 

Cash and due from banks

31,842 

 

 

 

32,861 

 

 

 

 

Allowance for loan losses

(8,408)

 

 

 

(8,869)

 

 

 

 

Premises and equipment, net

24,735 

 

 

 

24,068 

 

 

 

 

Goodwill

3,688 

 

 

 

3,688 

 

 

 

 

Other intangible assets

97 

 

 

 

148 

 

 

 

 

Accrued interest receivable

6,091 

 

 

 

5,731 

 

 

 

 

Other

 

16,516 

 

 

 

13,735 

 

 

 

 

 

Total noninterest-earning assets

74,561 

 

 

 

71,362 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

$

1,188,923 

 

 

 

$

1,121,939 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

Transaction and money market deposit accounts

$

488,384 

$

3,861 

3.14 

%

$

401,439 

$

2,684 

2.65 

%

 

Savings deposit accounts

40,440 

36 

0.35 

 

45,749 

39 

0.34 

 

 

Time deposit accounts

334,122 

3,766 

4.47 

 

385,448 

3,957 

4.07 

 

 

 

Total interest-bearing deposits

862,946 

7,663 

3.52 

 

832,636 

6,680 

3.18 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

14,187 

149 

4.17 

 

19,059 

213 

4.43 

 

 

Commercial paper (Master notes)

29,421 

312 

4.21 

 

22,402 

247 

4.37 

 

 

Other short-term borrowings

29,885 

414 

5.50 

 

667 

5 

2.97 

 

 

Long-term borrowings

- 

- 

- 

 

10,000 

97 

3.85 

 

 

 

Total interest-bearing liabilities

936,439 

8,538 

3.62 

 

884,764 

7,242 

3.25 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

135,249 

 

 

 

134,141 

 

 

 

 

Accrued interest payable

2,427 

 

 

 

2,370 

 

 

 

 

Other

 

7,104 

 

 

 

4,827 

 

 

 

 

 

Total noninterest-bearing liabilities

144,780 

 

 

 

141,338 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

1,081,219 

 

 

 

1,026,102 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

107,704 

 

 

 

95,837 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,188,923 

 

 

 

$

1,121,939 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME / NET YIELD ON

 

 

 

 

 

 

 

 

 

INTEREST-EARNING ASSETS

 

$

12,755 

4.54 

%

 

$

12,335 

4.66 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Calculated including mortgage loans held for sale.  Nonaccrual loans are included in average balances for yield computations.

 

The effect of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis.  All loans

 

and deposits are domestic.

(2)

The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.

 

 

 

 

 

 

 

 

 

 

 

 

 

43
During the three month period ended September 30, 2007 compared with the sameperiod of 2006, the Company experienced increases in both average yield oninterest-earning assets and average cost of interest-bearing liabilities. Theaverage yield on interest-earning assets increased 19 basis points to 7.58%during the third quarter of 2007 from 7.39% during the same period of 2006. Theaverage cost of interest-bearing liabilities increased 37 basis points to 3.25%from 3.62% when comparing the same periods. Average interest-earning assetsincreased $63.8 million during the quarter ended September 30, 2007 over thesame quarter of 2006, primarily within the loan portfolio, whileinterest-bearing liabilities increased $51.7 million over the same period. Rates paid during the three month period endedSeptember 30, 2007 increased from those paid for the three month period endedSeptember 30, 2006 primarily as a result of increases in the federalfunds rate by the Federal Reserve Open Market Committee. 

 

The following rate / volumeanalysis summarizes the dollar amount of changes in interest income andinterest expense attributable to changes in volume and the amount attributableto changes in rate when comparing the three month period ended September 30,2007 to the three month period ended September 30, 2006 (in thousands).  Theimpact of the combination of rate and volume change has been divided equallybetween the rate change and volume change.

  

 

 

 

**For the three month period ended September 30, 2007 		compared with the three month period ended September 30,**

 

 

 
		 
**2006**

 

 

 

 

 

**Volume**

 

**Rate**

 

**Total**

Interest-earnings assets

 

 

 

 

 

 

Loans, net of unearned

$

1,826 

 

153 

 

1,979 

 

Investment securities available for sale

(163)

 

66 

 

(97)

 

Federal funds sold

(193)

 

25 

 

(168)

 

FHLB stock

5 

 

(3)

 

2 

 

 

Total interest-earning assets

$

1,475 

 

241 

 

1,716 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

Interest-bearing deposits

$

250 

 

733 

 

983 

 

Retail repurchase agreements

(54)

 

(10)

 

(64)

 

Commercial paper

74 

 

(9)

 

65 

 

Other short-term borrowings

187 

 

222 

 

409 

 

Long-term borrowings

(326)

 

229 

 

(97)

 

 

Total interest-bearing liabilities

$

131 

 

1,165 

 

1,296 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME

$

1,344 

 

(924)

 

		420 

 

 

 

 

 

 

 

 

 

Provisionfor Loan Losses*.*The Company’s process for determining an appropriatelevel for the Allowance is based on a comprehensive, well-documented, andconsistently applied analysis of its loan portfolio. As discussed in Financial Condition, LendingActivities, all significant factors thataffect the collectibility of the portfolio and support the credit lossesestimated are considered during this process. Once this monthly process iscompleted, a provision for loan losses ischarged to earnings in order to maintain the Allowance at a level deemed adequate to provide for estimated probable lossesin the loan portfolio. Theprovision for loan losses was $400 thousand and $275 thousand for the threemonth periods ended September 30, 2007 and 2006.  The percentage of theAllowance to ending loans was reduced to 0.82% of gross loans, excludingmortgage loans held for sale, outstanding at September 30, 2007 from 0.94% atSeptember 30, 2006. SeeFinancial Condition, Lending Activities, contained herein for a discussionregarding the Company’s accountingpolicies related to, factors impacting, and methodology for analyzing, theadequacy of the Company’s Allowance and the related provision for loan losses.

 

Noninterest Income. Noninterest income during the three month periodended September 30, 2007 increased $808 thousand, or 21.2%, to $4.6 millionfrom $3.8 million during the three month period ended September 30, 2006 due,primarily, to increases in the mortgage-banking income and other noninterestincome financial statement line items.   

 

Service charges on deposit accounts comprise a significantcomponent of noninterest income and comprised 52.4% of noninterest incomeduring the three month period ended September 30, 2006 compared with 43.4% forthe same period of 2007. Management believes that this declining trend inservice charges on deposit accounts is primarily related to nonsufficient fundsand overdraft service charge declines due to an increase in alternativetransaction methods such as debit cards.  The increased use of debit cards hasdecreased the Company’s service charge opportunities, since the merchanttypically decline transactions that would otherwise result in overdrafts. The Company periodically monitorscompetitive fee schedules and examines alternative opportunities to maximizeearnings from this area. 

 

44

 

The Company sells most of theresidential mortgage loans it originates in the secondary market with servicingrights retained. Mortgage loans serviced for the benefit of others amounted to$339.4 million, $325.1 million, and $310.0 million at September 30, 2007,December 31, 2006, and September 30, 2006, respectively. 

 

The following table summarizesthe components of mortgage-banking income for the periods indicated (inthousands).

 

 

 

 

 

 

 

 

		 

 

		 
		 		 
**For the three month**		 		 
**periods ended September 30,**
 

 

**2007**

**2006**

Mortgage-servicing fees

$

204 

193 

Gain on sale of loans

279 

80 

Mortgage-serciving right amortization, impairment, and recoveries

(60)

(157)

Other mortgage-banking income

45 

66 

 

Total mortgage-banking income

$

468 

182 

 

 

 

 

 

The increase inmortgage-servicing fees correlates to the increase in mortgage loans servicedfor others.

 

Theincrease in gain on sale of mortgage loans was caused by the increase in saleswhen comparing the periods noted. During the three month period ended September30, 2007, proceeds from the sale of mortgage loans held for sale totaled $49.8million, up from $32.6 million during the same period of 2006.  

 

Amortization,impairment, and recoveries within the mortgage-servicing rights portfoliodeclined during the three month period ended September 30, 2007 as comparedwith the same period of 2006.  As interest rates have risen, refinancingactivity has slowed.  As such, the component of mortgage-servicing rightsamortization, impairment, and recoveries relative to refinancing activity(prepayment speeds) slowed as well thereby positively impacting theamortization, impairment, and recoveries within the Company’smortgage-servicing rights portfolio. Although the Federal Reserve Open MarketCommittee decreased rates during September 2007, due to the timing of thedecrease, the Company did not experience any significant impacts of thisdecrease during the third quarter of 2007.

 

See Part I, Item 1. FinancialStatements, Note 6 contained herein for a further discussion regardingthe Company’s mortgage-servicing rights portfolio.

 

Other noninterest income increased $597 thousand, or 73.7%,during the three month period ended September 30, 2007 over the same period of2006 primarily as a result of the Company’s sale of its MasterCard stock. During the second quarter of 2007, the Board of Directors of MasterCardIncorporated approved an amendment to its certificate of incorporation designedto facilitate an accelerated, orderly conversion of its Class B common stockinto MasterCard Class A common stock for subsequent sale.  Accordingly, duringthe third quarter of 2007, the Bank converted its shares of Class B commonstock on a one-for-one basis into shares of Class A common stock for subsequentsale to public investors.  This transaction resulted in pretax income, net oftransaction fees, totaling $487 thousand.  

 

Noninterest Expense.  Noninterest expense during the three month periodended September 30, 2007 increased $1.4 million, or 13.6%, to $11.4 million from$10.0 million during the three month period ended September 30, 2006. Thisincrease resulted primarily from increases in the salaries and other personnelexpense and loss on disposition of premises, furniture, and equipment financialstatement line items slightly offset by a decrease in the marketing financialstatement line item.

 

Salaries and other personnelexpense increased by $1.3 million to $7.0 million during the three month periodended September 30, 2007 from $5.8 million during the three month period endedSeptember 30, 2006. The increase in salaries and other personnel expenseresulted from several factors, both recurring and nonrecurring in nature.

 

Annual merit raises foremployees and officers as well as the addition of new officer positions includingthose positions created in connection with the opening of the new BoilingSprings banking office during 2006 contributed to the increase in salaries andother personnel expense during the three month period ended September 30, 2007over the same period of 2006.  The Bank celebrated the grand opening of itsBoiling Springs banking office on October 16, 2006.

 

45

 

The Company usessplit-dollar life insurance arrangements to provide retirement and deathbenefits to key employees. Financial Accounting Standards Board (“FASB”) TechnicalBulletin No. 85-4, “Accounting for Purchases of Life Insurance,” requires that theamount that could be realized under the insurance contract as of the date ofthe statement of financial position be reported as an asset. The Companypreviously recorded the amount that could be realized under the insurancecontract as of the date of the statement of financial position as expense inthe Bank’s Consolidated Statement of Income. During the third quarter of 2007,the Company recorded cash surrender value of $898 thousand in Other Assets onthe Consolidated Balance Sheets with an offsetting entry to income (as theseamounts had been expensed in the past) with regard to these policies.

 

During 2007, in conjunction with the audit of the Company’s401(k) Retirement Plan (the “Plan”), an administrative error was discoveredthat had resulted in participants being denied the opportunity to fully deferthe appropriate amount of compensation under the plan.  During thethird quarter of 2007, the Company calculated and accrued the denied deferralamount and the resulting employer match, including missed earnings, andbelieves such amounts total approximately $1.3 million through December 31,2006. As such, the Company accrued this amount within Salaries and OtherPersonnel Expense on the Consolidated Statements of Income for the three andnine month periods ended September 30, 2007.  The Company is currentlycalculating such amounts for the period since December 31, 2006.  The Company’smanagement intends to contribute these amounts to each participant’s accountduring the fourth quarter of 2007 by correcting the error under guidelinesestablished by the Internal Revenue Service.  

 

During the second quarter of 2007, the Company signed abuild-to-suit lease agreement with regard to the relocation of its corporateheadquarters to Greenville, South Carolina.  Under the terms of this agreement,the Company’s new headquarters will be constructed on the site of the Company’scurrent downtown Greenville banking office that is leased from the same lessor.In conjunction with the demolition of the current downtown Greenville bankingoffice, the Company wrote off $346 thousand in leasehold improvements duringthe third quarter of 2007.  See PartI, Item 1. Financial Statements, Note 5contained herein for further discussion regarding this write off.

 

Marketing and advertising expense decreased $271thousand during the three month period ended September 30, 2007 comparedwith the three month period ended September 30, 2006 primarily due to marketingcosts incurred during the third quarter of 2006 in conjunction with the Company’s 100-year anniversary celebration.

 

During the second quarter of 2006, as a result of a software upgrade, the Company experienced a temporary delay in check processing and electronic check processing.  At December 31, 2006, the Bank had exposure of, and reserved for in Other Noninterest Expense in the Consolidated Statements of Income, approximately $174 thousand related to items uncollected at that date.  At the end of the first quarter of 2007, the Bank had collected virtually all of these items.  As such, this reserve was reversed during the first quarter of 2007. As of September 30, 2007, approximately $36 thousand in check processing and electronic check processing items had been presented for which the Bank had to cover.  Inclusive of these transactions, sundry losses decreased $74 thousand during the third quarter of 2007 over the same period of 2006 to a balance of $40 thousand.  Exclusive of the first quarter reversal of the 2006 reserve, sundry losses increased $100 thousand during the third quarter of 2007 over the same period of 2006 to a balance of $214 thousand.

 

Provisionfor Income Taxes. Income tax expensetotaled $1.7 million for the three month period ended September 30, 2007compared with $2.0 million for the three month period ended September 30, 2006. The Company’s effective tax rate was 30.1% during the 2007 period and 34.9%during the 2006 period.  The decrease in the effective tax rate when comparingthe two periods was primarily the result of the recognition of an increase innontaxable income relative to cash surrender value of key man life insuranceduring the third quarter of 2007. In the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2006, the Company reported that it anticipatedthe effective income tax rate applicable to current taxable income toapproximate between 34% and 36% for 2007. Since December 31, 2006, there havebeen no events or conditions that management believes would change thisprojection.

 

46

For the Nine MonthPeriod Ended September 30, 2007

** **

Overview. The following information is intended to supplementany information relating to the Consolidated Statements of Income containedwithin Part I, Item 1 of this Quarterly Report on Form 10-Q.   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Statements of Income**

**(dollars in thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the nine month periods**

 

 

 

 

 

 

 

 

 

 

**ended September 30,**

 

**Variance**

 

 

 

 

 

 

**2007**

 

**2006**

 

**$**

 

 

**%**

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

58,079 

 

51,601 

 

6,478 

 

12.6 

 

Interest on investment securities available for sale

3,386 

 

3,646 

 

(260)

 

(7.1)

 

Interest on federal funds sold

 

600 

 

903 

 

(303)

 

(33.6)

 

Dividends on FHLB stock

 

122 

 

144 

 

(22)

 

(15.3)

 

 

 

Total interest income

 

62,187 

 

56,294 

 

5,893 

 

10.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

22,327 

 

17,943 

 

4,384 

 

24.4 

 

Interest on retail repurchase agreements

425 

 

564 

 

(139)

 

(24.6)

 

Interest on commercial paper

 

839 

 

591 

 

248 

 

42.0 

 

Interest on other short-term borrowings

497 

 

119 

 

378 

 

317.6 

 

Interest on long-term borrowings

173 

 

479 

 

(306)

 

(63.9)

 

 

 

Total interest expense

 

24,261 

 

19,696 

 

4,565 

 

23.2 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

37,926 

 

36,598 

 

1,328 

 

3.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

1,200 

 

1,325 

 

(125)

 

(9.4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

36,726 

 

35,273 

 

1,453 

 

4.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

5,900 

 

6,023 

 

(123)

 

(2.0)

 

Fees for trust and brokerage services

2,258 

 

2,445 

 

(187)

 

(7.6)

 

Mortgage-banking income

 

987 

 

679 

 

308 

 

45.4 

 

Investment securities gains

 

- 

 

3 

 

(3)

 

(100.0)

 

Other

 

 

 

3,164 

 

2,533 

 

631 

 

24.9 

 

 

 

Total noninterest income

12,309 

 

11,683 

 

626 

 

5.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

Salaries and other personnel

 

19,234 

 

17,256 

 

1,978 

 

11.5 

 

Occupancy

 

 

1,124 

 

1,152 

 

(28)

 

(2.4)

 

Premises,		furniture, and equipment leases and rentals

946 

 

987 

 

(41)

 

(4.2)

 

Premises,		furniture, and equipment depreciation

1,478 

 

1,528 

 

(50)

 

(3.3)

 

		Other furniture and equipment

 

1,385 

 

1,408 

 

(23)

 

(1.6)

 

Loss on disposition of premises, furniture, and equipment

346 

 

- 

 

346 

 

100.0 

 

Marketing

 

 

695 

 

1,217 

 

(522)

 

(42.9)

 

Amortization of core deposit intangibles

36 

 

36 

 

- 

 

- 

 

Other

 

 

 

6,160 

 

6,592 

 

(432)

 

(6.6)

 

 

 

Total noninterest expense

31,404 

 

30,176 

 

1,228 

 

4.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

17,631 

 

16,780 

 

851 

 

5.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

5,909 

 

5,598 

 

311 

 

5.6 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

11,722 

 

11,182 

 

540 

 

4.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common and per share data

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

1.84 

 

1.76 

 

0.08 

 

4.5 

 

Net income - diluted

 

1.81 

 

1.74 

 

0.07 

 

4.0 

 

Cash dividends

 

0.57 

 

0.54 

 

0.03 

 

5.6 

 

Book value

 

 

17.02 

 

15.29 

 

1.73 

 

11.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,385,625 

 

6,351,646 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,484,293 

 

6,427,536 

 

 

 

 

 

47

 

Net Interest Income.**  The followingtable summarizes the Company’s average balance sheets and net interest incomeanalysis for the periods indicated (dollars in thousands). 

 

 

 

 

 

For the nine month periods ended September 30,

 

 

 

 

 

2007

 

2006

 

 

 

 

 

Average

Income/

Yield/

 

Average

Income/

Yield/

 

 

 

 

 

balance

expense

rate

 

balance

expense

rate

 

Assets

 

 

 

 

 

 

 

 

 

 

Interest-earnings assets

 

 

 

 

 

 

 

 

 

Loans, net of unearned (1)

$

973,358 

$

58,079 

7.98 

%

$

885,480 

$

51,601 

7.79 

%

 

Investment securities available for sale, nontaxable (2)

49,973 

1,340 

3.59 

 

55,409 

1,505 

3.63 

 

 

Investment securities available for sale, taxable (2)

57,771 

2,046 

4.74 

 

65,903 

2,141 

4.34 

 

 

Federal funds sold

15,517 

600 

5.17 

 

23,941 

903 

5.04 

 

 

FHLB stock

2,724 

122 

5.99 

 

3,043 

144 

6.33 

 

 

 

Total interest-earning assets

1,099,343 

62,187 

7.56 

 

1,033,776 

56,294 

7.28 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-earning assets

 

 

 

 

 

 

 

 

 

Cash and due from banks

30,841 

 

 

 

37,238 

 

 

 

 

Allowance for loan losses

(8,426)

 

 

 

(8,716)

 

 

 

 

Premises and equipment, net

24,861 

 

 

 

23,529 

 

 

 

 

Goodwill

3,688 

 

 

 

3,688 

 

 

 

 

Other intangible assets

109 

 

 

 

158 

 

 

 

 

Accrued interest receivable

5,975 

 

 

 

5,298 

 

 

 

 

Other

 

14,366 

 

 

 

13,066 

 

 

 

 

 

Total noninterest-earning assets

71,414 

 

 

 

74,261 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

$

1,170,757 

 

 

 

$

1,108,037 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

Transaction and money market deposit accounts

$

466,518 

$

10,488 

3.01 

%

$

377,519 

$

6,429 

2.28 

%

 

Savings deposit accounts

41,518 

106 

0.34 

 

46,007 

112 

0.33 

 

 

Time deposit accounts

357,493 

11,733 

4.39 

 

391,663 

11,402 

3.89 

 

 

 

Total interest-bearing deposits

865,529 

22,327 

3.45 

 

815,189 

17,943 

2.94 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

13,502 

425 

4.21 

 

18,492 

564 

4.08 

 

 

Commercial paper (Master notes)

26,185 

839 

4.28 

 

19,630 

591 

4.03 

 

 

Other short-term borrowings

11,932 

497 

5.57 

 

3,445 

119 

4.62 

 

 

Long-term borrowings

6,044 

173 

3.83 

 

17,810 

479 

3.60 

 

 

 

Total interest-bearing liabilities

923,192 

24,261 

3.51 

 

874,566 

19,696 

3.01 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

133,663 

 

 

 

133,317 

 

 

 

 

Accrued interest payable

2,455 

 

 

 

2,189 

 

 

 

 

Other

 

6,411 

 

 

 

4,381 

 

 

 

 

 

Total noninterest-bearing liabilities

142,529 

 

 

 

139,887 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

1,065,721 

 

 

 

1,014,453 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

105,036 

 

 

 

93,584 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,170,757 

 

 

 

$

1,108,037 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME / NET YIELD ON

 

 

 

 

 

 

 

 

 

INTEREST-EARNING ASSETS

 

$

37,926 

4.61 

%

 

$

36,598 

4.73 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Calculated including mortgage loans held for sale.  Nonaccrual loans are included in average balances for yield computations.

 

The effect of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis.  All loans

 

and deposits are domestic.

(2)

The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

48
During the nine month period ended September 30, 2007 compared with the sameperiod of 2006, the Company experienced increases in both average yields oninterest-earning assets and average cost of interest-bearing liabilities. Theaverage yield on interest-earning assets increased 28 basis points to 7.56%during the nine month period ended September 30, 2007 from 7.28% during thesame period of 2006. The average cost of interest-bearing liabilities increased50 basis points to 3.51% from 3.01% when comparing the same periods. Averageinterest-earning assets increased $65.6 million during the nine month periodended September 30, 2007 over the same period of 2006, primarily within theloan portfolio, while interest-bearing liabilities increased $48.6 million overthe same period. Rates paid during the ninemonth period ended September 30, 2007 increased from those paid for the ninemonth period ended September 30, 2006 primarily as a result of theincreases in the federal funds rate by the Federal Reserve Open MarketCommittee. 

The following rate / volumeanalysis summarizes the dollar amount of changes in interest income andinterest expense attributable to changes in volume and the amount attributableto changes in rate when comparing the nine month period ended September 30,2007 to the nine month period ended September 30, 2006 (in thousands).  The impactof the combination of rate and volume change has been divided equally betweenthe rate change and volume change.

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the nine month period ended September**

**30, 2007 compared with the nine month**

**period ended September 30, 2006**

 

 

 

**Volume**

 

**Rate**

 

**Total**

Interest-earnings assets

 

 

 

 

 

 

Loans, net of unearned

$

5,220 

 

1,258 

 

6,478 

 

Investment securities available for sale

(439)

 

179 

 

(260)

 

Federal funds sold

(327)

 

24 

 

(303)

 

FHLB stock

(14)

 

(8)

 

(22)

 

 

Total interest-earning assets

$

4,440 

 

1,453 

 

5,893 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

Interest-bearing deposits

$

1,158 

 

3,226 

 

4,384 

 

Retail repurchase agreements

(159)

 

20 

 

(139)

 

Commercial paper

208 

 

40 

 

248 

 

Other short-term borrowings

12 

 

366 

 

378 

 

Long-term borrowings

(83)

 

(223)

 

(306)

 

 

Total interest-bearing liabilities

$

1,136 

 

		3,429 

 

4,565 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME

$

3,304 

 

(1,976)

 

1,328 

 

 

 

 

 

 

 

 

 

Provisionfor Loan Losses*.*The provision for loan losses was $1.2 million and$1.3 million for the nine month periods ended September 30, 2007 and 2006.  The percentage of the Allowance to ending loans wasreduced to 0.82% of gross loans, excluding mortgage loans held for sale,outstanding at September 30, 2007 from 0.94% at September 30, 2006. See Financial Condition, LendingActivities, contained herein for a discussion regarding the Company’s accounting policies related to, factorsimpacting, and methodology for analyzing the adequacy of the Company’sAllowance and the related provision for loan losses.

 

Noninterest Income. Noninterest income during thenine month period ended September 30, 2007 increased $626 thousand, or 5.4%, to$12.3 million from $11.7 million during the nine month period ended September30, 2006 due, primarily, to increases in the mortgage-banking income and othernoninterest income financial statement line items offset by decreases in theservice charges on deposit accounts and fees for trust and brokerage servicesfinancial statement line items.   

 

Service charges on depositaccounts comprise a significant component of noninterest income and comprised51.6% of noninterest income during the nine month period ended September 30,2006 compared with 47.9% for the same period of 2007. See For the Three MonthsEnded September 30, 2007, Noninterest Income, for discussion regarding thisdeclining trend over these periods.

 

Fees for trust and brokerage services declined $187 thousandduring the nine month period ended September 30, 2007 over the same period of2006 primarily as a result of declined opportunities for estate fees.  TheBank’s Trust Department serves as executor of its customers’ estates and, assuch, administers the deceased’s estate based on his or her wishes.  Fees areearned in conjunction with the Trust Department’s services provided asexecutor.  The opportunity for such services and the resulting fees declinedfrom the nine month period ended September 30, 2006 to the same period of 2007.

 

49

 

The following table summarizes the components ofmortgage-banking income for the periods indicated (in thousands).

 
		 		 **For the nine month**		 		 		 **periods ended September 30,**		 
 

 

**2007**

**2006**

 

Mortgage-servicing fees

$

613 

580 

 

Gain on sale of loans

614 

370 

 

Mortgage-serciving right amortization, impairment, and recoveries

(360)

(429)

 

Other mortgage-banking income

120 

158 

 

 

Total mortgage-banking income

$

987 

679 

 

 

 

 

 

 

 

See For the Three Months EndedSeptember 30, 2007, Noninterest Income, for discussion regarding fluctuationsin the components of mortgage-banking income for the nine month periods endedSeptember 30, 2007 when compared with the same period of 2006.

 

See For the Three Months EndedSeptember 30, 2007, Noninterest Income, for discussion regarding increase in othernoninterest income for the nine month periods ended September 30, 2007 whencompared with the same period of 2006.

 

Noninterest Expense.  Noninterest expense during the nine month periodended September 30, 2007 increased $1.2 million, or 4.1%, to $31.4 million from$30.2 million during the nine month period ended September 30, 2006. Thisincrease resulted primarily from increases in the salaries and other personnelexpense and loss on disposition of premises, furniture, and equipment financialstatement line items slightly offset by decreases in the marketing and othernoninterest expense financial statement line items.

 

Salaries and other personnelexpense increased by $2.0 million to $19.2 million during the nine month periodended September 30, 2007 from $17.3 million during the nine month period endedSeptember 30, 2006 as a result of the same factors discussed above with regardto the fluctuation in this financial statement line item when comparing thethree month period ended September 30, 2007 to the same period of 2006. 

 

See For the Three Months EndedSeptember 30, 2007, Noninterest Expense, for discussion regarding the increasein Loss on Disposition of Premises, Furniture, and Equipment for the nine monthperiods ended September 30, 2007 when compared with the same period of 2006.

 

Marketing and advertising expense decreased $522thousand during the nine month period ended September 30, 2007 comparedwith the nine month period ended September 30, 2006 as a result of the samefactors discussed above with regard to the fluctuation in this financialstatement line item when comparing the three month period ended September 30,2007 to the same period of 2006.

 

Other noninterest expense decreased $432 thousand during thenine month period ended September 30, 2007 when compared with the same periodof 2006.  The decrease in other noninterest expense was the result of anaccumulation of changes in several accounts, none of which were determined tobe material.  

 

During the second quarter of 2006, as a result of a software upgrade, the Company experienced a temporary delay in check processing and electronic check processing.  At December 31, 2006, the Bank had exposure of, and reserved for in Other Noninterest Expense in the Consolidated Statements of Income, approximately $174 thousand related to items uncollected at that date.  At the end of the first quarter of 2007, the Bank had collected virtually all of these items.  As such, this reserve was reversed during the first quarter of 2007. As of September 30, 2007, approximately $36 thousand in check processing and electronic check processing items had been presented for which the Bank had to cover.  Inclusive of these transactions, sundry losses increased $102 thousand during the first nine months of 2007 over the same period of 2006 to a balance of $114 thousand.  Exclusive of the first quarter reversal of the 2006 reserve, sundry losses increased $276 thousand during the nine month period ended September 30, 2007 over the same period of 2006 to a balance of $288 thousand.

 

Provisionfor Income Taxes. Income tax expensetotaled $5.9 million for the nine month period ended September 30, 2007compared with $5.6 million for the nine month period ended September 30, 2006. The Company’s effective tax rate was 33.5% during the 2007 period and 33.4%during the 2006 period.  

 

*Accounting and Reporting Matters*

 

See Part I, Item1. Financial Statements, Note 1 containedherein for further discussion regarding recently adopted and recentlyissued accounting pronouncements and their expected impact on the Company.

 

50

 

Item 3.  Quantitativeand Qualitative Disclosures about Market Risk

 

The Company has risk managementpolicies and systems to monitor and limit exposure to interest rate risk.Specifically, the Company manages its exposure to fluctuations in interestrates through policies established by its Asset / Liability Committee andapproved by its Board of Directors. The primary goal of the Asset / LiabilityCommittee is to monitor and limit exposure to interest rate risk throughimplementation of various strategies. While the Asset / Liability Committeedevelops these strategies with the goal of ultimately positioning the balance sheet to minimize fluctuations inincome associated with interest rate risk, it also monitors the Company’sliquidity and capital positions to ensure that its strategies result inadequate capital positions. The Company’s primary source of capital hasbeen the retention of net income. In order to ensure adequate levels ofcapital, an ongoing assessment is conducted of projected sources and uses ofcapital in conjunction with projected increases in assets and the level ofrisk. Management believes it has adequate capital to meet its needs withoutentering capital markets.

 

Market risk sensitiveinstruments are generally defined as derivatives and other financialinstruments. At September 30, 2007, the Company had not used any derivatives toalter its interest rate risk profile. The Company’s financial instrumentsinclude loans, federal funds sold, FHLB stock, investment securities, deposits,and borrowings. At September 30, 2007, the Company’s interest-sensitive assetstotaled approximately $1.1 billion while interest-sensitive liabilities totaledapproximately $933.3 million. At December 31, 2006, the Company’sinterest-sensitive assets totaled approximately $1.1 billion whileinterest-sensitive liabilities totaled approximately $911.4 million. 

 

The yield on interest-sensitiveassets and the cost of interest-sensitive liabilities for the three monthperiod ended September 30, 2007 was 7.58% and 3.62%, respectively, compared to7.39% and 3.25%, respectively, for the same period of 2006. The yield oninterest-sensitive assets and the cost of interest-sensitive liabilities forthe nine month period ended September 30, 2007 was 7.56% and 3.51%,respectively, compared to 7.28% and 3.01%, respectively, for the same period of2006. The increase in the yield on interest-sensitive assets and the cost ofinterest-sensitive liabilities during both the three and nine month periodsended September 30, 2007 over the same periods of 2006 resulted primarily fromincreases in the federal funds rate by the Federal Reserve Open MarketCommittee. 

 

TheCompany evaluated the results of its net interest income simulation prepared asof September 30, 2007 for interest rate risk management purposes. Overall, themodel results indicate that the Company’s interest rate risk sensitivity iswithin limits set by the Company’s guidelinesand the Company’s balance sheet is liability sensitive. A liability sensitivebalance sheet suggests that in falling interest rate environment, net interestmargin would increase and during an increasing interest rate environment, netinterest margin would decrease.

 

Net Interest Income Simulation

 

The following table summarizesthe forecasted change in net interest income and net interest margin as ofSeptember 30, 2007 using a base market rate and the estimated change to thebase scenario given upward and downward movement in interest rates of 100 basispoints and 200 basis points (dollars in thousands).

 

 

 

 

 

 

**Interest rate scenario**

**Percentage**

**change from**

**current**

**projection of**

**net interest**

**income**

 

**Net**

**interest**

**margin**

**change**

**(in basis**

**points)**

 

Up 200 basis points

(8.01)

%

(0.37)

 

Up 100 basis points

(3.90)

 

(0.18)

 

BASE CASE

- 

 

- 

 

Down 100 basis points

3.39 

 

0.16 

 

Down 200 basis points

6.68 

 

0.31 

 

 

 

The simulation results as ofSeptember 30, 2007, assuming all other variables remained unchanged,  indicatethe Company’s interest rate risk position was liability sensitive as thesimulated impact of a downward movement in interest rates of 100 basis pointswould result in a 3.39% increase in net interest income over the subsequent 12month period while an upward movement in interest rates of 100 basis pointswould result in a 3.90% decrease in net interest income over the next 12months. The simulation results indicate that a 100 basis point downward shiftin interest rates would result in a 16 basis point increase in net interest margin.Conversely, a 100 basis point increase in interest rates would cause an 18basis point decrease in net interest margin. The projected negative impact onthe Company’s net interest income for the twelve month period does not exceedthe 20% threshold prescribed by the Asset – Liability Committee’s policy. 

 

51

 

**Item 4.****Controls and Procedures**

 

Evaluation ofDisclosure Controls and Procedures

 

An evaluation of the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) promulgated under the SecuritiesExchange Act of 1934) was carried out under the supervision and with theparticipation of the Company’s Chief Executive Officer, the President and ChiefOperating Officer (Principal Financial Officer) and several other members ofthe Company’s senior management as of September 30, 2007, the last day of theperiod covered by this Quarterly Report. The Company’s Chief Executive Officerand the President and Chief Operating Officer (Principal Financial Officer)concluded that the Company’s disclosure controls and procedures were effectiveas of September 30, 2007 in ensuring that the information required to bedisclosed by the Company in the reports it files or submits under theSecurities Exchange Act of 1934 is (i) accumulated and communicated to theCompany’s management (including the Chief Executive Officer and the Presidentand Chief Operating Officer (Principal Financial Officer)) in a timely manner,and is (ii) recorded, processed, summarized, and reported within the time periodsspecified in the SEC’s rules and forms.

 

During the third quarter of 2007, the Company did not make any changesin its internal controls over financial reporting that has materially affectedor is reasonably likely to materially affect those controls.

 

 

52
****
PART II – OTHERINFORMATION

 

Any item which is inapplicable or to which the answer isnegative has been omitted and no reference thereto has been made in thisreport. 

 

**Item 1.****Legal Proceedings**

 

See Part I, Item 1. FinancialStatements, Note 14 contained herein for a discussion of the informationrequired by this item.

 

**Item 6.  Exhibits**

 

31.1         L.Leon Patterson's Certification Pursuant to Section 302 of the Sarbanes-OxleyAct of 2002 

31.2         PaulW. Stringer's Certification Pursuant to Section 302 of the Sarbanes-Oxley Actof 2002 

32            Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 

 

Exhibits 31.1, 31.2, and 32 have been filed with the Securities andExchange Commission in conjunction with this Quarterly Report on Form 10-Q. Copiesof these exhibits are available upon written request to Lauren S. Greer, ThePalmetto Bank, Post Office Box 49, Laurens, South Carolina 29360.
 
 
 
53

**SIGNATURES**

 

 

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 

 

PALMETTOBANCSHARES, INC.

 

 

 

/s/     L. Leon Patterson                          

 L. LeonPatterson

 Chairman andChief Executive Officer

 

 

 

/s/     Paul W. Stringer                                         

 Paul W.Stringer

 Presidentand Chief Operating Officer

 (PrincipalFinancial Officer)

 

 

Dated:   November 9, 2007

 

 

54 |