** **

| **U. S. SECURITIES AND EXCHANGE COMMISSION**                    |
|-----------------------------------------------------------------|
| **WASHINGTON, 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 March 31, 2009 |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   | OR |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|  (  )                                                 | TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            | For the transition period from __________ to  __________ |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
| Commission file number  0-26016                            |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
| **PALMETTO BANCSHARES, INC.**                                   |
| (Exact name of  registrant as specified in its charter)         |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
| **South Carolina**                                              |   | **74-2235055** |
| (State or other  jurisdiction of incorporation or organization) |   | (IRS Employer  Identification No.) |
|                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   |
|                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   |
| **306 East North Street, Greenville, South Carolina**           |   | **29601** |
| (Address of  principal executive offices)                       |   | (Zip Code) |
| ** **                                                      |   | ** ** | ** ** | ** ** | ** ** |   |   | ** ** | ** ** | ** ** | ** ** |   |
| ** **                                                      |   | ** ** | ** ** | ** ** | ** ** |   |   | ** ** | ** ** | ** ** | ** ** |   |
| **(800) 725–2265**                                         |
| (Registrant’s  telephone number)                           |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            | Indicate by check mark  whether the registrant (1) has filed all reports required to be filed by  Section 13 or 15(d) of the Securities Exchange Act of  1934 during the preceding 12 months (or for such shorter period that the  registrant was required to file such reports), and (2)  has been subject to such filing requirements for the past 90 days. Yes [x] No  [] |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            | Indicate by check mark  whether the registrant is a large accelerated filer, an accelerated filer, a  non-accelerated filer, or a smaller reporting  company. See definitions of "large accelerated filer,"  "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the  Exchange Act. |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   | Large accelerated filer [ ] |   | Accelerated filer [x] |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   | Non-accelerated filer [ ] |   | Smaller reporting company [  ] |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            | 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 May 8, 2009 |   |   |
|                                                            |   |  ----------------------------- |   |   ------------------------------- |   |   |
|                                                            |   | Common stock, $5.00 par value |   | 6,487,630 |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |   |   |   |   |   |   |   |   |   |   |   |

 

----

 

 

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY** |
|-----------------------------------------------|
| **Table of  Contents**                        |
|                                          |   |   |   |   |   |
|                                          |   |   | Page |   |   |
|                                          |   |   |   |   |   |
| PART I - FINANCIAL INFORMATION                |   |   |   |
|                                          | Item 1. | Financial Statements |   |   |   |
|                                          | Item 2. | Management's Discussion and Analysis of Financial  Condition and | 4 |   |   |
|                                          |   |     			Results of Operations | 31 |   |   |
|                                          | Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 53 |   |   |
|                                          | Item 4. | Controls and Procedures | 54 |   |   |
|                                          |   |   |   |   |   |
| PART II - OTHER INFORMATION                   |   |   |   |
|                                          | Item 1. | Legal Proceedings | 55 |   |   |
|                                          | Item 1A. | Risk Factors | 55 |   |   |
|                                          | Item 2. | Unregistered Sales of Equity Securities and Use of  Proceeds | 56 |   |   |
|                                          | Item 3. | Defaults Upon Senior Securities | 56 |   |   |
|                                          | Item 4. | Submission of Matters to a Vote of Security Holders | 56 |   |   |
|                                          | Item 5. | Other Information | 56 |   |   |
|                                          | Item 6. | Exhibits | 56 |   |   |
|                                          |   |   |   |   |   |
| SIGNATURES                                    | 57 |   |   |
|                                          |   |   |   |   |   |

** **

2

----

 

 

 

 

 

 

 

*This Quarterly Report on Form 10-Q,including information included or incorporated by reference in this document,contains statements which constitute forward-looking statements within the meaningof Section 27A of the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934. These statements are estimatesor forecasts about Palmetto Bancshares, Inc. and our subsidiary,Palmetto Bank (the “Bank”) which includes the Bank’s brokerage subsidiary, Palmetto Capital (collectivelyreferred to as the “Company”, which may be referred to as we, us, orour), and ourmarkets based on assumptions and estimates and are not guarantees offuture performance.  Our actual results may differ materially from thoseanticipated in any forward-looking statements, as they will depend on manyfactors about which we are unsure and which are beyond our control.  The words“may,” “would,” “could,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,”and “estimate,” as well as similar expressions, are meant to identify suchforward-looking statements. *

* *

*Forward-looking statementsinvolve risks and uncertainties that may cause actual results to differmaterially from those in such statements. Refer to our Annual Report on Form10-K for the year ended December 31, 2008 for a discussion of the material risks and uncertainties that we believe may causeactual results to differ from those discussed in the forward-lookingstatements.*

* *

*We undertake no obligation to publicly update orotherwise revise any forward-looking statements, whether as a result of newinformation, future events, or otherwise.*

* *

 

 

 

 

 

 

 

3

----

 

 

 

 

 

**PART I - FINANCIAL INFORMATION**

** **

**Item 1. Financial Statements**

** **

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                          |
|------------------------------------------------------------------------|
| **Consolidated  (Interim) Balance Sheets**                             |
| **(dollars in  thousands, except common and per share data)**          |
|                                                                   |   |   |   |   |   |   |   |
| ** **                                                             |   |   |   |   | **March 31,** |   | **December 31,** |
|                                                                   |   |   |   |   | **2009** | ** ** | **2008** |
|                                                                   |   |   |   |   | (unaudited) |   |   |
| Assets                                                                 |   |   |       |   |
| Cash and cash equivalents                                              |   |   |   |   |
|                                               | Cash and due from banks |   |  $ | 67,992  |   | 29,305  |
|                                                                   | Federal funds sold |   | -    |   | -    |
|                                                                   |   | Total cash and cash equivalents | 67,992  |   | 29,305  |
|                                                                   |       |       |   |   |   |   |   |
| Federal Home Loan Bank ("FHLB") stock, at cost               | 7,010  |   | 6,566  |
| Investment securities available for sale, at fair value                | 117,961  |   | 125,596  |
| Mortgage loans held for sale                                           |   | 11,562  |   | 7,415  |
|                                                                   |   |   |   |   |   |   |   |
| Loans, gross                                                           |   | 1,156,362  |   | 1,158,480  |
|                                                                   | Less: allowance for loan losses |   | (12,606) |   | (11,000) |
|                                                                   |   | Loans, net |   | 1,143,756  |   | 1,147,480  |
|                                                                   |   |   |   |   |   |   |   |
| Premises and equipment, net                                            |   | 28,794  |   | 26,347  |
| Premises held for sale                                                 |   | -    |   | 1,651  |
| Goodwill, net                                                          |   | 3,691  |   | 3,691  |
| Core deposit intangibles, net                                          |   | 23  |   | 34  |
| Accrued interest receivable                                            |   | 5,491  |   | 5,466  |
| Other                                                                  |   | 17,290  |   | 18,724  |
|                                                                   |   |   | Total assets |   |  $ | 1,403,570  |   | 1,372,275  |
|                                                                   |   |   |   |   |   |   |   |
| Liabilities and shareholders' equity                                   |   |   |   |   |
| Liabilities                                                            |   |   |   |   |
| Deposits                                                               |   |   |   |   |
|                                                                   | Noninterest-bearing |   |  $ | 130,003  |   | 133,248  |
|                                                                   | Interest-bearing |   | 1,037,149  |   | 937,031  |
|                                                                   |   | Total deposits |   | 1,167,152  |   | 1,070,279  |
|                                                                   |   |   |   |   |   |   |   |
| Retail repurchase agreements                                           |   | 21,105  |   | 16,357  |
| Commercial paper (Master notes)                                        |   | 23,222  |   | 27,955  |
| Other short-term borrowings                                            |   | 15,403  |   | 79,785  |
| Long-term borrowings                                                   |   | 52,000  |   | 52,000  |
| Accrued interest payable                                               |   | 1,867  |   | 1,857  |
| Other                                                                  |   | 5,271  |   | 8,266  |
|                                                                   |   | Total liabilities |   | 1,286,020  |   | 1,256,499  |
|                                                                   |   |   |   |   |   |   |   |
| Shareholders' equity                                                   |   |   |   |   |
| Common stock - par value $5.00 per share;  authorized  10,000,000 |   |   |   |
|                                                                   | shares; issued and outstanding 6,487,630 and 6,446,090 |   |   |   |
|                                                                   | at March 31, 2009 and December 31, 2008, respectively | 32,260  |   | 32,230  |
| Capital surplus                                                        |   | 2,373  |   | 2,095  |
| Retained earnings                                                      |   | 89,173  |   | 87,568  |
| Accumulated other comprehensive loss, net of tax                       | (6,256) |   | (6,117) |
|                                                                   |   | Total shareholders' equity |   | 117,550  |   | 115,776  |
|                                                                   |   |   |   |   |   |   |   |
|                                                                   |   |   | Total liabilities and shareholders' equity |  $ | 1,403,570  |   | 1,372,275  |
|                                                                   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements                |

 

4

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| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                             |
|---------------------------------------------------------------------------|
| **Consolidated  Interim Statements of Income**                            |
| **(dollars in  thousands, except common and per share data) (unaudited)** |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      |   |   |   |   |   | **For the three  month periods ended March 31,** |
|                                                                      |   |   |   |   |   | **2009** | ** ** | **2008** |
| Interest income                                                           |   |   |   |   |
|                                                                      | Interest earned on cash and cash equivalents |  $ | 6  |   | 42  |
|                                                                      | Dividends paid on FHLB stock |   | -    |   | 57  |
|                                                                      | Interest earned on investment securities available for  sale |   |   |   |
|                                                                      |   | United States ("U.S.") Treasury and federal  agencies (taxable) | -    |   | 199  |
|                                                                      |   | State and municipal (nontaxable) |   | 429  |   | 459  |
|                                                                      |   | Collateralized mortgage obligations (taxable) | 841  |   | 157  |
|                                                                      |   | Other mortgage-backed (taxable) |   | 263  |   | 275  |
|                                                                      | Interest and fees earned on loans |   | 16,048  |   | 19,051  |
|                                                                      |   |   | Total interest income |   | 17,587  |   | 20,240  |
|                                                                      |   |   |   |   |   |   |   |   |
| Interest expense                                                          |   |   |   |   |
|                                                                      | Interest paid on deposits |   | 4,712  |   | 7,116  |
|                                                                      | Interest paid on retail repurchase agreements | 13  |   | 112  |
|                                                                      | Interest paid on commercial paper   |   | 15  |   | 144  |
|                                                                      | Interest paid on other short-term borrowings | 77  |   | 251  |
|                                                                      | Interest paid on long-term borrowings |   | 371  |   | 68  |
|                                                                      |   |   | Total interest expense |   | 5,188  |   | 7,691  |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      |   |   |   | Net interest income |   | 12,399  |   | 12,549  |
|                                                                      |   |   |   |   |   |   |   |   |
| Provision for loan losses                                                 |   | 2,175  |   | 488  |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      |   |   |   | Net interest income after provision for loan losses | 10,224  |   | 12,061  |
|                                                                      |   |   |   |   |   |   |   |   |
| Noninterest income                                                        |   |   |   |   |
|                                                                      | Service charges on deposit accounts, net |   | 1,884  |   | 2,167  |
|                                                                      | Fees for trust and investment management and brokerage  services | 534  |   | 756  |
|                                                                      | Mortgage-banking income |   | 865  |   | 469  |
|                                                                      | Investment securities gains |   | 2  |   | -    |
|                                                                      | Other |   | 1,146  |   | 1,513  |
|                                                                      |   |   | Total noninterest income |   | 4,431  |   | 4,905  |
|                                                                      |   |   |   |   |   |   |   |   |
| Noninterest expense                                                       |   |   |   |   |
|                                                                      | Salaries and other personnel |   | 5,862  |   | 6,195  |
|                                                                      | Occupancy |   | 916  |   | 805  |
|                                                                      | Furniture and equipment |   | 883  |   | 944  |
|                                                                      | Loss on disposition of premises, furniture, and equipment | 55  |   | -    |
|                                                                      | Marketing |   |   | 297  |   | 332  |
|                                                                      | Amortization of core deposit intangibles |   | 11  |   | 11  |
|                                                                      | Other |   | 3,514  |   | 3,096  |
|                                                                      |   |   | Total noninterest expense |   | 11,538  |   | 11,383  |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      |   |   |   | Net income before provision for income taxes | 3,117  |   | 5,583  |
|                                                                      |   |   |   |   |   |   |   |   |
| Provision for income taxes                                                |   | 1,123  |   | 1,937  |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      |   |   |   | Net income |   |  $ | 1,994  |   | 3,646  |
|                                                                      |   |   |   |   |   |   |   |   |
| Common and per share data                                                 |   |   |   |   |
|                                                                 | Net income - basic |   |  $ | 0.31  |   | 0.57  |
|                                                                      | Net income - diluted |   | 0.31  |   | 0.56  |
|                                                                      | Cash dividends |   | 0.06  |   | 0.20  |
|                                                                      | Book value |   | 18.12  |   | 17.54  |
|                                                                      |   |   |   |   |   |   |   |   |
|                                                                      | Weighted average common shares outstanding - basic | 6,448,668  |   | 6,431,172  |
|                                                                      | Weighted average common shares outstanding - diluted | 6,529,972  |   | 6,519,127  |
|                                                                      |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements                   |

** **

5

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| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                                                                               |
|-----------------------------------------------------------------------------------------------------------------------------|
| ** Consolidated  Interim Statements of Changes in Shareholders' Equity and Comprehensive  Income (Loss)**              |
| **(dollars in  thousands, except common and per share data) (unaudited)**                                                   |
|                                                                                                                        |
|                                                                                                                        |   | ** **

**Shares of**

**common**

**stock** | ** **

** **

** **

** ** | ** **

** **

**Common**

**stock** | ** **

** **

** **

** ** | ** **

** **

**Capital**

**surplus** | ** **

** **

** **

** ** | ** **

** **

**Retained**

**earnings** | ** **

** **

** **

** ** | **Accumulated**

**other**

**comprehensive**

**income (loss),  net** | ** **

** **

** **

** ** | ** **

** **

** **

**Total** |
|                                                                                                                        |   |
|                                                                                                                        |   |
|                                                                                                                        |   |
|                                                                                                                        |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at December 31, 2007                                                                                                |   | 6,421,765  |   |  $ | 32,109  |   |  $ | 1,664  |   |  $ | 79,221  |   |  $ | (2,738) |   |  $ | 110,256  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |   |   |   |   |   |   |   | 3,646  |   |   |   | 3,646  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Other comprehensive income (loss), net of tax                                                                               |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
|      Investment securities available for sale                                                           |   |   |   |   |   |   |   |   |   |   |   |
|           Change in unrealized position during the period,  net                |   |   |   |   |   |   |   |   |   |   |   |
|                of tax impact of $276                  |   |   |   |   |   |   |   |   |   | 445  |   |   |
|           Reclassification adjustment included                                 |   |   |   |   |   |   |   |   |   |   |   |
|                in net income, net of tax impact of $0 |   |   |   |   |   |   |   |   | -    |   |   |
|      Net unrealized gain on investment securities  available for sale                                   |   |   |   |   |   |   |   |   |   |   | 445  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
|      Defined benefit pension plan                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |
|           Impact of FASB No. 158, net of tax impact of  $186                   |   |   |   |   |   |   |   |   | (345) |   | (345) |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Comprehensive income                                                                                                        |   |   |   |   |   |   |   |   |   |   |   | 3,746  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative effect of adoption of new accounting standard                                                                    |   |   |   |   |   |   |   |   |   |   |   |
|      Emerging Issues Task Force ("EITF") No.  06-10                                           |   |   |   |   |   |   | (99) |   |   |   | (99) |
| Cash dividend declared and paid ($0.20 per share)                                                                           |   |   |   |   |   |   | (1,287) |   |   |   | (1,287) |
| Compensation expense related to stock option plan                                                                           |   |   |   |   | 23  |   |   |   |   |   | 23  |
| Income tax benefits from exercises of nonqualified stock		options    in excess of amount previously provided |   |   |   |   | 78  |   |   |   |   |   | 78  |
| Common stock issued pursuant to stock option plan                                                                           | 11,000  |   | 55  |   | 64  |   |   |   |   |   | 119  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at March 31, 2008                                                                                                   |   | 6,432,765  |   |  $ | 32,164  |   |  $ | 1,829  |   |  $ | 81,481  |   |  $ | (2,638) |   |  $ | 112,836  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31, 2008                                                                                                |   | 6,446,090  |   |  $ | 32,230  |   |  $ | 2,095  |   |  $ | 87,568  |   |  $ | (6,117) |   |  $ | 115,776  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                                  |   |   |   |   |   |   |   | 1,994  |   |   |   | 1,994  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Other comprehensive income (loss), net of tax                                                                               |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
|      Investment securities available for sale                                                           |   |   |   |   |   |   |   |   |   |   |   |
|           Change in unrealized position during the period,  net                |   |   |   |   |   |   |   |   |   |   |   |
|                of tax impact of $84                   |   |   |   |   |   |   |   |   |   | (138) |   |   |
|           Reclassification adjustment included                                 |   |   |   |   |   |   |   |   |   |   |   |
|                in net income, net of tax impact of $1 |   |   |   |   |   |   |   |   | (1) |   |   |
|      Net unrealized loss on investment securities  available for sale                                   |   |   |   |   |   |   |   |   |   |   | (139) |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Comprehensive income                                                                                                        |   |   |   |   |   |   |   |   |   |   |   | 1,855  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash dividend declared and paid ($0.06 per share)                                                                           |   |   |   |   |   |   | (389) |   |   |   | (389) |
| Compensation expense related to stock option plan                                                                           |   |   |   |   | 16  |   |   |   |   |   | 16  |
| Income tax benefits from exercises of nonqualified stock                                                                    |   |   |   |   |   |   |   |   |   |   |   |
|      options in excess of amount previously provided                                                    |   |   |   |   | 107  |   |   |   |   |   | 107  |
| Common stock issued pursuant to stock option plan                                                                           | 4,000  |   | 20  |   | 86  |   |   |   |   |   | 106  |
| Common stock issued pursuant to restricted stock plan                                                                       | 37,540  |   | 10  |   | 69  |   |   |   |   |   | 79  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at March 31, 2009                                                                                                   |   | 6,487,630  |   |  $ | 32,260  |   |  $ | 2,373  |   |  $ | 89,173  |   |  $ | (6,256) |   |  $ | 117,550  |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements                                                                     |
|                                                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |

 

 

6

----

 

 

 

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY			Consolidated  Interim Statements of Cash Flows 			(in thousands)** |
|------------------------------------------------------------------------------------------------------------------|
|                                                                                                             |   |   |   | **For the three months ended March 31,** |
|                                                                                                             |   |   |   | **2009** | ** ** | **2008** |
|                                                                                                             |   |   |   | (unaudited) |
| Operating activities                                                                                             |   |   |   |
|                                                                                                             | Net income |  $ | 1,994  |   | 3,646  |
|                                                                                                             | Adjustments to reconcile net income to net cash provided  by operating activities |   |   |   |
|                                                                                                             |   | Depreciation | 570  |   | 482  |
|                                                                                                             |   | Loss on dispositions of premises, furniture, and equipment | 47  |   | -    |
|                                                                                                             |   | Loss on dispositions of premises held for sale | 8  |   | -    |
|                                                                                                             |   | Amortization of core deposit intangibles | 11  |   | 11  |
|                                                                                                             |   | Amortization of unearned discounts / premiums on  investment securities available for sale, net | 27  |   | 69  |
|                                                                                                             |   | Investment securities gains | (2) |   | -    |
|                                                                                                             |   | Provision for loan losses | 2,175  |   | 488  |
|                                                                                                             |   | Originations of mortgage loans held for sale | (52,276) |   | (19,120) |
|                                                                                                             |   | Proceeds from sale of mortgage loans held for sale | 53,432  |   | 14,043  |
|                                                                                                             |   | Gains on sales of mortgage loans held for sale, net | (522) |   | (189) |
|                                                                                                             |   | Writedowns and losses on sales of real estate acquired in  settlement of loans | 19  |   | 70  |
|                                                                                                             |   | Compensation expense related to stock options granted | 16  |   | 23  |
|                                                                                                             |   | Income tax benefits from exercises of nonqualified			stock options in excess of amount previously provided | 107  |   | 78  |
|                                                                                                             |   | Decrease in interest receivable and other assets, net | 464  |   | 301  |
|                                                                                                             |   | Decrease in accrued interest payable and other  liabilities, net | (1,903) |   | (357) |
|                                                                                                             |   |   | Net cash provided by (used in) operating activities | 4,167  |   | (455) |
|                                                                                                             |   |   |   |   |   |   |
| Investing activities                                                                                             |   |   |   |
|                                                                                                             | Proceeds from maturities, calls, and paydowns of  investment securities available for sale | 7,386  |   | 13,832  |
|                                                                                                             | Purchases of investment securities available for sale | -    |   | (44,615) |
|                                                                                                             | Purchases of FHLB stock | (1,344) |   | (2,576) |
|                                                                                                             | Redemptions of FHLB stock | 900  |   | 405  |
|                                                                                                             | Increase in loans, net | (3,505) |   | (28,865) |
|                                                                                                             | Proceeds on sale of real estate acquired in settlement of  loans | 202  |   | 105  |
|                                                                                                             | Proceeds on sale of premises held for sale | 1,643  |   | -    |
|                                                                                                             | Purchases of premises and equipment, net | (3,064) |   | (1,446) |
|                                                                                                             |   |   | Net cash provided by (used in) investing activities | 2,218  |   | (63,160) |
|                                                                                                             |   |   |   |   |   |   |
| Financing activities                                                                                             |   |   |   |
|                                                                                                             | (Decrease) increase in transaction, money market, and  savings deposit accounts, net | (19,248) |   | 2,567  |
|                                                                                                             | Increase (decrease) in time deposit accounts, net | 116,121  |   | (6,187) |
|                                                                                                             | Increase in retail repurchase agreements, net | 4,748  |   | 4,518  |
|                                                                                                             | (Decrease) increase in commercial paper, net | (4,733) |   | 3,099  |
|                                                                                                             | (Decrease) increase in other short-term borrowings | (64,382) |   | 7,500  |
|                                                                                                             | Increase in long-term borrowings | -    |   | 35,000  |
|                                                                                                             | Proceeds from exercise of stock options | 185  |   | 119  |
|                                                                                                             | Cash dividends paid on common stock | (389) |   | (1,287) |
|                                                                                                             |   |   | Net cash provided by financing activities | 32,302  |   | 45,329  |
|                                                                                                             |   |   |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                                             | 38,687  |   | (18,286) |
| Cash and cash equivalents, beginning of period                                                                   | 29,305  |   | 52,232  |
| Cash and cash equivalents, end of period                                                                         |  $ | 67,992  |   | 33,946  |
|                                                                                                             |   |   |   |   |   |   |
| Supplemental cash flow disclosures                                                                               |   |   |   |
|                                                                                                             | Cash paid during the period for: |   |   |   |
|                                                                                                             |   | Interest expense |  $ | 5,178  |   | 7,817  |
|                                                                                                             |   | Income taxes | 1,510  |   | 2,212  |
|                                                                                                             | Significant noncash activities |   |   |   |
|                                                                                                             |   | Net unrealized (losses) gains on investment securities  available for sale, net of tax |  $ | (139) |   | 445  |
|                                                                                                             |   | Loans transferred to real estate acquired in settlement of  loans, at fair value | 273  |   | 392  |
|                                                                                                             |   | Premises reclassified as held for sale, at fair value | -    |   | -    |
|                                                                                                             |   | Net unrealized (losses) gains on pension plan assets, net  of tax | -    |   | (345) |
|                                                                                                             |   | Impact of defined benefit pension plan curtailment, net of  tax | -    |   | -    |
|                                                                                                             |   | Loans transferred from held for investment portfolio to  held for sale portfolio | 4,781  |   | -    |
|                                                                                                             |   |   |   |   |   |   |
| See Notes to  Consolidated Interim Financial Statements                                                          |

7

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**PALMETTOBANCSHARES, INC. AND SUBSIDIARY**

**Notes ToConsolidated Interim Financial Statements**

** **

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

 

*Natureof Operations*

* *

PalmettoBancshares, Inc. (the “Company”, which may be referred to as we, us, or our) is a regional bank holding company organized in1982 under the laws of South Carolina currently headquartered in Greenville,South Carolina.  Palmetto Bancshares provides, through our subsidiary, the PalmettoBank (the “Bank”), and the Bank's wholly ownedsubsidiary, Palmetto Capital, a broad array of commercial banking, consumerbanking, trust and investment management, and brokerage services throughout ourmarket area primarily within northwest South Carolina.

* *

*Principles of Consolidation / Basis ofPresentation   *

*** ***

The accompanying ConsolidatedInterim Financial Statements include the accounts of the Company.  Inmanagement’s opinion, all significantintercompany accounts and transactions have been eliminated in consolidation,and all adjustments necessary for a fair presentation of the financialcondition and results of operations for periods presented have been included.Any such adjustments are of a normal and recurring nature.  Assets thatwe hold in a fiduciary or agency capacity for customers are not included in ourConsolidated Interim Financial Statements becausethose items do not represent assets of the Company.  Our accounting andfinancial reporting policies conform, in all material respects, to accountingprinciples generally accepted in the United States of America and to generalpractices within the financial services industry. 

 

The Consolidated InterimFinancial Statements contained in this Quarterly Report on Form 10-Qhave not been audited by our independent registered public accounting firm, butin the opinion of management, reflect all adjustments necessary for a fairpresentation of our financial position and results of operations. All suchadjustments were of a normal and recurring nature, unless otherwise disclosed.The Consolidated Interim FinancialStatements have been prepared in accordance with accounting principlesgenerally accepted in the United States for interim financial information andwith the instructions to Form 10-Q adopted by the Securities and ExchangeCommission (“SEC”). Accordingly, the ConsolidatedInterim Financial Statements do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements and should be read in conjunction withthe Consolidated Financial Statements,and notes thereto, for the year ended December 31, 2008, included in theCompany’s Annual Report on Form 10-K. Operating results for the interim periodsdisclosed herein are not necessarily indicative of the results that may beexpected for a full year or any future period.

 

##### Business Segments

 

Operating segments are components of an enterprise aboutwhich separate financial information is available that are evaluated regularlyby the chief operating decision makers in deciding how to allocate resourcesand assess performance.  Asof and since March 31, 2009, we have madeno changes to our determination in the Annual Report on Form 10-K for the yearended December 31, 2008 that we had one reportable operating segment,  banking.

* *

*Use of Estimates*

* *

In preparing the ConsolidatedInterim Financial Statements, we make estimates and assumptions that impact thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities as of the date of the Consolidated Interim FinancialStatements for the years presented.  Actual results could differ fromthese estimates and assumptions.  Therefore, the results of operations for the quarterended March 31, 2009 are not necessarily indicative of the results ofoperations that may be expected in future periods.

 

#####  

* *

8

----

 

 

 

 

 

*Reclassifications*

 

Certain amounts previously presented in our Consolidated Interim Financial Statements andConsolidated Financial Statements for prior periods have beenreclassified to conform to current classifications.  All such reclassificationshad no impact on the prior periods’ net income or retained earnings aspreviously reported. 

 

Balance Sheet.  The following table summarizes the Consolidated Balance Sheet atDecember 31, 2008, as then reported, prior to reclassifications (in thousands).

 

|                                                                                       |                                                |                                                |                                                           |                  |            |   |   |
|--------------------------------------------------------------------------------------------|-----------------------------------------------------|-----------------------------------------------------|----------------------------------------------------------------|-----------------------|-----------------|--------|--------|
| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY**                           |                                                |                                                |
| **Consolidated Balance Sheet**                                                   |                                                |                                                |
| **(in thousands)**                                                                    |                                                |                                                |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
|                                                                                       |                                                |                                                |                                                           | **December 31,** |            |   |
|                                                                                       |                                                |                                                |                                                           | **2008**              |            |   |
|                                                                             |                                      |                                      |                                                           |                  |            |   |
| Assets                                                                                     |                                                |                                                |                                                           |
| Cash and cash equivalents                                                   |                                                |                                                |                                                           |
|                                                                                       | Cash and due from banks         | $                                                   | 29,305                                                    |                  |            |
|                                                                                       | Federal funds sold                        | -                                              |                                                           |                  |
|                                                                                       |                                                | Total cash and cash equivalents | 29,305                                                    |                  |            |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| FHLB stock, at cost                                                         | 6,566                                          |                                                |                                                           |
| Investment securities available for sale, at fair value | 125,596                                        |                                                |                                                           |
| Mortgage loans held for sale                                           | 7,415                                          |                                                |                                                           |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| Loans, gross                                                                          | 1,158,480                                      |                                                |                                                           |
|                                                                                       | Less: allowance for loan losses | (11,000)                                            |                                                           |                  |
|                                                                                       |                                                | Loans, net                                     | 1,147,480                                                 |                  |            |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| Premises and equipment, net                                                 | 26,347                                         |                                                |                                                           |
| Premises held for sale                                                      | 1,651                                          |                                                |                                                           |
| Goodwill, net                                                                         | 3,691                                          |                                                |                                                           |
| Core deposit intangibles, net                                               | 34                                             |                                                |                                                           |
| Accrued interest receivable                                                      | 5,466                                          |                                                |                                                           |
| Other                                                                                      | 16,449                                         |                                                |                                                           |
|                                                                                       |                                                |                                                | Total assets                                              | $                     | 1,370,000  |   |   |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| Liabilities and shareholders' equity                                        |                                                |                                                |                                                           |
| Liabilities                                                                                |                                                |                                                |                                                           |
| Deposits                                                                                   |                                                |                                                |                                                           |
|                                                                                       | Noninterest-bearing                                 | $                                                   | 133,248                                                   |                  |            |
|                                                                                       | Interest-bearing                                    | 937,031                                        |                                                           |                  |
|                                                                                       |                                                | Total deposits                                 | 1,070,279                                                 |                  |            |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| Retail repurchase agreements                                                     | 16,357                                         |                                                |                                                           |
| Commercial paper (Master notes)                                             | 27,955                                         |                                                |                                                           |
| Other short-term borrowings                                                      | 79,785                                         |                                                |                                                           |
| Long-term borrowings                                                                  | 52,000                                         |                                                |                                                           |
| Accrued interest payable                                                         | 1,857                                          |                                                |                                                           |
| Other                                                                                      | 5,991                                          |                                                |                                                           |
|                                                                                       |                                                | Total liabilities                              | 1,254,224                                                 |                  |            |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
| Shareholders' equity                                                                  |                                                |                                                |                                                           |
| Common stock                                                                          | 32,230                                         |                                                |                                                           |
| Capital surplus                                                                       | 2,095                                          |                                                |                                                           |
| Retained earnings                                                                     | 87,568                                         |                                                |                                                           |
| Accumulated other comprehensive loss, net of tax             | (6,117)                                             |                                                |                                                           |
|                                                                                       |                                                | Total shareholders' equity                | 115,776                                                   |                  |            |
|                                                                                       |                                                |                                                |                                                           |                  |            |   |
|                                                                                       |                                                |                                                | Total liabilities and shareholders' equity | $                     | 1,370,000  |   |   |

 

 

Included within the other assets and other liabilities financialstatement line items in the Consolidated Balance Sheet for the year endedDecember 31, 2008 were negative balance accounts.  In an effort to provide moretransparent information to the readers of our financial statements, thesenegative balances were reclassified to their normal balance position for theMarch 31, 2009 Consolidated (Interim) Balance Sheets.  

 

 

9

----

 

 

 

 

 

Statement of Income.  The following table summarizes the Consolidated Interim Statement ofIncome for the period ended March 31, 2008, as then reported, prior toreclassifications (in thousands).

 

| **PALMETTO BANCSHARES, INC. AND SUBSIDIARY** |
|------------------------------------------------------------------|
| **Consolidated Interim Statement of Income** |
| **(in thousands)**                                          |
|                                                             |   |   |   |   |   |   |
|                                                             |   |   |   |   | **For the three month		period ended 		March 31,**
 

 

 

 

 

**2008**

		     

 

 

		     

 

 

Interest income

 

 

Interest earned and fees on loans

$

19,051 

 

Interest earned on investment securities available for sale

1,090 

 

Dividends paid on FHLB stock

57 

 

Interest earned on federal funds sold

37 

 

Interest earned on cash and due from banks

5 

 

 

 

Total interest income

20,240 

 

 

 

 

 

 

Interest expense

 

 

Interest paid on deposits

7,116 

 

Interest paid on retail repurchase agreements

112 

 

Interest paid on commercial paper

144 

 

Interest paid on other short-term borrowings

251 

 

Interest paid on long-term borrowings

68 

 

 

 

Total interest expense

7,691 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,549 

 

 

 

 

 

 

Provision for loan losses

488 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,061 

 

 

 

 

 

 

Noninterest income

 

 

Service charges on deposit accounts

2,167 

 

Fees for trust and investment management and brokerage services

756 

 

Mortgage-banking income

253 

 

Other

1,513 

 

 

 

Total noninterest income

4,689 

 

 

 

 

 

 

Noninterest expense

 

 

Salaries and other personnel

6,195 

 

Occupancy

421 

 

Furniture and equipment

1,328 

 

Marketing

332 

 

Amortization of core deposit intangibles

11 

 

Other

2,880 

 

		   

		     

Total noninterest expense

11,167 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

5,583 

 

 

 

 

 

 

Provision for income taxes

1,937 

 

 

 

 

 

 

 

 

 

 

Net income

$

3,646 

 

Within this Quarterly Report on Form 10-Q, in an effort toprovide more transparent information to readers of our financial statements, wereclassified certain expenses relating to our mortgage-servicing rightsportfolio.  For periods that ended prior to December 31, 2008, such amountswere reported net of mortgage-banking income within the noninterest incomesection on the Consolidated Interim Statements of Income.  Within this QuarterlyReport on Form 10-Q for the period ended March 31, 2009, such expenses havebeen reclassified, resulting in prior period reclassifications, and arereported gross within the other noninterest expense financial statement lineitem within the Consolidated Interim Statements of Income.  

 

Additionally, balances previously reported within the furnitureand equipment financial statement line item within the noninterest expensesection of the Consolidated Interim Statements of Income were reclassified to theoccupancy financial statement line item also within noninterest expense formore appropriate comparative purposes.  The aggregate balance of these twoaccounts remains unchanged.  

 

Statement of Cash Flows. Duringthe first quarter of 2008, the clearing account in which mortgage loan salesproceeds are recorded until the paperwork is processed was reported withinother in the assets section of the Consolidated (Interim) Balance Sheet.  Duringthe second quarter of 2008, the clearing account began being offset againstmortgage loans held for sale.  Within this Quarterly Report on 10-Q, priorperiod balances have been reclassified and are reported within mortgage loansheld for sale.  This reclassification impacted the reporting of cash flowsrelative to mortgage loans held for sale for the three month period ended March 31, 2008.

 

 

10

 

 

 

 

 

*Recently Adopted Accounting Pronouncements*

 

Following is a summary of applicable accountingpronouncements adopted by the Company during the three month period ended March31, 2009.

 

In December 2007, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 141(R), “Business Combinations,” which replaces SFAS No.141, “Business Combinations.” SFAS No. 141(R) establishes principles andrequirements for how an acquirer in a business combination recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any controlling interest, recognizes and measuresgoodwill acquired in the business combination or a gain from a bargainpurchase, and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial impacts of thebusiness combination. SFAS No. 141(R) is effective for our acquisitions takingplace on or after January 1, 2009.  We will assess the impact SFAS No. 141(R)would have on our financial position, results of operations, or cash flows ifand when a future acquisition occurs.

 

InDecember 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests inConsolidated Financial Statements – an amendment of Accounting ResearchBulletin ("ARB") No. 51.” SFAS No. 160 establishes new accounting and reportingstandards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary. Before this statement, limited guidanceexisted for reporting noncontrolling interests (minority interest). As aresult, diversity in practice existed. In some cases, minority interest wasreported as a liability and in others it was reported in the mezzanine sectionbetween liabilities and equity. Specifically, SFAS No. 160 requires therecognition of a noncontrolling interest (minority interest) as equity in theconsolidated financials statements and separate from the parent’s equity. Theamount of net income attributable to the noncontrolling interest is to beincluded in consolidated net income on the face of the income statement. SFASNo. 160 clarifies that changes in a parent’s ownership interest in a subsidiarythat do not result in deconsolidation are equity transactions if the parentretains its controlling financial interest. In addition, this statementrequires that a parent recognize gain or loss in net income when a subsidiaryis deconsolidated. Such gain or loss will be measured using the fair value ofthe noncontrolling equity investment on the deconsolidation date. SFAS No. 160also includes expanded disclosure requirements regarding the interests of theparent and its noncontrolling interests. SFAS No. 160 was adopted on January 1,2009.  The adoption of SFAS No. 160 did not have a material impact on ourfinancial position, results of operations, or cash flows.  

 

InFebruary 2008, the FASB issued FASB Staff Position ("FSP") No. 140-3, “Accounting for Transfers ofFinancial Assets and Repurchase Financing Transactions.”  FSP No. 140-3provides guidance on accounting for a transfer of a financial asset and thetransferor’s repurchase financing of the asset and presumes that an initialtransfer of a financial asset and a repurchase financing are considered part ofthe same arrangement (linked transaction) under SFAS No. 140, “Accounting forTransfers and Servicing of Financial Assets and Extinguishments ofLiabilities-a replacement of FASB Statement No. 125.” However, if certaincriteria are met, the initial transfer and repurchase financing are not to beevaluated as a linked transaction but are to be evaluated separately under SFASNo. 140.  FSP No. 140-3 was effective for financial statements issued forfiscal years beginning after November 15, 2008 and interim periods within thosefiscal years. As such, FSP No. 140-3 was adopted on January 1, 2009.  Theadoption of FSP No. 140-3 did not have a material impact on our financialposition, results of operations, or cash flows.  

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities—an amendment of FASB StatementNo. 133,” which requires enhanced disclosures about an entity’s derivative andhedging activities and thereby improves the transparency of financialreporting.  It is intended to enhance the disclosure framework in SFAS No. 133by requiring that objectives for using derivative instruments be disclosed interms of underlying risk and accounting designation.  This disclosure isintended to convey the purpose of derivative use in terms of the risks that theentity is intending to manage.  SFAS No. 161 was effective for financialstatements issued for fiscal years beginning after November 15, 2008 andinterim periods within those fiscal years. As such, we adopted SFAS No.161 on January 1, 2009. Because SFAS No. 161 amends only the disclosurerequirements for derivative instruments and hedged items, its adoption did nothave a material impact on our financial position, results of operations, orcash flows.  

 

InApril 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life ofIntangible Assets.”  FSP No. 142-3 amends the factors that should be consideredin developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under SFAS No. 142.  FSP No. 142-3 is intended to improve theconsistency between the useful life of a recognized intangible asset under SFASNo. 142 and the period of expected cash flows used to measure the fair value ofthe asset under SFAS No. 141(R)**and other U.S. generally acceptedaccounting principles.  FSPNo. 142-3 was effective for financial statements issued for fiscal yearsbeginning after December 15, 2008 and interim periods within those fiscalyears. As such, weadopted FSP No. 142-3 on January 1, 2009.  The adoption of FSP No. 142-3 did nothave a material impact on our financial position, results of operations, orcash flows.  

 

 

11

 

 

 

 

 

InMay 2008, the FASB issued FSP Accounting Principles Board (“APB”) No. 14-1,“Accounting for Convertible Debt Instruments That May Be Settled in Cash uponConversion (Including Partial Cash Settlement).”  The Staff Position specifiesthat issuers of convertible debt instruments that may be settled in cash uponconversion should separately account for the liability and equity components ina manner that will reflect the entity’s nonconvertible debt borrowing rate wheninterest cost is recognized in subsequent periods.  FSP APB No. 14-1 providesguidance for initial and subsequent measurement as well as derecognitionprovisions.  FSP APB No. 14-1 was effective for financial statements issued for fiscalyears beginning after December 15, 2008 and interim periods within those fiscalyears. As such, weadopted the Staff Position on January 1, 2009.  Its adoption did nothave a material impact on our financial position, results of operations, orcash flows.  

 

InJune 2008, the FASB issued FSP EITF No. 03-6-1, “Determining Whether Instruments Grantedin Share-Based Payment Transactions are Participating Securities.” The Staff Positionprovides that unvested share-based payment awards that contain nonforfeitablerights to dividends or dividend equivalents are participating securities andmust be included in the income per share computation.  FSP EITF No. 03-6-1 was adopted on January 1, 2009. The adoption of FSP EITFNo. 03-6-1 did not have a material impact on our financial position, results ofoperations, or cash flows.  

 

In September 2008, the FASB issued SFAS No. 133-1 and FASBInterpretation (“FIN”) No. 45-4, “Disclosures about Credit Derivatives andCertain Guarantees: An Amendment of FASB Statement No. 133 and FASBInterpretation No. 45; and Clarification of the Effective Date of FASBStatement No. 161.”  The Staff Position is effective for reporting periods(annual or interim) ending after November 15, 2008.  FSP No. 133-1 and FINNo. 45-4 amends SFAS No. 133 to require the seller of credit derivatives todisclose the nature of the credit derivative, the maximum potential amount offuture payments, fair value of the derivative, and the nature of any recourseprovisions.  Disclosures must be made for entire hybrid instruments that haveembedded credit derivatives.  The Staff Position also amends FIN No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness to Others,” to require disclosure of the currentstatus of the payment / performance risk of the credit derivative guarantee. If an entity utilizes internal groupings as a basis for the risk, how thegroupings are determined must be disclosed as well as how the risk is managed. The Staff Position encourages that the amendments be applied in periods earlierthat the effective date to facilitate comparisons at initial adoption.  Afterinitial adoption, comparative disclosures are required only for subsequentperiods.  FSP No. 133-1 and FIN No. 45-4 clarifies the effective date ofSFAS No. 161 such that required disclosures should be provided for anyreporting period (annual or interim) beginning after November 15, 2008.  Weadopted FSP SFAS No. 133-1 and FIN No. 45-4 on January 1, 2009.  Thesepronouncements amend only the disclosure requirements for credit derivativesand certain guarantees.   Therefore, the adoption of FSP SFAS No. 133-1 and FINNo. 45-4 did not have a material impact on our financial position, results ofoperations, or cash flows.  

 

In January 2009, the FASB issued FSP EITFNo. 99-20-1,“Amendments to the Impairment Guidance of EITF Issue No. 99-20.”  Prior to theFSP, other-than-temporary impairment was determined by using either EITF IssueNo. 99-20, “Recognition of Interest Income and Impairment on PurchasedBeneficial Interests and Beneficial Interests that Continue to be Held by aTransferor in Securitized Financial Assets,” or SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities,” depending onthe type of security. EITF No. 99-20 required the use of market participantassumptions regarding future cash flows regarding the probability of collectingall cash flows previously projected. SFAS No. 115 determined impairment to be other-than-temporary if it was probable that the holder would be unable to collectall amounts due according to the contractual terms. To achieve a moreconsistent determination of other-than-temporary impairment, the FSP amendsEITF No. 99-20 to determine any other-than-temporary impairment based on theguidance in SFAS No. 115, allowing management to use more judgment in determiningany other-than-temporary impairment. The FSP was effective for reporting periodsending after December 15, 2008. We have reviewed our security portfolio andevaluated the portfolio for any other-than-temporary impairments.  Itsadoption did not have a material impact on our financialposition, results of operations, or cash flows.  

 

InApril 2009, the FASB issued FSP SFAS 141(R)-1, “Accounting for Assets Acquiredand LiabilitiesAssumed in a Business Combination That Arise from Contingencies.” The StaffPosition requires that assets acquired and liabilities assumed in a businesscombination that arise from a contingency be recognized at fair value. If fairvalue cannot be determined during the measurement period as determined in SFASNo. 141(R), the asset or liability can still be recognized if it can be determinedthat it is probable that the asset existed or the liability had been incurredas of the measurement date and if the amount of the asset or liability can bereasonably estimated. If it is not determined to be probable that the asset /liability existed / was incurred or no reasonable amount can be determined, noasset or liability is recognized. Each entity should determine a rational basisfor subsequently measuring the acquired assets and assumed liabilities.Contingent consideration agreements should be recognized initially at fairvalue and subsequently reevaluated in accordance with guidance found inparagraph 65 of SFAS No. 141(R). The Staff Position was effective for businesscombinations with an acquisition date on or after the beginning of our firstannual reporting period beginning on or after December 15, 2008. We will assessthe impact FSP SFAS No. 141(R)-1 would have on our financial condition, resultsof operations, or cash flows if and when a future acquisition occurs.

 

12

 

 

 

 

 

Alsoin April 2009, the SEC issued StaffAccounting Bulletin (“SAB”) No. 111 to amend Topic 5.M., “Other Than TemporaryImpairment of Certain Investments in Debt and Equity Securities” and tosupplement FSP SFAS No. 115-2 and SFAS No. 124-2.  SAB  No. 111 maintains the staff’sprevious views related to equity securities; however debt securities areexcluded from its scope.  The SAB provides that other-than-temporaryimpairment is not necessarily the same as permanent impairment and unlessevidence exists to support a value equal to or greater than the carrying valueof the equity security investment, a writedown to fair value should berecorded and accounted for as a realized loss. The SAB was effective uponissuance, and its adoption had no impact on our financialposition, results of operations, or cash flows.

 

*Recently Issued Applicable Accounting Pronouncements*

 

In February 2008, the FASB issuedFSP No. 157-2, “Effective Date of FASB Statement No.157,” which delayed the effective date of SFAS No. 157, “Fair ValueMeasurements,” for nonrecurring, nonfinancial instruments to fiscal yearsbeginning after November 15, 2008. Therefore, these disclosurerequirements will be required in our 2009 annual reporting.  Because SFAS No.157 provides guidance and amends only the disclosure requirements for fairvalue measurements, we do not anticipate that its adoption will have a materialimpact on our financial position, results of operations, or cash flows.

 

In December 2008, the FASB issued FSP SFAS No. 132(R)-1,“Employers’ Disclosures about Postretirement Benefit Plan Assets.” The StaffPosition provides guidance on an employer’s disclosures about plan assets of adefined benefit pension or other postretirement plan to provide the users offinancial statements with an understanding of: (a) how investment allocationdecisions are made, including the factors that are pertinent to anunderstanding of investment policies and strategies; (b) the major categoriesof plan assets; (c) the inputs and valuation techniques used to measure thefair value of plan assets; (d) the effect of fair value measurements usingsignificant unobservable inputs (Level 3) on changes in plan assets for theperiod; and (e) significant concentrations of risk within plan assets.  FSPSFAS No. 132(R)-1is effective for fiscal years ending after December 15, 2009. Therefore, these disclosure requirements will be required in the Company’s 2009annual reporting.  The Staff Position will require us to provide additionaldisclosures related it to our benefit plans.  However, because suchpronouncements amend only the disclosure requirements for plan assets of adefined benefit pension or other postretirement plan, we do not anticipate thatits adoption will have a material impact on our financial position, results ofoperations, or cash flows.  

 

In April 2009, the FASB issued FSPSFAS 115-2 and SFAS 124-2, “Recognition and Presentation ofOther-Than-Temporary Impairments,” which categorize losses on debt securitiesavailable-for sale or held-to-maturity determined by management to beother-than-temporarily impaired into losses due to credit issues and lossesrelated to all other factors. Other-than-temporary impairment ("OTTI") exists whenit is more likely than not that the security will mature or be sold before itsamortized cost basis can be recovered. An OTTI related to credit losses shouldbe recognized through earnings. An OTTI related to other factors should berecognized in other comprehensive income. The FSP does not amend existing recognitionand measurement guidance related to other-than-temporary impairments of equitysecurities.  Annual disclosures required in SFAS No. 115 and FSP SFAS No. 115-1 andSFAS No. 124-1, "The Meaning of Other-than-Temporary Impairment and itsApplication to Certain Investments" are also required for interim periods (including the aging ofsecurities with unrealized losses).  FSP SFAS No. 115-2 and SFAS No. 124-2 areeffective for periods ending after June 15, 2009, with early adoption permittedfor periods ending after March 15, 2009. We will adopt the staff position duringthe second quarter of 2009 but do not anticipate its adoption will have a materialimpact on our financial position, results of operations, or cash flows. 

 

 

13

 

 

 

 

 

In April 2009, the FASB issued FSPSFAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity forthe Asset or Liability Have Significantly Decreased and IdentifyingTransactions that are Not Orderly.”  The Staff Position recognizes that quotedprices may not be determinative of fair value when the volume and level of tradingactivity has significantly decreased. The evaluation of certain factors maynecessitate that fair value be determined using a different valuationtechnique. Fair value should be the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction, not a forcedliquidation or distressed sale. If a transaction is considered to not beorderly, little, if any, weight should be placed on the transaction price. Ifthere is not sufficient information to conclude as to whether or not thetransaction is orderly, the transaction price should be considered whenestimating fair value. An entity’s intention to hold an asset or liability isnot relevant in determining fair value. Quoted prices provided by pricing servicesmay still be used when estimating fair value in accordance with SFAS No. 157;however, the entity should evaluate whether the quoted prices are based oncurrent information and orderly transactions.  Inputs and valuation techniquesare required to be disclosed in addition to any changes in valuation techniques.  FSP SFASNo. 157-4 is effective for periods ending after June 15, 2009, with earlyadoption permitted for periods ending after March 15, 2009. We will adopt the staffposition during the second quarter of 2009 but do not anticipate that itsadoption will have a material impact on our financial condition, results ofoperations, or cash flows.  

 

Also in April 2009, the FASBissued FSP SFAS No. 107-1 and APB No. 28-1, “Interim Disclosures about Fair Value ofFinancial Instruments,”  which require disclosures about the fair value offinancial instruments for interim reporting periods of publicly tradedcompanies as well as in annual financial statements and also requires thosedisclosures in summarized financial information at interim reporting periods.  Apublicly traded company includes any company whose securities trade in a publicmarket on either a stock exchange or in the over-the-counter market, or anycompany that is a conduit bond obligor.  Additionally, when a company makes afiling with a regulatory agency in preparation for sale of its securities in apublic market, it is considered a publicly traded company for this purpose. FSPSFAS No. 107-1 and APB No. 28-1 are effective for periods ending after June 15,2009, with early adoption permitted for periods ending after March 15, 2009.  We will adopt the staffposition during the second quarter of 2009. Because the FSP pertains todisclosure requirements, we do not anticipate that its adoption will have amaterial impact on our financial condition, results of operations, or cashflows.

 

Other accounting standards that have been issued or proposedby the FASB or other standards-setting bodies are not expected to have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

***2.      Cash and CashEquivalents***

 

*Required Reserve Balances*

 

The Federal Reserve Act requireseach depository institution to maintain reserves against its reservableliabilities as prescribed by Federal Reserve Board regulations. The Bankreports its reservable liabilities to the Federal Reserve on a weekly basis.  Weeklyreporting institutions maintain reserves on their reservable liabilities with a30-day lag.  For the maintenance period ended on April 8, 2009, based onreservable liabilities from February 24, 2009 through March 9, 2009, theFederal Reserve required the Bank to maintain reserves of $9.2 million.  Due toour levels of vault cash, no reserves were required to be maintained at ourcorrespondent transaction settlement bank in addition to $1.0 million that wasrequired to be maintained with the Federal Reserve. 

 

 The Emergency Economic Stimulus Act (“EESA”)accelerated, to October 1, 2008, the effective date for the Federal Reserve’sauthority to pay interest on account balances that depository institutions holdat the Federal Reserve banks.  The provisions to pay interest on suchbalances were contained in the Financial Services Regulatory Relief Act of 2006with an original implementation date of October 1, 2011.  Accordingly,interest is now paid on balances held to satisfy reserve requirements and onbalances held in excess of required reserve balances and clearing balancescommencing with the maintenance period beginning on October 9, 2008. Theinterest rate paid on required reserve balances is the average targeted federalfunds rate established by the Federal Open Market Committee over each reservemaintenance period less 10 basis points. The Federal Reserve anticipated thatpaying interest on required reserve balances would essentially eliminate theopportunity cost of holding required reserves, promoting efficiency in thebanking sector.  The rate paid on excess balances was set initially as thelowest targeted federal funds rate for each reserve maintenance period less 75basis points.  The formula for the interest rate on excess balances may beadjusted in light of experience and evolving market conditions. Thepayment of interest on excess reserves permits the Federal Reserve to expandits balance sheet as necessary to provide the liquidity to support financialstability while implementing the monetary policy that is appropriate in lightof the Federal Reserve System’s macroeconomic objectives of maximum employmentand price stability.  On October 22, 2008, the Federal Reserve announced thatit would alter the formula usedto determine the interest rate paid to depository institutions on excessbalances. Under the new formula, the rate on excess balances was set equal tothe lowest Federal Open Market Committee target rate in effect during thereserve maintenance period less 35 basis points.  This change becameeffective for the maintenance periods beginning Thursday, October 23, 2008. The Federal Reserve judged that a narrower spread between the target funds rateand the rate on excess balances would help foster trading in the funds marketat rates closer to the target rate.  Additionally, it agreed to continueto evaluate the appropriate setting of the rate on excess balances in light ofevolving market conditions and make further adjustments as needed. 

 

14

 

 

 

 

*Concentrationsand Restrictions on Cash and Cash Equivalents*

 

In aneffort to manage our associated risks, we generally do not maintain depositswith other financial institutions in amounts that exceed federal depositinsurance coverage. Furthermore, federal funds sold are essentiallyuncollateralized loans to other financial institutions that are not subject tofederal deposit insurance coverage. Therefore, management regularly evaluatesthe risk associated with the counterparties to these transactions to ensurethat we do not expose ourselves to any significant risks with regard to ourcash and cash equivalent balances.  

* *

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

 

The following tablessummarize the amortized cost, gross unrealized gains, gross unrealizedlosses, and fair values of investment securities available for sale at thedates indicated (in thousands).

 

 

 

 

 

**March 31, 2009**

 

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair value**

 

 

 

 

 

 

 

 

State and municipal

$

47,088 

1,535 

(37)

48,586 

 

Collateralized mortgage obligations

54,756 

56 

(4,952)

49,860 

 

Other mortgage-backed (federal agencies)

18,953 

562 

- 

19,515 

 

 

Total investment securities available

for sale

$

120,797 

2,153 

(4,989)

117,961 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2008**

 

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair value**

 

 

 

 

 

 

 

 

State and municipal

$

50,297 

635 

(102)

50,830 

 

Collateralized mortgage obligations

58,033 

23 

(3,417)

54,639 

 

Other mortgage-backed (federal agencies)

19,876 

270 

(19)

20,127 

 

 

Total investment securities available

for sale

$

128,206 

928 

(3,538)

125,596 

 

 

 

 

 

 

 

 

Palmetto Bancshares uses prices from third party pricingservices and, to a lesser extent, indicative (non-binding) quotes from thirdparty brokers, to measure fair value of our investment securities. See Note 16 for further discussion regarding theamount and fair value hierarchy classification of investment securitiesmeasured at fair value using a third party pricing service and those measuredat fair value using broker quotes.  Weutilize multiple third party pricing services and brokers to obtain fair values;however, management generally obtains one price / quote for each individualsecurity. For securities priced by third party pricing services, managementdetermines the most appropriate and relevant pricing service for each securityclass and has that vendor provide the price for each security in the class. Werecorded the unadjusted value provided by the third party pricing service /broker in our Consolidated Interim Financial Statements, subject to ourinternal price verification procedures. Based upon management’s internal priceverification procedures and review of fair value methodology documentationprovided by third party pricing services, we have concluded that the fairvalues for our investment securities available for sale at March 31, 2009 wereconsistent with the guidance in SFAS No. 157.  At March 31, 2009, allcollateralized mortgage obligations were valued using level three inputs as noactive trading market existed at that time.

 

15

 

 

 

 

 

*Other-Than-Temporary Impairment Analysis*

 

Management conducts other-than-temporary impairment analysison a quarterly basis or more often if a potential loss-triggering event occurs.We recognize other-than-temporary impairment when it is probable that we willbe unable to collect all amounts due according to the contractual terms of thesecurity, and the fair value of the investment security is less than itsamortized cost. The initial indication of other-than-temporary impairment forinvestment securities is a decline in the market value below the amountrecorded for an investment and the severity and duration of the decline. Indetermining whether an impairment is other-than-temporary, we consider thelength of time and the extent to which the market value has been below cost,recent events specific to the issuer, including investment downgrades by ratingagencies and economic conditions of its industry, and the ability and intent tohold the investment for a period of time, sufficient to allow for anyanticipated recovery.  We also consider the cause of the price decline (generallevel of interest rates and industry- and issuer-specific factors), theissuer’s financial condition, near-term prospects and current ability to makefuture payments in a timely manner, the issuer’s ability to service debt, anychange in agencies’ ratings at evaluation date from acquisition date and anylikely imminent action, and for collateralized mortgage obligations, the creditperformance of the underlying collateral, including delinquency rates,cumulative losses to date, and the remaining credit enhancement compared toexpected credit losses of the security. 

 

The following tables summarize the gross unrealized losses,fair 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 the dates indicated (dollars in thousands).

 

 

 

**March 31, 2009**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

State and municipal

4 

$

1,147 

$

37 

 

- 

- 

- 

 

4 

1,147 

37 

Collateralized mortgage obligations

5 

18,003 

1,305 

 

7 

25,423 

3,647 

 

12 

43,426 

4,952 

Other mortgage-backed (federal agencies)

4 

248 

		- 

 

- 

- 

- 

 

4 

248 

		- 

		  

Total investment securities available for sale

13 

$

19,398 

$

1,342 

 

7 

25,423 

3,647 

 

20 

44,821 

4,989 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2008**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

State and municipal

12 

$

5,441 

$

101 

 

1 

423 

1 

 

13 

5,864 

102 

Collateralized mortgage obligations

13 

52,603 

3,417 

 

- 

- 

- 

 

13 

52,603 

3,417 

Other mortgage-backed (federal agencies)

4 

1,336 

15 

 

1 

838 

4 

 

5 

2,174 

19 

		  

Total investment securities available for sale

29 

$

59,380 

$

3,533 

 

2 

1,261 

5 

 

31 

60,641 

3,538 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The increase in investment securities available for sale ina gross unrealized losses position at March 31, 2009 was caused byextraordinarily wide asset spreads resulting from an extremely illiquid market,causing these assets to be valued at significant discounts from cost. The fairvalue is expected to recover as the bonds approach their maturity dates orrepricing dates or if market yields for such investments decline further. Grossunrealized losses increased $1.5 million from December 31, 2008 to March 31,2009 primarily within the collateralized mortgage obligation sector of theinvestment securities portfolio.  Partially offsetting this increase wereimprovements within the state and municipal and other mortgage-backed sectors. Gross unrealized losses on collateralized mortgage obligations in the twelvemonths or longer category increased based on our date of purchase.  Wepurchased each of the seven securities twelve to thirteen months prior to March31, 2009.

 

Any decline in the fair value of available for salesecurities below cost deemed to be other-than-temporary is reflected in incomeas a realized loss. As of March 31, 2009, we have received all principal andinterest payments, believe that the principal and interest on these securitiesare fully recoverable, and have the ability and intent to hold the securitiesfor the foreseeable future.  Accordingly, management believes the grossunrealized losses detailed in the preceding table are temporary, and,therefore, the securities were not other-than-temporarily impaired at March 31,2009.

 

The fair values of the investment securities portfolio coulddecline in the future if the underlying performance of the collateral forcollateralized mortgage obligations or other securities deteriorates, and thecredit enhancement levels do not provide sufficient protection for contractualprincipal and interest. As a result, there is risk that other-than-temporaryimpairments may occur in the future particularly in light of the currenteconomic environment.

 

 

16

 

 

 

 

 

*Concentrations of Risk*

 

No state and municipal securityissuers issued securities with fair values exceeding 2% of total shareholders’equity at March 31, 2009.  Five state and municipal security issuers issuedsecurities with fair values exceeding 1% of total shareholders’ equity at March31, 2009 ranging from 1.0% to 1.8%.  Although all state and municipalsecurities are not rated “AAA,” all are within our ratings standard outlined inour Investment Policy which requires rated bonds to average between “Aa” to “A”by one of the major bond rating agencies.

 

Collateralized mortgage obligationissuers issued securities with fair values ranging from 1.5% to 7.6% of totalshareholders’ equity at March 31, 2009. 

 

The following table summarizesissuer fair value concentration of other mortgage-backed investment securities,by issuer, at March 31, 2009 (dollars in thousands).

 

 

 

**Federal**

**National**

**Mortgage**

**Association**

 

**Federal**

**Home Loan**

**Mortgage**

**Corporation**

**Total**

Other mortgage-backed

$

16,349 

 

3,166 

19,515 

 

 

 

 

 

 

As a percentage of shareholders' equity

13.9 

%

2.7 

16.6 

 

*Pledged*

 

Approximately 57% of theinvestment securities portfolio, at fair value, was pledged to secure publicdeposits and trust assets at March 31, 2009 as compared with 55% at December31, 2008.  Of the $67.5 million pledged available for sale investmentsecurities balance at March 31, 2009, $54.7 million of the investmentsecurities portfolio, at fair value, was securing public deposits and trustassets.  Of the $69.1 million pledged available for sale investment securitiesbalance at December 31, 2008, $47.0 million of available for sale investmentsecurities was securing public deposits and trust assets.  

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities.  Approximately $39.4 million, or 33%, of the investmentsecurities portfolio, at fair value, was pledged to collateralize FHLB advancesand letters of credit as of March 31, 2009 of which $35.4 million was utilizedas lendable collateral.  In order to compute lendable collateral amounts,investment security market values are multiplied by a collateral valuepercentage.  At December 31, 2008, approximately $41.6 million, or 33%, of theinvestment securities portfolio, at fair value, was pledged to collateralizeFHLB advances and letters of credit of which $37.5 million was utilized aslendable collateral.  

 

***4.       Loans***

 
Composition
 

The following table summarizesgross loans, categorized by loan purpose, excluding those mortgage loans heldfor sale, at the dates indicated (dollars in thousands). 

 

 

 

**March 31,**

 

**December 31,**

 

 

 

**2009**

 

**2008**

 

 

 

**Total**

**% of**

**total**

 

**Total**

**% of**

**total**

 

Commercial business

$

143,809 

12.4 

%

154,304 

13.3 

 

Commercial real estate

758,498 

65.6 

 

740,420 

63.9 

 

Installment

22,236 

1.9 

 

23,547 

2.0 

 

Installment real estate

85,295 

7.4 

 

85,506 

7.4 

 

Indirect

34,859 

3.0 

 

34,566 

3.0 

 

Credit line

1,913 

0.2 

 

2,090 

0.2 

 

Prime access

65,860 

5.7 

 

64,384 

5.5 

 

Residential mortgage

28,405 

2.5 

 

36,611 

3.2 

 

Bankcards

11,943 

1.0 

 

12,470 

1.1 

 

Business manager

293 

- 

 

152 

- 

 

Other

1,846 

0.2 

 

1,934 

0.2 

 

Loans in process

1,086 

0.1 

 

2,141 

0.2 

 

Deferred loans fees and costs

319 

- 

 

355 

- 

 

 

Loans, gross

$

1,156,362 

100.0 

%

1,158,480 

100.0 

 

 

 

 

 

 

 

 

 

 

17

 

 

 

 

 

 

 

The following table summarizesgross loans, categorized by the Federal Deposit Insurance Corporation (the“FDIC”) code, excluding those mortgage loans held for sale, at the datesindicated (dollars in thousands). 

 

 

 

**March 31, 2009**

 

**December 31, 2008**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Secured by real estate

 

 

 

 

 

 

Construction, land development, and other land loans

$

267,091 

23.1 

%

$

235,216 

20.3 

 

Farmland

650 

0.1 

 

882 

0.1 

 

Single-family residential

217,763 

18.8 

 

217,734 

18.8 

 

Multifamily residential

39,050 

3.4 

 

36,349 

3.1 

 

Nonfarm nonresidential

477,259 

41.3 

 

510,180 

44.1 

Commercial and industrial

74,184 

6.4 

 

73,609 

6.4 

Obligations of states and political subdivisions of the U.S.

1,223 

0.1 

 

2,602 

0.2 

General consumer

59,209 

5.1 

 

60,626 

5.2 

Credit line

5,878 

0.5 

 

6,215 

0.5 

Bankcards

11,841 

1.0 

 

12,416 

1.1 

Others

2,214 

0.2 

 

2,651 

0.2 

 

Loans, gross

$

1,156,362 

100.0 

%

$

1,158,480 

100.0 

 

 

 

 

 

 

 

 

Loans included in both of the preceding loan compositiontables are net of participations sold and mortgage loans sold and serviced forothers.  Participations sold totaled $26.7 million at March 31, 2009 andDecember 31, 2008.  Mortgage loans serviced for the benefit of others amountedto $396.5 million and $377.3 million at March 31, 2009 and December 31, 2008,respectively. 

* *

*Pledged*

 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of residential, multifamily, home equity lines and second mortgages,and commercial loans as well as a number of types of securities. Approximately$370.0 million, or 32%, of gross loans, excluding mortgage loans held for sale,were pledged to collateralize FHLB advances and letters of credit at March 31,2009, of which $158.5 million was available as lendable collateral.  Of the$379.4 million loan balance, gross, excluding mortgage loans held for sale,pledged at December 31, 2008, $159.1 million was available as lendablecollateral.  In order to compute lendable collateral amounts, pledged loanunpaid principal balances are reduced by a collateral verification reviewextrapolation factor before being multiplied by a collateral value percentage. 

 

*Concentrations of Risk*

* *

Borrower Concentration. Management does not believethat the loan portfolio is concentrated in loans toany single borrower or a relatively small number of borrowers.

 

Geographic Concentration. Unlike larger national or regional banks that are more geographically diversified, our services are primarily provided to customers within our market area. Deterioration in local economic conditions could result in declines in asset quality, loan collateral values, and the demand for our products and services, among other things. Although the geographic concentration limits us to the economic risks within our market area, the lack of geographic diversification may make us particularly susceptible to the adverse impacts of negative economic conditions that impact our market area.

 

Loan Type / IndustryConcentration. The following table summarizes loans secured by commercialreal estate, categorized by FDIC code, at March 31, 2009 (dollars inthousands).  

 

 

 

 

**Total**

**% of Bank's**

**loan**

**portfolio,**

**gross**

 

**% of Bank's**

**tier 1**

**capital**

 

Secured by commercial real estate

 

 

 

 

 

 

Construction, land development, and other land loans

$

267,091 

23.1 

%

223.3 

 

 

Multifamily residential

39,050 

3.4 

 

32.7 

 

 

Nonfarm nonresidential

477,259 

41.2 

 

399.0 

 

 

 

Total loans secured by commercial real estate

$

783,400 

67.7 

%

655.0 

 

 

 

 

 

 

 

 

 

 

 

18

 

 

 

 

 

The following table furthercategorizes loans secured by commercial real estate, categorized by FDIC code,at March 31, 2009 (dollars in thousands).  

 

		   

		   

		   

		   

 

**Total**

**% of Bank's**

**loan**

**portfolio,**

**gross**

 

**% of Bank's**

**tier 1**

**capital**

Development commercial real estate loans

 

 

 

 

 

Loans secured by:

 

 

 

 

 

 

Land - unimproved (commercial or residential)

$

31,384 

2.7 

%

26.2 

 

 

Land development - commercial

12,593 

1.1 

 

10.5 

 

 

Land development - residential

142,850 

12.3 

 

119.4 

 

 

Commercial construction:

 

 

 

 

 

 

 

Hotel / motel

13,338 

1.2 

 

11.2 

 

 

 

Retail

2,378 

0.2 

 

2.0 

 

 

 

Multifamily

16,933 

1.5 

 

14.2 

 

 

 

Industrial and warehouse

6,690 

0.6 

 

5.6 

 

 

 

Health care

9,293 

0.8 

 

7.8 

 

 

 

Miscellaneous commercial

15,084 

1.3 

 

12.6 

 

 

 

 

Total development commercial real estate loans

250,543 

21.7 

 

209.5 

 

 

 

 

 

 

 

 

 

Existing and other commercial real estate loans

 

 

 

 

 

Loans secured by existing real estate:

 

 

 

 

 

 

Hotel / motel

100,454 

8.7 

 

84.0 

 

 

Retail

32,877 

2.8 

 

27.5 

 

 

Office

 

31,923 

2.8 

 

26.7 

 

 

Multifamily

39,050 

3.4 

 

32.6 

 

 

Industrial and warehouse

14,223 

1.2 

 

11.9 

 

 

Healthcare

28,811 

2.5 

 

24.1 

 

 

Miscellaneous commercial

129,507 

11.2 

 

108.3 

 

 

Residential construction - speculative

20,004 

1.7 

 

16.7 

 

 

 

 

Total existing and other commercial real estate loans

396,849 

34.3 

 

331.8 

 

 

 

 

 

 

 

 

 

Commercial real estate owner occupied and residential loans

 

 

 

 

 

Loans secured by:

 

 

 

 

 

 

Commercial - owner occupied

132,717 

11.5 

 

111.0 

 

 

Commercial construction - owner occupied

3,013 

0.2 

 

2.5 

 

 

Residential construction - contract

278 

0.0 

 

0.2 

 

 

 

 

Total commercial real estate owner occupied and residential loans

136,008 

11.7 

 

113.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans secured by commercial real estate

$

783,400 

67.7 

%

655.0 

 

We believe that the properties securing our commercial realestate portfolio are diverse in terms of type. This diversity reduces ourexposure to adverse economic events that impact any single industry.

 

Lending Practices. We do not loan in excess of 100%of collateral value, offer loan payment arrangements resulting in negativeamortization, engage in lending practices subjectingborrowers to substantial payment increases (e.g. principal deferral periods,loans with initial interest-only periods, etc.), nor does it offer loanpayment arrangements with minimum payments that are less than accrued interest.

 
Asset Quality 
Nonaccrual Loans andLoans Past Due 90 Days and Still Accruing. The following table summarizes nonaccrual loans and loans past due 90days and still accruing interest at the dates indicated (in thousands).

 

 

 

 

 

 

 

**March 31,**

**December 31,**

 

**2009**

**2008**

Nonaccrual loans

$

56,115 

$

42,968 

Loans past due 90 days and still accruing (1)

226 

206 

 

$

56,341 

$

43,174 

 

 

 

(1) Substantially all of these loans are bankcard loans

 

 
 
The following table summarizes the total additional amountof interest that would have been reported in income for the periods indicatedhad loans classified as nonaccrual at each of these dates performed inaccordance with their original terms and the amount of total interest collectedduring each of these periods relative to loans classified as nonaccrual at eachof the periods (in thousands).

 

 

**For the three months periods ended March 31, **

 

**2009**

**2008**

Foregone interest

889 

227 

Interest collected

31 

14 

 

 

 

19

 

 

 

 

 

 

 

Troubled Debt Restructurings. At March 31, 2009, the principal balance of troubled debt restructurings totaled $1.7 million. 
 Allowance for Loan Losses
 

The following tablesummarizes the activity impacting the allowance for loan losses for theperiods indicated (in thousands).

 
  
**At and for the three month periods**
 

 

**ended March 31,**

 

 

**2009**

**2008**

Allowance for loan losses, beginning of period

$

11,000 

7,418 

Provision for loan losses

2,175 

488 

 

 

 

 

Loans charged-off

(615)

(447)

Loan recoveries

46 

29 

 

Net loans charged-off

(569)

(418)

 

 

 

 

Allowance for loan losses, end of period

$

12,606 

7,488 

 

 

 

 

 

Impaired Loans.  The following table summarizes information relativeto impaired loans at the dates and for the periods indicated (in thousands).

 

 

 

 

 

 

 

**March 31,**

**December 31,**

 

 

**2009**

**2008**

 

Impaired loans, at end of period

$

54,612 

37,468 

 

Impaired loans subject to specific reserve allocation, at end of period

25,354 

21,413 

 

Specific allowance allocation on impaired loans, at end of period

3,521 

4,453 

 

Average impaired loans (1)

46,040 

22,568 

 

 

 

 

 

(1) Average impaired loans calculated using a simple average.

 

 

 

 

 

 

 

*** ***

**5. ** ***Premises and Equipment, Net***

* *

*Composition*

* *

The following tablesummarizes the premises andequipment balances at the dates indicated (in thousands).

 

 

 

**March 31,**

**December 31,**

 

 

 

 

**2009**

**2008**

 

 

Land

$

6,532 

$

6,530 

 

 

Buildings

19,839 

19,668 

 

 

Leasehold improvements

4,145 

2,884 

 

 

Furniture and equipment

20,290 

19,412 

 

 

Software

3,661 

3,495 

 

 

Bank automobiles

940 

941 

 

 

 

Premises and equipment, gross

55,407 

52,930 

 

 

 

 

 

 

 

 

Accumulated depreciation

(26,613)

(26,583)

 

 

 

Premises and equipment, net

$

28,794 

$

26,347 

 

 

 

 

 

 

 

 

 

We relocated our corporate headquartersto downtown Greenville, South Carolina during March 2009 primarily impactingleasehold improvements and furniture and equipment balances during the threemonth period ended March 31, 2009.  

 

During 2008, we purchased property at the intersection of West Wade HamptonBoulevard and Middleton Way in Greenville County on which to construct andrelocate the existing Greer banking office.  The grand opening celebrationoccurred in April 2009.  During the three month period ended March 31,2009, this relocation primarily impacted building and furniture and equipmentbalances.

 

 

20

 

 

 

 

 

During 2008, we consolidated ourexisting banking office network, reducing the number of banking offices byfour. Three of these consolidated banking offices continue to be leased, andone is owned.  Management is currently considering options with regard to theselocations.  Also during 2008, we completed construction and celebrated the grandopening of our relocated Pendleton office in Anderson County.  The previousPendleton banking office is owned.  Management is also considering options withregard to this location.  Costs related to the operation of these locations areincluded in branch closure expense within the other noninterest expensefinancial statement line item for thethree month period ended March 31, 2009, since these banking offices are no longerused in the ordinary course of banking business.  

 

*Accumulated Depreciation*

* *

The following table summarizes the activity impactingaccumulated depreciation for the periods indicated (in thousands). 
 
 

 

 

**At and for the three month**

 

 

 

 

**periods ended March 31,**

 

 

 

 

**2009**

**2008**

 

Accumulated depreciation, beginning of year

$

26,583 

24,637 

 

 

 

 

 

 

 

Depreciation on current premises, furniture, and equipment used in ordinary course of business

 

		   

Buildings

119 

136 

 

 

Leasehold improvements

61 

30 

 

 

Furniture and equipment

249 

230 

 

 

Software

57 

42 

 

 

Bank automobiles

43 

44 

 

 

 

Total depreciation

529 

482 

 

 

 

 

 

 

 

Depreciation on consolidated banking office premises and equipment

 

 

 

 

Buildings

14 

- 

 

 

Leasehold improvements

27 

- 

 

 

 

Total depreciation moved to branch closure expense

41 

- 

 

 

 

 

 

 

 

Disposals

(540)

(14)

 

 

 

 

 

 

 

Accumulated depreciation, end of year

$

26,613 

25,105 

 

 

 

 

 

 

 

 

 

 

21

 

 

* Loss on Disposition ofPremises, Furniture, and Equipment*

 

The following table summarizespremises, furniture, and equipment written-off during the three month periodended March 31,2009 (in thousands) in conjunction with the relocation of our new corporateheadquarters. 

 

 

 

 

 

 

**For the three month period ended**

**March 31, 2009**

Assets written off in conjunction with the headquarters move
 
 

 

Assets written off, gross
 
 

 

 

Building
$
342 

 

 

Furniture and equipment
 
191 

 

 

 

 

 
 
533 

 

Accumulated depreciation on assets written off
 
 

 

 

Building
 
(337)

 

 

Furniture and equipment
 
(149)

 

 

 

 

 
 
(486)

 

 

 

 

 
 
 

 

 

 

Assets written off in conjunction with headquarters move, net
 
47 

 

 

 

 

 
 
 

Assets written off in the normal course of banking operations
 
 

 

Assets written off, gross
 
 

 

 

Building
 
3 

 

 

Bank automobiles
 
52 

 

 

 

 

 
 
55 

 

Accumulated depreciation on assets written off
 
 

 

 

Building
 
(3)

 

 

Bank automobiles
 
(52)

 

 

 

 

 
 
(55)

 

 

 

 

 
 
 

 

 

 

Assets written off in conjunction with normal course of banking operations,		net
 
- 

		   

		   

		   

		   

 
 
 

 

 

 

 

Total assets written off , net
 
47 

 

 

 

 

 
 
 

 

 

 

 

Loss for expenses associated with sale of premises held for sale
 
8 

 

 

 

 

 
 
 

 

 

 

 

Loss on disposition of premises, furniture, and equipment
$
55 

 

*Premises Held for Sale*

* *

Long-lived assets to be sold are classified as held for saleand are no longer depreciated. Certain criteria must be met for the long-livedasset to be classified as held for sale including that a sale is probable andexpected to occur within a one-year period. Long-lived assets classified asheld for sale are recorded at the lower of carrying amount or fair market valueless the estimated costs to sell. At December 31, 2008, two parcels of landwith a book value approximating $1.7 million were classified as held for sale. These parcels were sold during the three months ended March 31, 2009 at thecarrying amount, in conjunction with the relocation of our corporateheadquarters to downtown Greenville. 

 

***6.       Goodwill,net and Core Deposit Intangibles, net   ***

** **

All of our goodwill resulted from past businesscombinations.  We perform our annual impairment testing as of June 30. Theimpairment testing as of June 30, 2008 and June 30, 2007 indicated that noimpairment charge was required as of those dates.

 

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

 

 

**March 31,**

**2009**

**December 31,**

**2008**

Core deposit intangibles, gross

$

1,779 

1,779 

     Less: accumulated amortization

(1,756)

(1,745)

Core deposit intangibles, net

$

23 

34 

 

 

 

 

***7.       Mortgage-Banking Activities***

 

*Mortgage-Servicing Rights Portfolio*

 

Mortgage loans serviced for the benefit of others amountedto $396.5 million and $377.3 million at March 31, 2009 and December 31, 2008,respectively.  Thebook value of the mortgage-servicing rights portfolio at March 31, 2009 andDecember 31, 2008 was $3.0 million and $2.9 million, respectively. The mortgage-servicing rights portfolio is included within other in the assetssection of the Consolidated (Interim) Balance Sheets.  The aggregate fairvalue of the mortgage-servicing rights portfolio at March 31, 2009 and December31, 2008 was $3.5 million and $3.2 million, respectively.

 

22

 
*Mortgage-Servicing Rights Activity*
 

The following tablesummarizes the changes in thethe Company’s mortgage-servicing rights portfolio for the periods indicated (inthousands). 

 

 

 

 

 

 

 

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2009**

**2008**

Mortgage-servicing rights portfolio, net of valuation

 

 

 

allowance, beginning of period

$

2,932 

2,949 

 

 

Capitalized mortgage-servicing rights

475 

165 

 

 

Mortgage-servicing rights portfolio amortization

(405)

(213)

 

 

Change in mortgage-servicing rights portfolio valuation allowance

(9)

(3)

Mortgage-servicing rights portfolio, net of valuation

 

 

 

allowance, end of period

$

2,993 

2,898 

 

 

 

 

 

 

* *

*Mortgage-Servicing Rights Valuation Allowance*

 

The following table summarizesthe activity impacting the valuation allowance for impairment of themortgage-servicing rights portfolio for the periods indicated (in thousands).

 

 

 

 

 

 

 

 

**At and for the periods**

 

 

**ended March 31,**

 

 

**2009**

**2008**

Valuation allowance, beginning of period

$

30 

10 

     Aggregate (additions charged to) and reductions credited from operations

		9

3 

Valuation allowance, end of period

$

39 

13 

 

 

 

 

 

See Consolidated InterimStatements of Cash Flows for a summary of activity impacting our mortgage-servicingrights portfolio during the three month periods ended March 31, 2009 and March31, 2008.

 

*Mortgage-Banking Income*

* *

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

 

 

 

 

 

 

 

 

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2009**

 

**2008**

Mortgage-servicing fees

$

240 

 

216 

Gain on sale of mortgage loans held for sale

522 

 

189 

Other mortgage-banking income

103 

 

64 

 

Total mortgage-banking income

$

865 

 

469 

 

 

 

 

 

 

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

* *

*Composition*

* *

The following table summarizes real estate and personal propertyacquired in settlement of loans, which are included within other in the assetssection of the Consolidated (Interim) Balance Sheets at the dates indicated (inthousands). 

 

 

 

 

 

 

**March 31,**

**December 31,**

 

**2009**

**2008**

Real estate acquired in settlement of loans

$

6,771 

6,719 

Repossessed automobiles acquired in settlement of loans

762 

564 

     Total property acquired in settlement of loans

$

7,533 

7,283 

 

 

 

 

 

23

 

 

 

 

 

*Activity*

* *

The following table summarizes the changesin the real estate acquired in settlement of loans portfolio at and for theperiods indicated (in thousands).

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2009**

**2008**

 

Real estate acquired in settlement of loans, beginning of period

$

6,719 

7,743 

 

		   

Add: New real estate acquired in settlement of loans and related adjustments

273 

392 

 

 

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

(202)

(105)

 

 

Less: Provision charged to expense

(19)

(70)

 

Real estate acquired in settlement of loans, end of period

$

6,771 

7,960 

 

 

***9.       Deposits***

* *

*Composition*

* *

The following table summarizestraditional deposit composition at the dates indicated (in thousands).

 

 

 

**March 31,**

**December 31,**

 

 

 

**2009**

**2008**

 

Transaction deposit accounts

$

471,417 

497,563 

 

Money market deposit accounts

97,215 

93,746 

 

Savings deposit accounts

40,052 

36,623 

 

Time deposit accounts $100,000 and greater

234,864 

180,083 

 

Time deposit accounts less than $100,000

323,604 

262,264 

 

		   

Total traditional deposit accounts

$

1,167,152 

1,070,279 

 

 

At both March 31, 2009 and December 31, 2008, $1.2 millionof overdrawn deposit accounts had been reclassified as loan balances.  

* *
Interest Expense on Traditional Deposit Accounts
 

The following table summarizes interest paid on traditionaldeposit accounts for the periods indicated (in thousands).

 

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2009**

**2008**

Transaction deposit accounts

$

245 

2,029 

Money market deposit accounts

168 

776 

Savings deposit accounts

31 

30 

Time deposit accounts

4,268 

4,281 

		   

Total interest expense on traditional deposit accounts

$

4,712 

7,116 

 

***10.    Borrowings***

*** ***
FHLB Borrowings
 

To borrow from the FHLB, members must pledge collateral tosecure advances and letters of credit.  Acceptable collateral includes avariety of single-family residential loans, commercial real estate loans, homeequity lines of credit, and multifamily residential loans as well as a numberof types of securities.  

 

24

 

 

 

 

 

The following table summarizes FHLB borrowed fundsutilization and availability at the datesindicated (in thousands).

 

 

 

 

**March 31,**

**December 31,**

 

 

 

 

 

**2009**

**2008**

 

 

Available lendable loan collateral value to serve against FHLB advances

$

158,475 

159,060 

 

 

Available lendable investment security collateral value to serve against FHLB advances

35,421 

37,481 

 

 

 

 

 

 

 

 

 

Advances and letters of credit

 

 

 

 

 

Short-term advances

- 

(44,000)

 

 

 

Long-term advances

(52,000)

(52,000)

 

 

 

Letters of credit

(69,000)

(69,000)

 

 

 

 

Total advances and letters of credit

(121,000)

(165,000)

 

 

 

 

 

 

 

 

 

Available lendable collateral value to serve against FHLB advances

$

72,896 

31,541 

 

 

 

The following table summarizes long-term FHLB borrowings at March 31, 2009(dollars in thousands).  The Company’s long-term FHLB advances do nothave embedded call options. 

 

 

 

 

 

 

 

Total

Borrowing balance

$

5,000 

 

12,000 

30,000 

5,000 

52,000 

Interest rate

2.57 

%

2.75 

2.89 

3.61 

2.90 

Maturity date

3/8/2010

 

4/2/2010

3/7/2011

4/2/2013

 

 

 

*Federal Funds Accommodations*

* *

In addition to the FHLBborrowing capacity summarized above, at March 31, 2009, we had access tofederal funds funding from correspondent banks.  During March 2009, acorrespondent bank canceled an existing federal funds accommodation of $10million, thereby reducing our overall federal funds accommodation.  Thefollowing table summarizes the federal funds funding utilization andavailability at the dates indicated (inthousands).  

 

 

 

 

**March 31,**

**December 31,**

 

 

 

**2009**

**2008**

Authorized federal funds funding accomodations

$

57,500 

67,500 

 

 

 

 

 

Utilized federal funds funding accomodations

(15,403)

(35,785)

 

 

 

 

 

Available federal funds funding accomodations

$

42,097 

31,715 

 

 

 

 

 

 

Subsequent to March 31, 2009, a correspondent bank canceledan existing federal funds accommodation of $12.5 million, thereby reducing ouroverall federal funds accommodation to $45.0 million.  Of this $45.0 million inauthorized federal funds funding sources from correspondent banks, $25.0million are not committed facilities and may be canceled at any time at thecorrespondent banks’ discretion.  Although the remaining $20.0 million inauthorized federal funds funding sources from a correspondent bank is committedannually, the accommodation may be terminated at any time at thecorrespondent bank’s discretion.

 

***11.    EmployeeBenefit Plans***

*** ***

*401(k) Plan*

 

During the three month periods ended March 31, 2009 andMarch 31, 2008, matching contributions made to our employee 401(k) plan totaled$108 thousand and $91 thousand, respectively.  

 

*Defined Benefit Pension Plan*

 

Historically, as part of a comprehensive employment program,a noncontributory, defined benefit pension plan was offered that covered allfull-time employees having at least twelve months of continuous service andhaving attained age 21.  The plan was originally designed to produce adesignated retirement benefit, and benefits were fully vested after five yearsof service.  No vesting occurred until five years of service had beenachieved.  Contributions to the plan were made as required by the EmployeeRetirement Income Security Act of 1974. 

 

During the fourth quarter of 2007,employees were notified that, effective 2008, we would cease accruing pensionbenefits for employees with regard to the Company’s noncontributory,defined benefit pension plan.  Although nopreviously accrued benefits were lost, employees are no longer able to accruebenefits for service after 2007.

 

25

 

 

 

 

Accounting Policy. The defined benefit pension plan is accounted for inaccordance with SFAS No. 87 and SFAS No. 158.  We conformed our pensionasset and pension and postretirement liabilities to SFAS No. 158 and recorded acorresponding reduction of $4.1 million, after-tax, to the December 31,2007 balance of accumulated other comprehensive income (loss) in stockholders’equity relative to the adoption of SFAS No. 158.  Additionally, we recorded areduction of $2.0 million, after-tax, to accumulated other comprehensive income(loss) in stockholders’ equity in order to recognize the underfunded status of ourdefined benefit pension plan at December 31, 2008. 

 
 Defined Benefit Pension Plan Assets. As reported in our Annual Report on Form 10-K for the year ended December31, 2008, the fair value of plan assets totaled $10.8 million.  At March 31,2009, the fair value of plan assets totaled $9.9 million.
 

Current and Future Expected Contributions.  No contributionswere made during the three month period ended March 31, 2009.  Our actuary iscurrently analyzing the actual impact that the defined benefit pension plan curtailment will have on futurecontributions.  
 
***12.    EquityBased Compensation***

 
Stock Option Plan
 

General. As of January 2007, all of the stock optionawards available for grant under the Palmetto Bancshares, Inc. 1997 StockCompensation Plan had been granted with various expiration dates throughDecember 31, 2016.  Of these, 165,330 stock option awards remained outstandingat March 31, 2009 with exercise prices ranging from $13.00 to $30.40.  Allstock option awards granted have a vesting term of five years and an exerciseperiod of ten years.  

 

Stock Option CompensationExpense. The compensation cost that was charged against pretax net incomefor stock option awards granted during the three month periods ended March 31,2009 and 2008 was $16 thousand and $23 thousand, respectively.  Managementestimates that stock option award forfeitures will not be significant and,therefore, does not adjust stock option compensation expense for forfeitures.

 

At March 31, 2009, based onstock option awards outstanding at that time, the total pretax compensationcost related to nonvested stock option awards granted under the stock optionplans but not yet recognized was $79 thousand. Stock option compensationexpense is recognized on a straight-line basis over the stock option awardvesting period. Remaining stock option compensation expense is expected to berecognized through 2011. 

 

Stock Option Activity.The following table summarizes stock option activity for the 1997 StockCompensation Plan for the periods indicated.

 

 

 

 

 

 

 

 

 

**Stock options**

**outstanding**

**Weighted-**

**average**

**exercise**

**price**

Outstanding at December 31, 2007

198,155 

$  20.29 

 

Exercised

(11,000)

10.80 

Outstanding at March 31, 2008

187,155 

$  20.85 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2008

169,330 

$  20.98 

 

Exercised

(4,000)

26.60 

Outstanding at March 31, 2009

165,330 

$  20.84 

 

 

 

 

 

 

There were no grants orforfeitures of stock options during the three month periods ended March 31,2009 or 2008.  Cash received from stock optionexercises under the stock option plan for the three month periods ended March31, 2009 and 2008 was $106 thousand and $119 thousand, respectively.  The total intrinsic value of stock options exercised duringthe three month period ended March 31, 2009 was $62 thousand.

 

26

 

 

 

 

 

 

 

Stock Options Outstanding. The following table summarizes information regarding stock optionawards outstanding and exercisable at March 31, 2009.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Options outstanding**

**Options exercisable**

**Exercise price or range of**

**exercise prices**

**Number of**

**stock options**

**outstanding**

**Weighted-**

**average**

**remaining**

**contractual**

**life (years)**

**Weighted-**

**average**

**exercise**

**price**

**Number of**

**stock options**

**exercisable**

**Weighted-**

**average**

**exercise**

**price**

13.00 

to

13.50 

25,920 

1.05 

$

13.15 

25,920 

$

13.15 

15.00 

to

20.00 

54,410 

3.16 

17.02 

54,410 

17.02 

23.30 

to

26.60 

51,200 

5.12 

24.47 

44,600 

24.16 

27.30 

to

30.40 

33,800 

6.78 

27.37 

19,320 

27.35 

 

 

Total

165,330 

4.18 

20.84 

144,250 

19.92 

 

 

 

 

 

 

 

 

 

Based on the last known trading price of common stock known by management, theintrinsic value of stock options outstanding and exercisable at March 31, 2009was $3.2 million. 

 
Restricted Stock Plan
* *

The first awards were granted under the 2008 RestrictedStock Plan during the first quarter of 2009.  The following table summarizesnonvested restricted stock for the three month period ended March 31, 2009

  

 

 

**Weighted Average**

**Restricted Stock**

**Shares**

**Date Fair Value  Grant-**

Outstanding at December 31, 2008

- 

$

- 

Granted

37,540 

42.00 

Vested

- 

- 

Forfeited

- 

- 

Outstanding at March 31, 2009

37,540 

$

42.00 

 

 

 

 
During the three month period ended March 31, 2009, 37,540 shares of common stock were granted pursuant to the restricted stock plan.  The value of the stock awarded is established as the fair market value of the stock at the time of the grant.  Expenses, equal to the total value of such awards, are recognized ratably over the vesting period of the stock grants.  Grants to employees vest over a 5 year period.  The first awards granted in January 2009 resulted in an expense of $79 thousand for the three month period ended March 31, 2009.  As of March 31, 2009, there was $1.5 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plan.  This cost is expected to be recognized over the remaining 4.75 years.  The intrinsic value of restricted shares outstanding at March 31, 2009 was $1.6 million.  No shares vested during the three month period ended March 31, 2009. At March 31, 2009, 212,460 shares were available for issuance under the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan.  
***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 ended March 31,**

 

 

**2009**

**2008**

Weighted average common shares outstanding - basic

6,448,668 

6,431,172 

 

Dilutive impact resulting from potential common share issuances

81,304 

87,955 

Weighted average common shares outstanding - diluted

6,529,972 

6,519,127 

 

Basic net income per share is computed by dividing netincome available to common shareholders by the weighted-average number ofshares of common stock outstanding during the year.  For diluted net income pershare, the denominator is increased to include the number of additional commonshares that would have been outstanding if dilutive potential common shares hadbeen issued.  If dilutive, common stock equivalents are calculated for optionsand restricted shares using the treasury stock method.  At March 31, 2009, alloutstanding stock option awards and restricted shares were included in thecalculation of diluted net income per common share because the exercise pricewas equal to or lower than the current market price.  

 

27

 

 

 

 

 

***14.    Guarantees,Commitments, and Contingencies***

 
Unused Lending Commitments 
At March 31, 2009, unused lending availability totaled $285.6 million.

 
Guarantees
 

Standby letters of credit, which include performance andfinancial guarantees, are issued for customers in connection with contractsbetween the customers and third parties. Standby letters of credit guaranteethat the third parties will receive specified funds if customers fail to meettheir contractual obligations. The Company is obligated to make payment if acustomer defaults. At March 31, 2009, no liability was recorded for ourobligation to perform as a guarantor under standby letters of credit. Themaximum potential amount of undiscounted future payments related to standbyletters of credit at March 31, 2009 was $4.7 million compared with $8.6 millionat December 31, 2008.  Through our various sources of liquidity, we believethat we have the necessary resources available to meet these obligations shouldthe need arise.  Additionally, we do not believe that the current fair value ofsuch guarantees was material at March 31, 2009.

 

 

We enter into indemnification agreements in the ordinarycourse of business under which we agree to indemnify third parties against anydamages, losses, and expenses incurred in connection with legal and otherproceedings arising from relationships or transactions with us. Because theextent of our obligations under these agreements depends entirely upon theoccurrence of future events, our potential future liability under theseagreements is not determinable. 

 

*Derivatives*

 

See Note15 for discussion regarding thecommitments related to derivative loan commitmentsand related forward loan sales commitments.  

 
Capital Expenditure Obligations 
Capital expenditure obligations relative to our relocated Greer banking officeand corporate headquarters did not change materially from those reported in ourAnnual Report on Form 10-K for the year ended December 31, 2008.  Weanticipate that materially all such remaining obligations will be satisfied bythe end of the second quarter of 2009.

 

*Real Property Operating LeaseObligations*

 

As discussed in the Annual Report on Form 10-K for the yearended December 31, 2008, we lease certain of our office facilities and realestate relating to banking services under operating leases.  We relocated our corporateheadquarters to downtown Greenville, South Carolina during March 2009.  Duringconstruction, we paid real property operating lease payments under our previouslease with the Lessor with regard to our previous downtown Greenville bankingoffice.  Upon occupancy, these real property operating lease payments werereplaced with those required by the build-to-suit operating lease agreement.  Basedon our occupancy date, occupancy expense for the first quarter of 2009 includesa partial month’s payment under the Company’s lease agreement for the newheadquarters.  

 

Other than as discussed in Note 5, there has been nosignificant change in future minimum lease payments payable as reported in ourAnnual Report on Form 10-K for the year ended December 31, 2008.  

 

28

 

 

 

 
Legal Proceedings We are currently subject to various legal proceedings and claims that havearisen in the ordinary course of our business. In our opinion, based onconsultation with external legal counsel, all such claims fall into one of thefollowing categories:-  Any reasonably foreseeableoutcome of such current litigation would not materially impact our financialcondition or results of operations; or
-  We have not yet answered becausethe investigation into the matter is just beginning.  As such, legal counsel isunable to provide an assessment of the potential outcome of the case.  However,based on information available at this time, we expect to prevail in such mattes and  view the claims to be withoutmerit.

***15.    FreestandingDerivative Financial Instruments and Hedging Activities***

 

At March 31, 2009, and December 31, 2008, the fair value of ourderivative assets related to derivative loancommitments and our forward loan sales commitments was immaterial. 

 

***16.     DisclosuresRegarding Fair Value of Financial Instruments***

 
Financial Assets and Liabilities Recorded at Fair Value on a RecurringBasis 
* *

The following table summarizes assets and liabilitiesmeasured at fair value on a recurring basis at March 31, 2009 (in thousands).  Forinvestment securities available for sale, we obtain fair value measurementsfrom brokers or third party pricing services. 

 

 

 

 

**Level 1**

**Level 2**

**Level 3**

**Total**

 

Investment securities available for sale

 

 

 

 

 

 

Brokers

$

- 

- 

49,860 

49,860 

 

 

Third party pricing services

- 

68,101 

- 

68,101 

 

 

 

Total

$

- 

68,101 

49,860 

117,961 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following table summarizes the changes in Level 3 assetsand liabilities measured at fair value on a recurring basis during the firstquarter of 2009 (in thousands).

 

 

 

 

**Investment securities**

**available for sale**

 

Balance, December 31, 2008

$

54,639 

 

 

Total unrealized gain (loss) included in:

 

 

 

 

Net income

- 

 

 

		   

Accumulated other comprehensive income (loss)

(1,502)

 

		   

Purchases, sales, issuances, and settlements, net

(3,277)

 

 

Transfers in and (out) of level three

- 

 

Balance, March 31, 2009

$

49,860 

 

* *

*Financial Assets and Liabilities Recorded at FairValue on a Nonrecurring Basis*

* *

For assets measured at fair value on a nonrecurring basis duringthe three months ended March 31, 2009 that were still held at quarter end, thefollowing table summarizes the level of valuation assumptions used to determineeach adjustment and the carrying value of the related individual assets orportfolios at March 31, 2009 (in thousands).

 

 

**Level 1**

**Level 2**

**Level 3**

**Total**

Loans (1)

$

- 

51,091 

- 

51,091 

Real estate acquired in settlement of loans (2)

- 

6,771 

- 

6,771 

 

 

 

 

 

 

(1) Represents carrying value and		related writedowns of loans for which adjustments are based on the appraised value of the		collateral.

(2) Represents the fair value and related losses of real estate acquired in settlement of loans that were measured at fair value		subsequent to their initial classification as such.

* *

29

 

 

 

***17.    RegulatoryCapital Requirements***

 

Thefollowing table summarizes the Company’s and the Bank’s actual and requiredcapital ratios at the dates indicated (dollars in thousands).  As of March 31,2009, the Company and the Bank were categorized as “well capitalized” under theregulatory framework based on the most recent notification from federal bankingagencies. Since March 31, 2009, no conditions or events have occurred that haveresulted in a material change in the Company's or the Bank's category. 

 

 

 

 

 

**Actual**

**For capital adequacy**

**purposes**

**To be "well capitalized"**

**under prompt**

**corrective action**

**provisions**

 

 

 

 

**amount**

**ratio**

**amount**

**ratio**

**amount**

**ratio**

**At March 31, 2009**

 

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

132,400 

10.77% 

98,365 

8.00 

n/a 

n/a 

 

Bank

 

 

132,211 

10.74 

98,492 

8.00 

123,115 

10.00 

 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

119,794 

9.74 

49,183 

4.00 

n/a 

n/a 

 

Bank

 

 

119,605 

9.71 

49,246 

4.00 

73,869 

6.00 

 

 

 

 

 

 

 

 

 

 

*Tier 1 leverage ratio*

 

 

 

 

 

 

 

 

Company

 

 

119,794 

8.67 

55,256 

4.00 

n/a 

n/a 

 

Bank

 

 

119,605 

8.66 

55,272 

4.00 

69,090 

5.00 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At December 31, 2008**

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

128,876 

10.44% 

98,750 

8.00 

n/a 

n/a 

 

Bank

 

 

128,872 

10.44 

98,750 

8.00 

123,437 

10.00 

 

 

 

 

 

 

 

 

 

 

*Tier 1 capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

117,876 

9.55 

49,375 

4.00 

n/a 

n/a 

 

Bank

 

 

117,872 

9.55 

49,375 

4.00 

74,062 

6.00 

 

 

 

 

 

 

 

 

 

 

*Tier 1 leverage ratio*

 

 

 

 

 

 

 

 

Company

 

 

117,876 

8.70 

54,220 

4.00 

n/a 

n/a 

 

Bank

 

 

117,872 

8.69 

54,240 

4.00 

67,800 

5.00 

* *

30

 

 

 

 

 

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

 

Thefollowing discussion and analysis presents factors impacting our financialcondition as of March 31, 2009, and results of operations and cash flows forthe three month period ended March 31, 2009.  This discussion should beread in conjunction with our Consolidated Interim Financial Statements and thenotes thereto included in this Quarterly Report on Form 10-Q and ourConsolidated Financial Statements, and notes thereto, for the year endedDecember 31, 2008, included in our Annual Report on Form 10-K for that period. Results for the three month period ended March 31, 2009 are not necessarilyindicative of the results for the year ending December 31, 2009 or any futureperiod.  Percentage calculations contained herein have been calculated based onactual not rounded results presented herein.

 

***SelectedFinancial Data***

 

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

** **

** **

** **

** **
			 
** **

** **

 

 

**For the three**

**month period ended**

**March 31, 2009**

** **

**For the three**

**month period ended**

**March 31, 2008**

** **

**Percent change for the**

**three month period ended**

**March 31, 2009 over the**

**three month period ended**

**March 31, 2008**

** **

**For the**

**year ended**

**December 31, 2008**

** **

** **

**(unaudited)**
			 
** **
			 
** **

** **

** **

** **

** **

** **

** **

** **

** **

**STATEMENTS OF INCOME**

 

 

 

 

 

 

 

Interest income

 $

17,587  

 

20,240 

 

 (13.1)

 % 

 78,341 

Interest expense

5,188  

 

7,691 

 

 (32.5)

 

 26,606 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,399  

 

12,549 

 

   (1.2)

 

 51,735 

Provision for loan losses

2,175  

 

488  			

 

 345.7 

 

   5,619 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after  provision for loan losses

10,224  

 

12,061 

 

 (15.2)

 

 46,116 

Noninterest income

4,431  

 

 4,905 

 

   (9.7)

 

 18,898  			

Noninterest expense

11,538  

 

11,383 

 

     1.4 

 

 43,951 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision  for income taxes

3,117  

 

5,583 

 

 (44.2)

 

 21,063 

Provision for income taxes

1,123  

 

1,937 

 

 (42.0)

 

   7,464 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Net income

 $

1,994  

 

3,646 

 

 (45.3)

 % 

 13,599 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**COMMON AND PER SHARE  DATA**

 

 

 

 

 

 

 

Net income per common  share:

 

 

 

 

 

 

 

 

Basic

 $

0.31  

 

0.57 

 

 (45.5)

 % 

    2.11  			

 

Diluted

0.31  

 

0.56 

 

 (45.4)

 

     2.09 

Cash dividends per common  share

0.06  

 

0.20 

 

 (70.0)

 

     0.80 

Book value per common share

18.12  

 

17.54 

 

   3.3 

 

  17.96  			

Outstanding common shares

6,487,630  

 

6,432,765 

 

   0.9 

 

   6,446,090 

Weighted average common  shares outstanding - basic 

6,448,668  

 

6,431,172 

 

   0.3 

 

   6,438,071 

Weighted average common  shares outstanding - diluted

6,529,972  

 

6,519,127 

 

  0.2  			

 

   6,519,849 

Dividend payout ratio

19.51  

%

 35.30 

 

 (44.7)

 

    37.89 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PERIOD-END BALANCES**

 

 

 

 

 

 

 

Assets

 $

1,403,570  

 

1,295,775 

 

    8.3 

 % 

 1,372,275 

Investment securities  available for sale, at fair value

117,961  

 

127,150 

 

 (7.2)

 

    125,596 

Total loans

1,167,924  

 

 1,083,096 

 

   7.8			

 

   1,165,895 

Deposits (including  traditional and nontraditional)

1,211,479  

 

 1,100,397 

 

 10.1 

 

   1,114,591 

Other short-term borrowings

15,403  

 

 37,500 

 

 (58.9)

 

   79,785 

Long-term borrowings

52,000  

 

 35,000 

 

   48.6  			

 

   52,000 

Shareholders' equity

117,550  

 

112,836 

 

     4.2 

 

 115,776 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**AVERAGE BALANCES**

 

 

 

 

 

 

 

Assets

 $

1,387,349  

 

1,260,526 

 

   10.1 

 % 

 1,322,541 

Interest-earning assets

1,315,765  

 

 1,195,808 

 

   10.0 

 

 1,253,381 

Investment securities  available for sale, at fair value

123,511  

 

102,202 

 

  20.8  			

 

 123,551 

Total loans

1,164,661  

 

 1,067,468 

 

    9.1 

 

   1,111,430 

Deposits (including traditional  and nontraditional)

1,153,009  

 

 1,098,924 

 

    4.9 

 

   1,106,252 

Other short-term borrowings

54,437  

 

 28,217 

 

  92.9  			

 

   48,543 

Long-term borrowings

52,000  

 

   9,615 

 

 440.8 

 

   41,415 

Shareholders' equity 

117,894  

 

 112,714 

 

    4.6 

 

   116,222 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PERFORMANCE RATIOS**

 

 

 

 

 

 

 

Return on average assets

0.58  

%

 1.16 

 

 (50.0)

 % 

     1.03 

Return on average  shareholders' equity

6.86  

 

 13.01 

 

 (47.3)

 

   11.70 

Net interest margin

3.82  

 

   4.22 

 

   (9.5)

 

    4.13 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**CAPITAL RATIOS**

 

 

 

 

 

 

 

Average shareholders'  equity as a percentage of average assets

8.50  

%

   8.94 

 

   (4.9)

 % 

   8.79 

Shareholders' equity as a  percentage of assets at period end 

8.38  

 

   8.71 

 

   (3.8)

 

    8.44 

Tier 1 risk-based capital

9.74  

 

   9.55 

 

   2.0 

 

    9.55 

Total risk-based capital

10.77  

 

 10.19 

 

  5.7 

 

 10.44 

Tier 1 leverage ratio

8.67  

 

   8.87 

 

   (2.3)

 

   8.70 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**ASSET QUALITY RATIOS**

 

 

 

 

 

 

 

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

1.09  

 % 

   0.70 

 

   55.7 

 % 

   0.95 

Nonaccrual loans as a  percentage of loans and foreclosed assets (1)

4.82  

 

   0.52 

 

 829.8 

 

   3.69 

Nonperforming assets as a  percentage of assets

4.53  

 

   1.08 

 

 321.7 

 

   3.66 

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

0.20  

 

   0.16 

 

  25.8  			

 

   0.18 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Loans calculated  excluding mortgage loans held for sale, net of unearned income, excluding  allowance for loan losses.

 

 

 

 

 

 

 

 

* *

31

 

 

***Management’s Overview***

*** ***

Since year-end 2008 we have all come to realize that no onehas been immune from the real estate recession that plunged the U.S. economy into its biggest decline in 75 years.  Our response to the deepeningcrisis has been proactive, and, we believe, appropriate addressing liquidity,capital and reserves, loan quality, dividends and expense controls, and aimedsquarely at supporting our highest priority – to maintain the safety andsoundness of The Palmetto Bank as we have done for over 102 years.

 

While results for the first quarter were below ourprojections, we were profitable and maintained our well capitalized position inthe industry.  Net income for the first quarter of 2009 totaled $2.0million compared with $3.6 million for the same period of 2008.  Thisdecrease in net income was primarily the result of an increase in the provisionfor loan losses of $1.7 million over the same periods.

 

We believe that continuing to strengthen loan loss reservesis the prudent action due to increases in nonaccrual loans collateralized byreal estate, specifically, construction and land development and nonfarmresidential loans, which have been negatively impacted by the economic turmoil. Nonperforming assets increased to $63.6 million or 4.53% of total assets atMarch 31, 2009, compared to $50.3 million or 3.66% of total assets on December31, 2008. The bulk of these nonperforming loans are concentrated in arelatively small number of higher balance commercial real estate loans. We continue to be aggressive in working with customers to resolve any loanproblems as quickly as possible.  Actual loans charged-off in the firstquarter 2009 were 0.20% of average loans excluding mortgage loans held for salecompared to 0.18% for the year ended December 31, 2008. Management believesthat the current economic and real estate market conditions will result inelevated credit costs.  See Part II – Other Information, Item 1a. Risk Factorsfor a discussion of certain factors that could cause our financial results andoperations to vary materially from periodto period or cause actual results to differ from expectations for futurefinancial and business performance. 

 

Capital preservation and liquidity management continue to betop priorities for management.  We strengthened liquidity levels duringthe first quarter of 2009 by successfully raising additional core deposits of$97 million through our customer base thereby decreasing our reliance on wholesalefunding.  From a net borrowed position at year end 2008, at March 31,2009 the company maintained excess liquidity of approximately $43 million inits account with the Federal Reserve.  In the second quarter, we intend totake additional measures to boost liquidity levels by raising additionaldeposits through our own customer base.

 

While reducing the cash dividend for the first quarter was adifficult decision, we believe that it was the right thing to do.  We alsofeel obligated to achieve further improvements in expense control through arigorous re-examination of the budget for 2009, and we believe that we haveidentified ways to reduce overhead over the next 12 months by an additional $1million without planned reductions in staff.  No one can foresee with anycertainty when this recession will end.  It is the intent of the Board ofDirectors to address the dividend payment quarterly to balance the need foradditional capital and reserves against the progress we see in resolving loanquality issues and evidence of a change for the better in key economicindicators.

 

While these are challenging times for all of us, we remainfocused on the future and the opportunity it brings as we continue building oneof the most successful banking franchises in South Carolina.  

 

We opened our new corporate headquarters in downtown Greenville, South Carolina during March 2009. In April 2009, we celebrated the grandopening of a relocated banking office in the city of Greer.  

 

 

32

 

 

 

 

 

 

On February 17, 2009, the American Recovery and ReinvestmentAct (the “Recovery Act”) was signed into law in an effort to, among otherthings, create jobs and stimulate growth in the U.S. economy.  The Recovery Actspecifies appropriations of approximately $787 billion for a wide range ofFederal programs.  The Recovery Act imposes certain limitations on compensation paid byparticipants in the troubled assetrelief program (“TARP”).  However, since we did notparticipate in TARP, these limitations had no effect on us. 

 

Traditional deposit accountscontinue to be our primary source of funding and increased by approximately $97 millionduring the first three months of 2009 primarily as the result of a certificateof deposit promotion intended to increase liquidity during the period.  Investmentsecurities available for sale decreased by approximately $7.6 million at March 31,2009 compared to December 31, 2008, primarily within thecollateralized mortgage obligation sector of the portfolio.  As principalpaydowns occurred during the first quarter, we did not reinvest the proceedsinto the investment portfolio.  A portion of our excess liquidity during the firstquarter of 2009 was used to repay other short-term borrowings.  At March 31,2009, we had $72.9 million in secured FHLB borrowing availability and $42.1million in unused unsecured correspondent banking availability.  Loanscontinue to be the largest component of our assets. The increase in total loanswas primarily within the held for sale category.  Loans remained relativelyunchanged during the three month period ended March 31, 2009 because we placed less emphasis onasset growth and more emphasis on capital preservation and liquiditymanagement.

 

Net income for thefirst quarter of 2009 totaled $2.0 million compared with $3.6 million for the same period of 2008.  Net interest income totaled $12.4million for the three month period ended March 31, 2009 as compared to $12.5million for the same period of 2008. The net interest margin decreased from4.22% during the three month period ended March 31, 2008 to 3.82% during thesame period of 2009.  Therelationship between declining interest-earning assets yields and more slowlydeclining interest-bearing liability costs has caused, and may continue tocause, net interest margin compression.  As discussedabove, the provision for loanlosses increased from $488 thousand during the first three months of 2008 to$2.2 million for the same period of 2009. 

 

Noninterestincome decreased $474 thousand during the first quarter of 2009 when comparedwith the same period of 2008. This decrease was driven by a decline in all fee income areas with the exception of mortgage-bankingincome. Mortgage banking income increased over the periods presented primarilyas a result of the Bank capitalizing on refinancing opportunities resultingfrom historically low interest rates.  

Noninterest expense increased $155thousand, or 1.4%, during the first quarter of 2009 when compared with the sameperiod of 2008. 

 

***Critical Accounting Policies and Estimates***

 

Our significant accounting policiesare fundamental to understanding our results of operations and financialcondition because some accounting policies require the use of estimates andassumptions that may impact the value of assets or liabilities and financialresults. Such policies are critical because they require us to make difficult,subjective, and complex judgments about matters that are inherently uncertainand because it is likely that materially different amounts would be reportedunder different conditions or using different assumptions. As reported in theAnnual Report on Form 10-K for the year ended December 31, 2008, these policiesgovern the allowance for loan losses, the valuation of the mortgage-servicingrights portfolio, the defined benefit pension plan, and the determination ofthe fair value of financial instruments. On an annual basis, management, inconjunction with our registered public accounting firm, discusses the criticalaccounting estimates with the Audit Committee of our Board of Directors. Foradditional information regarding our critical accounting policies andestimates, refer to our Annual Report on Form 10-Kfor the year ended December 31, 2008. 

 

33

 

 

 

***Financial Condition*****

* *

*Overview*

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated (Interim) Balance Sheets**

**(dollars in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**March 31,**

 

**December 31,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2009**

 

**2008**

 

**variance**

 

**variance**

 

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

$

67,992 

 

29,305 

 

38,687 

 

132.0 

%

 

Federal funds sold

 

 

- 

 

- 

 

- 

 

- 

 

 

 

Total cash and cash equivalents

 

67,992 

 

29,305 

 

38,687 

 

132.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB stock, at cost

 

 

7,010 

 

6,566 

 

444 

 

6.8 

 

Investment securities available for sale, at fair value

 

117,961 

 

125,596 

 

(7,635)

 

(6.1)

 

Mortgage loans held for sale

 

 

11,562 

 

7,415 

 

4,147 

 

55.9 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, gross

 

 

1,156,362 

 

1,158,480 

 

(2,118)

 

(0.2)

 

 

Less: allowance for loan losses

 

(12,606)

 

(11,000)

 

(1,606)

 

14.6 

 

 

 

Loans, net

 

 

1,143,756 

 

1,147,480 

 

(3,724)

 

(0.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

28,794 

 

26,347 

 

2,447 

 

9.3 

 

Premises held for sale

 

 

- 

 

1,651 

 

(1,651)

 

(100.0)

 

Goodwill, net

 

 

3,691 

 

3,691 

 

- 

 

- 

 

Core deposit intangibles, net

 

 

23 

 

34 

 

(11)

 

(32.4)

 

Accrued interest receivable

 

 

5,491 

 

5,466 

 

25 

 

0.5 

 

Other

 

 

17,290 

 

18,724 

 

(1,434)

 

(7.7)

 

 

 

 

Total assets

 

 

$

1,403,570 

 

1,372,275 

 

31,295 

 

2.3 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing

 

 

$

130,003 

 

133,248 

 

(3,245)

 

(2.4)

%

 

Interest-bearing

 

 

1,037,149 

 

937,031 

 

100,118 

 

10.7 

 

 

 

Total deposits

 

 

1,167,152 

 

1,070,279 

 

96,873 

 

9.1 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

21,105 

 

16,357 

 

4,748 

 

29.0 

 

Commercial paper (Master notes)

 

23,222 

 

27,955 

 

(4,733)

 

(16.9)

 

Other short-term borrowings

 

 

15,403 

 

79,785 

 

(64,382)

 

(80.7)

 

Long-term borrowings

 

 

52,000 

 

52,000 

 

- 

 

100.0 

 

Accrued interest payable

 

 

1,867 

 

1,857 

 

10 

 

0.5 

 

Other

 

 

5,271 

 

8,266 

 

(2,995)

 

(36.2)

 

 

 

Total liabilities

 

 

1,286,020 

 

1,256,499 

 

29,521 

 

2.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

32,260 

 

32,230 

 

30 

 

0.1 

 

Capital surplus

 

 

2,373 

 

2,095 

 

278 

 

13.3 

 

Retained earnings

 

 

89,173 

 

87,568 

 

1,605 

 

1.8 

 

Accumulated other comprehensive loss, net of tax

 

(6,256)

 

(6,117)

 

(139)

 

2.3 

 

 

 

Total shareholders' equity

 

117,550 

 

115,776 

 

1,774 

 

1.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,403,570 

 

1,372,275 

 

31,295 

 

2.3 

%

 
Cash and Cash Equivalents
 

Cash and cash equivalents increased $38.7 million at March31, 2009 over December 31, 2008 because management decided to keep additionalcash reserves with the Federal Reserve to reduce risks associated with selling thosefunds to correspondent banks.  

 

In aneffort to manage our associated risks, we generally do not maintain depositswith other financial institutions in amounts that exceed federal depositinsurance coverage. Furthermore, federal funds sold are essentiallyuncollateralized loans to other financial institutions that are not subject tofederal deposit insurance coverage. Therefore, management regularly evaluatesthe risk associated with the counterparties to these transactions to ensurethat we do not expose ourselves to any significant risks with regard to ourcash and cash equivalent balances.  At March 31, 2009 our excess liquidity washeld at the Federal Reserve Bank of Richmond. 

* *

* Investment Activities*

 

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

 

 

**March 31, 2009**

 

**December 31, 2008**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

State and municipal

$

48,586 

41.2 

 

50,830 

40.5 

Collateralized mortgage obligations

49,860 

42.3 

 

54,639 

43.5 

Other mortgage-backed (federal agencies)

19,515 

16.5 

 

20,127 

16.0 

		   

Total investment securities available for sale

$

117,961 

100.0 

%

125,596 

100.0 

34

 

 

 

 

Average balances of investment securities available for saleremained relatively unchanged at $123.5 million during the three month period endedMarch 31, 2009 from $123.6 million for the year ended December 31, 2008.  The decrease in investment securities available for saleat March 31, 2009 over December 31, 2008 was primarilywithin the collateralized mortgage obligationsector of the portfolio.  As principalpaydowns occurred during the first quarter, we did not reinvest the proceedsinto the investment portfolio.  

 

The following tablesummarizes the amortized cost and fair value composition of the investmentsecurities available for sale portfolio at the dates indicated (dollars inthousands).

 

 

**March 31, 2009**

 

**December 31, 2008**

 

**Amortized**

**Fair**

 

**Amortized**

**Fair**

 

**cost**

**value**

 

**cost**

**value**

State and municipal

$

47,088 

48,586 

 

50,297 

50,830 

Collateralized mortgage obligations

54,756 

49,860 

 

58,033 

54,639 

Other mortgage-backed (federal agencies)

18,953 

19,515 

 

19,876 

20,127 

Total investment securities available for sale

$

120,797 

117,961 

 

128,206 

125,596 

 

We use prices from third party pricing services and, to alesser extent, indicative (non-binding) quotes from third party brokers, tomeasure fair value of the Company’s investment securities. See Item 1. Financial Statements, Note 16 forfurther discussion regarding the amount and fair value hierarchyclassification of investment securities measured at fair value using a thirdparty pricing service and those measured at fair value using broker quotes.  We utilize multiple third party pricingservices and brokers to obtain fair values; however, management generallyobtains one price / quote for each individual security. For securities pricedby third party pricing services, management determines the most appropriate andrelevant pricing service for each security class and has that vendor providethe price for each security in the class. We recorded the unadjusted valueprovided by the third party pricing service / broker in our Consolidated InterimFinancial Statements.  Wehave concluded that the fair values for our investment securities available forsale at March 31, 2009 were consistent with the guidance in SFAS No. 157.   AtMarch 31, 2009, all collateralized mortgage obligations were valued using levelthree inputs as no active trading market existed at that time. 

 

Other-Than-Temporary Impairment Analysis. We conductother-than-temporary impairment analysis on a quarterly basis or more often ifa potential loss-triggering event occurs. We recognize other-than-temporaryimpairment when it is probable that we will be unable to collect all amountsdue according to the contractual terms of the security, and the fair value ofthe investment security is less than its amortized cost. The initial indicationof other-than-temporary impairment for investment securities is a decline inthe market value below the amount recorded for an investment and the severityand duration of the decline. In determining whether an impairment isother-than-temporary, we consider the length of time and the extent to whichthe market value has been below cost, recent events specific to the issuer,including investment downgrades by rating agencies and economic conditions ofits industry, and our ability and intent to hold the investment for theforeseeable future.  We also consider the cause of the price decline (generallevel of interest rates and industry- and issuer-specific factors), theissuer’s financial condition, near-term prospects and current ability to makefuture payments in a timely manner, the issuer’s ability to service debt, anychange in agencies’ ratings at evaluation date from acquisition date and anylikely imminent action, and for collateralized mortgage obligations, the creditperformance of the underlying collateral, including delinquency rates,cumulative losses to date, and the remaining credit enhancement compared toexpected credit losses of the security. 

 

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

 

 

**March 31, 2009**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

State and municipal

4 

$

1,147 

$

37 

 

- 

- 

- 

 

4 

1,147 

37 

Collateralized mortgage obligations

5 

18,003 

1,305 

 

7 

25,423 

3,647 

 

12 

43,426 

4,952 

Other mortgage-backed (federal agencies)

4 

248 

- 

 

- 

- 

- 

 

4 

248 

- 

 

Total investment securities available for sale

13 

$

19,398 

$

1,342 

 

7 

25,423 

3,647 

 

20 

44,821 

4,989 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

35

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2008**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**value**

**Gross**

**unrealized**

**losses**

State and municipal

12 

$

5,441 

$

101 

 

1 

423 

1 

 

13 

5,864 

102 

Collateralized mortgage obligations

13 

52,603 

3,417 

 

- 

- 

- 

 

13 

52,603 

3,417 

Other mortgage-backed (federal agencies)

4 

1,336 

15 

 

1 

838 

4 

 

5 

2,174 

19 

 

Total investment securities available for sale

29 

$

59,380 

$

3,533 

 

2 

1,261 

5 

 

31 

60,641 

3,538 

 

The increase in investment securities available for sale ina gross unrealized losses position at March 31, 2009 was caused byextraordinarily wide asset spreads resulting from an extremely illiquid market,causing these assets to be valued at significant discounts from cost. The fairvalue is expected to recover as the bonds approach their maturity dates orrepricing dates or if market yields for such investments decline further. Grossunrealized losses increased $1.5 million from December 31, 2008 to March 31,2009, primarily within the collateralized mortgage obligation sector of theinvestment securities portfolio.  Partially offsetting this increase wereimprovements within the state and municipal and other mortgage-backed sectors. Gross unrealized losses on collateralized mortgage obligations in the twelvemonths or longer category increased based on our date of purchase.  Wepurchased each of the seven securities twelve to thirteen months prior to March31, 2009.

 

Any decline in the fair value of available for sale securitiesbelow cost that are deemed to be other-than-temporary is reflected in income asrealized losses. As of March 31, 2009, we have received all principal andinterest payments, believe that the principal and interest on these securitiesare fully recoverable, and have the ability and intent to hold the securitiesfor a period of time sufficient for a recovery of cost. Accordingly, managementbelieves the gross unrealized losses detailed in the preceding table aretemporary, and, therefore, were not other-than-temporarily impaired at March31, 2009.

 

The fair values of the investment securities portfolio coulddecline in the future if the underlying performance of the collateral forcollateralized mortgage obligations or other securities deteriorates and thecredit enhancement levels do not provide sufficient protection to contractualprincipal and interest. As a result, there is risk that other-than-temporaryimpairments may occur in the future particularly in light of the currenteconomic environment.

 

Concentrations of Risk. Nostate and municipal security issuers issued securities with fair valuesexceeding 2% of total shareholders’ equity at March 31, 2009.  Five state andmunicipal security issuers issued securities with fair values exceeding 1% oftotal shareholders’ equity at March 31, 2009 ranging from 1.0% to 1.8%. Althoughall state and municipal securities are not rated “AAA,” all are within ourratings standard outlined in our Investment Policy which requires rated bondsto average between “Aa” and “A” by one of the major bond rating agencies.

 

Collateralized mortgage obligationissuers issued securities with fair values ranging from 1.5% to 7.6% of totalshareholders’ equity at March 31, 2009. 

 

The following table summarizesissuer fair value concentration of other mortgage-backed investment securities,by issuer, at March 31, 2009 (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

**Federal**

**National**

**Mortgage**

**Association**

 

**Federal**

**Home Loan**

**Mortgage**

**Corporation**

**Total**

Other mortgage-backed

$

16,349 

 

3,166 

19,515 

 

 

 

 

 

 

As a percentage of shareholders' equity

13.9 

%

2.7 

16.6 

 

Pledged. Approximately57% of the investment securities portfolio, at fair value, was pledged tosecure public deposits and trust assets at March 31, 2009 as compared with 55%at December 31, 2008.  Of the $67.5 million pledged available for saleinvestment securities balance at March 31, 2009, $54.7 million of theinvestment securities portfolio, at fair value, was securing public depositsand trust assets.  Of the $69.1 million pledged available for sale investmentsecurities balance at December 31, 2008, $47.0 million of available for saleinvestment securities was securing public deposits and trust assets.  

36

 

 

 

 

To borrow from the FHLB, members must pledge collateral to secureadvances and letters of credit.  Acceptable collateral includes a variety ofsingle-family residential loans, commercial real estate loans, home equitylines of credit, and multifamily residential loans as well as a number of typesof securities.  Approximately $39.4 million, or 33%, of the investmentsecurities portfolio, at fair value, was pledged to collateralize FHLB advancesand letters of credit as of March 31, 2009 of which $35.4 million was utilizedas lendable collateral.  At December 31, 2008, approximately $41.6 million, or33%, of the investment securities portfolio, at fair value, was pledged tocollateralize FHLB advances and letters of credit of which $37.5 million wasutilized as lendable collateral.  

 

*Lending Activities*

* *

Composition.  Loanscontinue to be the largest component of our assets. Loans remained relativelyunchanged during the three month period ended March 31, 2009 because we placed lessemphasis on asset growth and more emphasis on capital preservation andliquidity management. The slight increase in total loans was primarily withinthe held for sale category. The following table summarizes gross loans,categorized by loan purpose, excluding those mortgage loans held for sale, atthe dates indicated (dollars in thousands). 

 

 

 

**March 31,**

 

**December 31,**

 

 

**2009**

 

**2008**

 

 

**Total**

**% of**

**total**

 

**Total**

**% of**

**total**

Commercial business

$

143,809 

12.4 

%

154,304 

13.3 

Commercial real estate

758,498 

65.6 

 

740,420 

63.9 

Installment

22,236 

1.9 

 

23,547 

2.0 

Installment real estate

85,295 

7.4 

 

85,506 

7.4 

Indirect

34,859 

3.0 

 

34,566 

3.0 

Credit line

1,913 

0.2 

 

2,090 

0.2 

Prime access

65,860 

5.7 

 

64,384 

5.5 

Residential mortgage

28,405 

2.5 

 

36,611 

3.2 

Bankcards

11,943 

1.0 

 

12,470 

1.1 

Business manager

293 

- 

 

152 

- 

Other

1,846 

0.2 

 

1,934 

0.2 

Loans in process

1,086 

0.1 

 

2,141 

0.2 

Deferred loans fees and costs

319 

- 

 

355 

- 

 

Loans, gross

$

1,156,362 

100.0 

%

1,158,480 

100.0 

 

 

 

 

 

 

 

 

The following table summarizesgross loans, categorized by FDIC code, excluding those mortgage loans heldfor sale, at the dates indicated (dollars in thousands). 

 

 

 

**March 31, 2009**

 

**December 31, 2008**

 

 

 

**Total**

**% of total**

 

**Total**

**% of total**

 

Secured by real estate

 

 

 

 

 

 

 

Construction, land development, and other land loans

$

267,091 

23.1 

%

$

235,216 

20.3 

 

 

Farmland

650 

0.1 

 

882 

0.1 

 

 

Single-family residential

217,763 

18.8 

 

217,734 

18.8 

 

 

Multifamily residential

39,050 

3.4 

 

36,349 

3.1 

 

 

Nonfarm nonresidential

477,259 

41.3 

 

510,180 

44.1 

 

Commercial and industrial

74,184 

6.4 

 

73,609 

6.4 

 

Obligations of states and political subdivisions of the U.S.

1,223 

0.1 

 

2,602 

0.2 

 

General consumer

59,209 

5.1 

 

60,626 

5.2 

 

Credit line

5,878 

0.5 

 

6,215 

0.5 

 

Bankcards

11,841 

1.0 

 

12,416 

1.1 

 

Others

2,214 

0.2 

 

2,651 

0.2 

 

		   

Loans, gross

$

1,156,362 

100.0 

%

$

1,158,480 

100.0 

 

 

 

 

 

 

 

 

 

Loans included in both of thepreceding loan composition tables are net of participations sold and mortgageloans sold and serviced for others.  Participations sold totaled $26.7 millionat March 31, 2009 and December 31, 2008.  Mortgage loans serviced for thebenefit of others amounted to $396.5 million and $377.3 million at March 31,2009 and December 31, 2008, respectively. 

* *

Pledged.  To borrow from the FHLB, members mustpledge collateral to secure advances and letters of credit.  Acceptablecollateral includes a variety of residential, multifamily, home equity linesand second mortgages, and commercial loans as well as a number of types ofsecurities. Approximately $370.0 million, or 32%, of the gross loans, excludingmortgage loans held for sale, were pledged to collateralize FHLB advances andletters of credit at March 31, 2009, of which $158.5 million was available aslendable collateral.  Of the $379.4 million loan balance, gross, excluding mortgageloans held for sale, pledged at December 31, 2008, $159.1 million was availableas lendable collateral.  In order to compute lendable collateral amounts,pledged loan unpaid principal balances are reduced by a collateral verificationreview extrapolation factor before being multiplied by a collateral valuepercentage.  

 

37

 

 

 

Concentrations of Risk. Borrower Concentration. Managementdoes not believe that the loan portfolio isconcentrated in loans to any single borrower or a relatively small number of borrowers.

 
Geographic Concentration. Unlike larger national or regional banks that are more geographically diversified, our services are primarily provided to customers within our market area. Deterioration in local economic conditions could result in declines in asset quality, loan collateral values, and the demand for our products and services, among other things. Although the geographic concentration limits us to the economic risks within our market area, the lack of geographic diversification may make us particularly susceptible to the adverse impacts of negative economic conditions that impact our market area.
 

LoanType / Industry Concentration.  The following table summarizes loanssecured by commercial real estate, categorized by FDIC code, at March 31, 2009(dollars in thousands).  

 

 

 

 

**Total**

**% of Bank's**

**loan**

**portfolio,**

**gross**

 

**% of Bank's**

**tier 1**

**capital**

Secured by commercial real estate

 

 

 

 

		   

Construction, land development, and other land loans

$

267,091 

23.1 

%

223.3 

 

Multifamily residential

39,050 

3.4 

 

32.7 

 

Nonfarm nonresidential

477,259 

41.2 

 

399.0 

 

 

Total loans secured by commercial real estate

$

783,400 

67.7 

%

655.0 

 

The following table furthercategorizes loans secured by commercial real estate, categorized by FDIC code,at March 31, 2009 (dollars in thousands).  

 

 

 

 

 

 

**Total**

**% of Bank's**

**loan**

**portfolio,**

**gross**

 

**% of Bank's**

**tier 1**

**capital**

Development commercial real estate loans

 

 

 

 

 

Loans secured by:

 

 

 

 

 

 

Land - unimproved (commercial or residential)

$

31,384 

2.7 

%

26.2 

 

 

Land development - commercial

12,593 

1.1 

 

10.5 

 

 

Land development - residential

142,850 

12.3 

 

119.4 

 

 

Commercial construction:

 

 

 

 

 

 

 

Hotel / motel

13,338 

1.2 

 

11.2 

 

 

 

Retail

2,378 

0.2 

 

2.0 

 

 

 

Multifamily

16,933 

1.5 

 

14.2 

 

 

 

Industrial and warehouse

6,690 

0.6 

 

5.6 

 

 

 

Health care

9,293 

0.8 

 

7.8 

 

 

 

Miscellaneous commercial

15,084 

1.3 

 

12.6 

 

 

 

 

Total development commercial real estate loans

250,543 

21.7 

 

209.5 

 

 

 

 

 

 

 

 

 

Existing and other commercial real estate loans

 

 

 

 

 

Loans secured by existing real estate:

 

 

 

 

 

 

Hotel / motel

100,454 

8.7 

 

84.0 

 

 

Retail

 

32,877 

2.8 

 

27.5 

 

 

Office

 

31,923 

2.8 

 

26.7 

 

 

Multifamily

39,050 

3.4 

 

32.6 

 

 

Industrial and warehouse

14,223 

1.2 

 

11.9 

 

 

Healthcare

28,811 

2.5 

 

24.1 

 

 

Miscellaneous commercial

129,507 

11.2 

 

108.3 

 

 

Residential construction - speculative

20,004 

1.7 

 

16.7 

 

 

 

 

Total existing and other commercial real estate loans

396,849 

34.3 

 

331.8 

 

 

 

 

 

 

 

 

 

Commercial real estate owner occupied and residential loans

 

 

 

 

 

Loans secured by:

 

 

 

 

 

 

Commercial - owner occupied

132,717 

11.5 

 

111.0 

 

 

Commercial construction - owner occupied

3,013 

0.2 

 

2.5 

 

 

Residential construction - contract

278 

		-  

 

0.2 

 

 

 

 

Total commercial real estate owner occupied and residential loans

136,008 

11.7 

 

113.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans secured by commercial real estate

$

783,400 

67.7 

%

655.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We believe that the properties securing our commercial realestate portfolio are diverse in terms of type. This diversity reduces ourexposure to adverse economic events that impact any single industry. 

 

 

38

 

 

 

 

 

Asset Quality. NonperformingAssets. The following table summarizes trends in nonperforming assets at the dates indicated (dollars inthousands). Nonaccrual loans are categorized by FDIC code. 

 

 

 

**March 31,**

 

**December 31,**

 

 

**2009**

 

**2008**

 

 

 

 

 

Secured by real estate

 

 

 

 

Construction, land development, and other land loans

$

18,234 

 

15,409 

 

Farmland

- 

 

- 

 

Single-family residential

3,006 

 

2,569 

 

Multifamily residential

814 

 

231 

 

Nonfarm nonresidential

32,830 

 

23,725 

Commercial and industrial

839 

 

763 

General consumer

392 

 

271 

 

Total nonaccrual loans

56,115 

 

42,968 

 

 

 

 

 

Real estate acquired in settlement of loans

6,771 

 

6,719 

Repossessed automobiles acquired in settlement of loans

762 

 

564 

 

Total foreclosed assets

7,533 

 

7,283 

 

 

 

 

 

 

Total nonperforming assets

$

63,648 

 

50,251 

 

 

 

 

 

Loans past due 90 days and still accruing (1)

$

226 

 

206 

 

 

 

 

 

Loans (2)

$

1,156,362 

 

1,158,480 

 

 

 

 

 

Total assets

1,403,570 

 

1,372,275 

 

 

 

 

 

Nonaccrual loans as a percentage of:

 

 

 

 

loans and foreclosed assets (2)

4.82 

%

3.69 

 

total assets

4.00 

 

3.13 

 

 

 

 

 

Nonperforming assets as a percentage of:

 

 

 

 

loans and foreclosed assets (2)

5.47 

%

4.31 

 

total assets

4.53 

 

3.66 

 

 

 

 

 

(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 for loan losses

 

Of the $63.6 million in nonperforming assets at March 31, 2009,approximately 97% of our exposure had underlying real estate collateral. 

 

The following table summarizes the changes in nonaccrualloans during the three month period ended March 31, 2009 (in thousands).

 

 

 

 

 

Nonaccrual loans, December 31, 2008

$

42,968 

		   

Less: December 31, 2008 nonaccrual loans removed from nonaccrual during 2009

(735)

 

Less: Change in balance of December 31, 2008 nonaccrual loans still in nonaccrual status at March 31, 2009

191 

 

Plus: 2009 nonaccrual additions, net

13,691 

Nonaccrual loans, March 31, 2009

$

56,115 

 

 

 

 

Approximately 94% of the$13.7 million of the 2009 net nonaccrual additions was contained within fourloan relationships.  The following table further summarizes these additions, byFDIC code, including number of loans and carrying loan value within eachcategory (dollars in thousands).  

 

 

 

 

 

 

 

 

#

Carrying value
Construction, land development and other land loans		
4 
$

8,594 
Secured by nonfarm nonresidential real estate
2 
		 
4,295 

 

Total

6 

$

12,889 

 

 

 

 

 

39

 

 

 

 

 

Real estate and personal property acquired in settlement ofloans is classified within other assets on the Consolidated (Interim) BalanceSheets until it is sold.  The followingtable summarizes the changes in the real estate acquired in settlementof loans portfolio at and for the periods indicated (in thousands).

 

 

 

**At and for the**

 

**At and for the**

 

 

**three month**

**At and for the**

**three month**

 

 

**period ended**

**year ended**

**period ended**

 

 

**March 31, 2009**

**December 31, 2008**

**March 31, 2008**

Real estate acquired in settlement of loans, beginning of period

$

6,719 

7,743 

7,743 

 

Add: New real estate acquired in settlement of loans and related adjustments

273 

2,778 

392 

 

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

(202)

(3,634)

(105)

		   

Less: Provision charged to expense

(19)

(168)

(70)

Real estate acquired in settlement of loans, end of period

$

6,771 

6,719 

7,960 

 

 

 

 

 

 

One loan relationship comprisesapproximately 62% of the real estate acquired in settlement of loansportfolio.  With regard to this relationship, the lead bank is managing theoperations of the property and is currently working with an external firm tomarket the property.  The Bank was a 20% participant in the loan relationshipand is now a 20% owner of the collateral property.  The relationship wascarried at market value at March 31, 2009 based on information available atthat time.  

 

In addition to the stepsmanagement has taken with regard to the loan loss reserve, we continue toactively manage our nonperforming assets and will continue to be aggressive inworking with customers to resolve these issues as quickly as possible. However,given the nature of the projects related to such loans, immediate resolution inall cases is not expected. Therefore, it is reasonable to expect the provisionwill remain at elevated levels for coming periods when compared to priorperiods. 

 

Increases in nonperformingassets and impaired loans collateralized by real estate resulted fromthe adverse conditions in the real estate markets and economy in general. Until conditions improve in the real estate markets, we likely will continue tohold more nonaccrual loans, nonperformingassets, and impaired loans, as we believe it is currently the mosteconomic option available. 

 

Management believes that the current economic and realestate market conditions will result in elevated credit costs.  See Part II –Other Information, Item 1a. Risk Factors for a discussion of certain factorsthat could cause our financial results and operations to vary materially from period to period or cause actual results todiffer from expectations for future financial and business performance. 

 

Troubled Debt Restructurings.  AtMarch 31, 2009, the principal balance of troubled debt restructurings totaled $1.7 million. 

 
PotentialProblem Loans.  Potential problem loans consist of loans that are generallyperforming in accordance with contractual terms but for which we have concernsabout the ability of the borrower to continue to comply with repayment termsbecause of the borrower’s potential operating or financial difficulties.Management monitors these loans closely and reviews performance on a regularbasis. As of March 31, 2009, potential problem loans, which were not alreadycategorized as nonaccrual, totaled $32.4 million. 
 

Allowance for Loan Losses.  The allowance for loan losses increased from $11.0 million at December31, 2008 to $12.6 million at March 31, 2009, increasing from 0.95% to 1.09% ofloans, respectively, calculated excluding mortgage loans held for sale and theallowance for loan losses, net of unearned income.  The increase in theallowance for loan losses during this period was due primarily to the increasein the level of nonaccrual and impaired loans during 2009. Our loss exposure onnonaccrual and impaired loans was mitigated by collateral we hold with respectto these loans. The value of this collateral, however, deteriorated during2008, which caused an increase in both nonaccrual loans and the relatedallocated allowance for loan losses, which continued into the three monthperiod ended March 31, 2009.  Approximately $3.5 million, or 28%, of the$12.6 million allowance for loan losses at March 31, 2009 relates to loansspecifically reserved. This compares to a specific reserve of$4.5 million, or 40% of the total allowance for loan losses atDecember 31, 2008. The decrease in the percentage of the portfolio fromspecific reserves is attributable to the reevaluation of one property in thebalance of impaired loans at March 31, 2009 as compared to December 31, 2008,in which the previous appraisal did not take into account highest and best use.The general reserve was approximately $9.1 million at March 31, 2009, comparedwith $6.5 million at December 31, 2008. 

 

40

 

 

 

 

Impaired Loans.  Thefollowing table summarizes information relative to impaired loans at the datesand for the periods indicated (in thousands). 

 

 

**At and for the three**

**At and for the**

 

 

 

**month period ended**

**year ended**

 

 

 

**March 31, 2009**

**December 31, 2008**

 

 

Impaired loans, end of period

$

54,612 

37,468 

 

 

Impaired loans subject to specific reserve allocation, end of period

25,354 

21,413 

 

 

Specific allowance allocation on impaired loans, end of period

3,521 

4,453 

 

 

Average impaired loans (1)

46,040 

22,568 

 

 

 

 

 

 

 

(1) Average impaired loans calculated using a simple average

 

 

 

 

 

The increase in impaired loans from December 31, 2008 toMarch 31, 2009 resulted from the addition of a relatively small number of largebalance loan relationships as well as additions to relationships that wereconsidered impaired at December 31, 2008.  Two loan relationships notconsidered impaired at December 31, 2008 totaling $16.4 million were impairedat March 31, 2009. Additionally, during the first quarter of 2009, additional loanswere considered impaired within two loan relationships for which other loanswithin the relationship were considered impaired at December 31, 2008 totaling$960 thousand.  Of the $16.4 million in impaired loan relationships addedduring the first quarter of 2009, $13.0 million was secured by construction,land development and other land real estate and $3.4 million was secured bycommercial nonfarm nonresidential real estate.  The average impaired loanrelationship at March 31, 2009 totaled $6.8 million. 

 

Activity. The following table summarizes activity within theallowance for loan losses, by FDIC code, at the dates and for the periodsindicated (dollars in thousands). Loans charged-off and recovered are chargedor credited to the allowance for loan losses at the time realized. 

 

 

 

 

41

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At and for the**

 

 

 

**At and for the**

 

 

 

 

**three month**

 

**At and for the**

 

**three month**

 

 

 

 

**period ended**

 

**year ended**

 

**period ended**

 

 

 

 

**March 31, 2009**

 

**December 31, 2008**

 

**March 31, 2008**

 

Allowance for loan losses, beginning of period

$

11,000 

 

7,418 

 

7,418 

 

 

		     

 

 

 

 

 

 

 

Provision for loan losses

2,175 

 

5,619 

 

488 

 

 

 

 

 

 

 

 

 

 

Loans charged-off

 

 

 

 

 

 

 

Secured by real estate

 

 

 

 

 

 

 

 

Construction, land development, and other land loans

84 

 

16 

 

- 

 

 

 

Farmland

- 

 

- 

 

- 

 

 

 

Single-family residential

208 

 

367 

 

77 

 

 

 

Multifamily residential

- 

 

- 

 

- 

 

 

 

Nonfarm nonresidential

- 

 

182 

 

13 

 

 

Commercial and industrial

33 

 

430 

 

125 

 

 

General consumer and other

290 

 

1,174 

 

232 

 

 

 

Total loans charged-off

615 

 

2,169 

 

447 

 

 

 

 

 

 

 

 

 

 

Recoveries

 

 

 

 

 

 

 

Secured by real estate

 

 

 

 

 

 

 

 

Construction, land development, and other land loans

- 

 

- 

 

- 

 

 

 

Farmland

- 

 

- 

 

- 

 

 

 

Single-family residential

2 

 

11 

 

2 

 

 

 

Multifamily residential

- 

 

- 

 

- 

 

 

 

Nonfarm nonresidential

10 

 

9 

 

1 

 

 

Commercial and industrial

3 

 

18 

 

8 

 

 

General consumer and other

31 

 

94 

 

18 

 

 

 

Total recoveries

46 

 

132 

 

29 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off

569 

 

2,037 

 

418 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses, end of period

$

12,606 

 

11,000 

 

7,488 

 

 

 

 

 

 

 

 

 

 

Average loans (1)

$

1,156,146 

 

1,107,001 

 

1,062,950 

 

 

 

 

 

 

 

 

 

 

Ending loans (1)

1,156,362 

 

1,158,480 

 

1,072,825 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans

56,115 

 

42,968 

 

5,606 

 

 

 

 

 

 

 

 

 

 

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

0.20 

%

0.18 

 

0.16 

 

 

 

 

 

 

 

 

 

 

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

1.09 

 

0.95 

 

0.70 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of nonaccrual loans

22.46 

 

25.60 

 

133.57 

 

 

 

 

 

 

 

 

 

 

(1)

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

 

 

Provision for loan lossesincreased from $488 thousand during the first three months of 2008 to $2.2million for the same period of 2009. Our decision to increase the provision forloan losses was prompted by a number of factors primarily driven by currenteconomic conditions, as well as our methodology for determining the level ofallowance for losses and regulatory guidelines regarding impaired assets. 

 

We believe that continuing tostrengthen loan loss reserves is the prudent action due to increases innonaccrual loans collateralized by real estate, specifically, construction andland development and nonfarm residential loans, which have been negativelyimpacted by the economic turmoil.  Due to ongoing negative market conditions,we further enhanced our analysis of the loan portfolio and determined anincrease was warranted to balance the current and forecasted economicenvironment and real estate market declines.  

 

Management believes that thecurrent economic and real estate market conditions will result in elevatedcredit costs.

 

42

 

 

 

 

 

Management considers the allowance for loan losses at March31, 2009 appropriate and adequate to cover current losses in the loanportfolio. However, underlying assumptions may be impacted in future periods bychanges in economic conditions, the impact of regulatory examinations, and thediscovery of information with respect to borrowers, which was not known tomanagement at the time of the issuance of the Consolidated Interim FinancialStatements. Therefore, assumptions may or may not prove valid. Thus, there canbe no assurance that loan losses in future periods will not exceed the currentallowance for loan losses amount or that future increases in the allowance forloan losses will not be required. Additionally, no assurance can be given thatmanagement’s ongoing evaluation of the loan portfolio, in light of changingeconomic conditions and other relevant factors, will not require significantfuture additions to the allowance for loan losses, thus adversely impacting ourbusiness, financial condition, results of operations, and cash flows.  See PartII – Other Information, Item 1a. Risk Factors for a discussion of certainfactors that could cause our financial results and operations to vary materially from period to period or causeactual results to differ from expectations for future financial and businessperformance. 

 
Premises and Equipment, Net
 

Premises and equipment, netincreased by $2.4 million, or 9.3%, primarily as a result of the relocation ofour corporate headquarters to our new building in downtown Greenville, SouthCarolina during March 2009 and the completion of our relocated Greer banking officewhich celebrated its grand opening in April 2009.  As discussed elsewhereherein, we recognized $55 thousand in losses with regard to the writeoff of premises,furniture, and equipment in conjunction with the move to the new corporateheadquarters during the three month period ended March 31, 2009.  See Part I –Financial Information, Item 1. Financial Statements, Note 5 contained hereinfor discussion regarding this loss.  

 
Premises Held for Sale
 

Long-lived assets to be sold are classified as held for saleand are no longer depreciated. Certain criteria must be met in order for along-lived asset to be classified as held for sale including that a sale isprobable and expected to occur within a one year period. Long-lived assetsclassified as held for sale are recorded at the lower of carrying amount orfair market value less the estimated costs to sell. At December 31, 2008, twoparcels of land with a book value approximating $1.7 million were classified asheld for sale.  These parcels were sold during the three months ended March 31,2009, at the carrying amount, in conjunction with the relocation of thecorporate headquarters to downtown Greenville. 

 

*Deposit Activities*

* *

The following tablesummarizes our traditional deposit composition at the dates indicated (dollars in thousands).

 

 

 

 

 

 

 

 

 

 

 

**March 31, 2009**

 

**December 31, 2008**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Noninterest-bearing transaction deposit accounts

$

130,003 

11.1 

%

133,248 

12.5 
Interest-bearing transaction deposit accounts
341,414 
29.3 

 

364,315 

34.0 

 

Transaction deposit accounts

471,417 

40.4 

 

497,563 

46.5 

 

 

 

 

 

 

 

Money market deposit accounts

97,215 

8.3 

 

93,746 

8.8 

Savings deposit accounts

40,052 

3.4 

 

36,623 

3.4 

Time deposit accounts

558,468 

47.9 

 

442,347 

41.3 

 

Total traditional deposit accounts

$

1,167,152 

100.0 

%

1,070,279 

100.0 

 

At December 31, 2008,traditional deposit accounts as a percentage of liabilities were 85.2% comparedwith 90.8% at March 31, 2009.   Traditional deposit accounts continue tobe our primary source of funding.  The increase in traditional deposit accountsduring the first three months of 2009 was primarily the result of a certificateof deposit promotion intended to increase liquidity during the period.  

 

*Borrowing Activities*

* *

During the first three months of 2009, we continued to makeliquidity management a top priority. In addition to the Company’s customerbase, we had access to sources of liquidity, including, but not limited to,additional borrowings from the FHLB and borrowings from correspondent banks to assist in meeting deposit withdrawalrequirements and to fund growth of interest-earning assets in excess oftraditional deposit growth.  Borrowings as a percentage of total liabilities decreasedfrom 14.0% at December 31, 2008 to 8.7% at March 31, 2009.  The decrease is dueto the growth in and our reliance on traditional deposit accounts over theseperiods.

 

 

43

 

 

 

 

 

The following tablesummarizes our borrowings composition at the dates indicated (dollars inthousands).

 

 

 

 

 

 

 

 

 

 

**March 31, 2009**

 

**December 31, 2008**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Retail repurchase agreements

$

21,105 

18.9 

%

16,357 

9.3 

Commercial paper

23,222 

20.8 

 

27,955 

15.9 

 

Total nontraditional deposit accounts

44,327 

39.7 

 

44,312 

25.2 

 

 

 

 

 

 

 

Other short-term borrowings

15,403 

13.8 

 

79,785 

45.3 

Long-term borrowings

52,000 

46.5 

 

52,000 

29.5 

 

Total wholesale funding

67,403 

60.3 

 

131,785 

74.8 

 

 

 

 

 

 

 

 

Total borrowed funds

$

111,730 

100.0 

%

176,097 

100.0 

 

 

 

 

 

 

 

 

A portion of our cash inflows generated during the firstquarter of 2009 was used to repay other short-term borrowings.  

 

FHLB Borrowings.**The following tablesummarizes FHLB borrowed funds utilization and availability at the dates indicated (in thousands).

 

 

 

 

**March 31,**

**December 31,**

 

 

 

 

 

**2009**

**2008**

 

 

Available lendable loan collateral value to serve against FHLB advances

$

158,475 

159,060 

 

 

Available lendable investment security collateral value to serve against FHLB advances

35,421 

37,481 

 

 

 

 

 

 

 

 

 

Advances and letters of credit

 

 

 

 

 

Short-term advances

- 

(44,000)

 

 

 

Long-term advances

(52,000)

(52,000)

 

 

 

Letters of credit

(69,000)

(69,000)

 

 

 

 

Total advances and letters of credit

(121,000)

(165,000)

 

 

 

 

 

 

 

 

 

Available lendable collateral value to serve against FHLB advances

$

72,896 

31,541 

 

 

 

Management is not aware of anychanges in the availability of FHLB borrowed funding as a result of the currenteconomic environment.  

 

The following table summarizes long-term FHLB borrowings at March 31, 2009(dollars in thousands).  The Company’s long-term FHLB advances do nothave embedded call options. 

 

 

 

 

 

 

 

Total
Borrowing balance

$

5,000 

 

12,000 

30,000 

5,000 

52,000
Interest rate

2.57 

%

2.75 

2.89 

3.61 

2.90
Maturity date

3/8/2010

 

4/2/2010

3/7/2011

4/2/2013
 
 

Federal Funds Accommodations.  In addition to theFHLB borrowing capacity summarized above, at March 31, 2009, we had access tofederal funds funding from correspondent banks.  During March 2009, acorrespondent bank canceled an existing federal funds accommodation of $10million, thereby reducing our overall federal funds accommodation.  Thefollowing table summarizes the federal funds funding utilization andavailability at the dates indicated (inthousands).

 

 

**March 31,**

**December 31,**

 

**2009**

**2008**

Authorized federal funds funding accomodations

$

57,500 

67,500 

 

 

 

Utilized federal funds funding accomodations

(15,403)

(35,785)

 

 

 

Available federal funds funding accomodations

$

42,097 

31,715 

 

 

 

Subsequent to March 31, 2009, a correspondent bank canceledan existing federal funds accommodation of $12.5 million, thereby reducing ouroverall federal funds accommodation to $45.0 million.  Of this $45.0 million inauthorized federal funds funding sources from correspondent banks, $25.0million are not committed facilities and may be canceled at any time at thecorrespondent banks’ discretion.  Although the remaining $20.0 million inauthorized federal funds funding sources from a correspondent bank is committedannually, the accommodation may be terminated at any time at thecorrespondent bank’s discretion.

44

 

 

 

 

 

 

 

*Capital*

* *

General. During the first three months of 2009, wecontinued to make capital preservation a top priority.  The following tablesummarizes capital key performance indicators at and for the periods indicated (dollars in thousands, exceptcommon and per share data).

 

 

**At and for the three month**

 

**periods ended March 31,**

 

**2009**

 

**2008**

Shareholders' equity

$

117,550 

 

112,836 

Average shareholders' equity

117,894 

 

112,714 

 

 

 

 

Shareholders' equity as a percentage of assets

8.38 

%

8.71 

Average shareholders' equity as a percentage of average assets

8.50 

 

8.94 

 

 

 

 

Cash dividends per common share

$

0.06 

 

0.20 

Dividend payout ratio

19.51 

%

35.30 

 

 

 

 

 

The following table summarizes activity impactingshareholders’ equity at and for the periodindicated (in thousands).

 

 

 

 

**At and for the three month**

 

 

 

**period ended March 31, 2009**

Total shareholders' equity, beginning of period

$

115,776 

 

 

 

 

Additions to shareholders' equity during period

 

 

Net income

1,994 

 

Common stock issued pursuant to stock option plans

106 

 

Common stock issued pursuant to restricted stock plan

79 

 

Compensation expense related to stock option plan

16 

 

Income tax benefits from exercises of nonqualified stock options in excess of amount previously provided

107 

 

 

Total additions to shareholders' equity during period

2,302 

 

 

 

 

Reductions in shareholders' equity during period

 

 

Net unrealized loss on investment securities available for sale

(139)

		   

Cash dividends declared and paid

(389)

 

		   

Total reductions in shareholders' equity during period

(528)

 

 

 

 

Total shareholders' equity, end of period

$

117,550 

 

 

 

 

 

AccumulatedOther Comprehensive Income (Loss). The following table summarizes the components of accumulated othercomprehensive income (loss) at and for the periods indicated (in thousands). 

 

 

**Impact of SFAS**

**No. 158**

**Impact of**

**curtailment**

**Total impact**

**of defined**

**benefit**

**pension plan**

**Impact of**

**investment**

**securities**

**available for**

**sale**

**Total**

Accumulated other comprehensive income (loss), after income tax impact, December 31, 2007

$

(4,116)

1,630 

(2,486)

(252)

(2,738)

 

 

 

 

 

 

Accumulated other comprehensive income (loss), before income tax impact

(531)

- 

(531)

721 

190 

Income tax impact

186 

- 

186 

(276)

(90)

Accumulated other comprehensive income (loss), after income tax impact

(345)

- 

(345)

445 

100 

 

 

 

 

 

 

Accumulated other comprehensive income (loss), after income tax impact, March 31, 2008

(4,461)

1,630 

(2,831)

193 

(2,638)

 

 

 

 

 

 

Accumulated other comprehensive income (loss), after income tax impact, December 31, 2008

(6,126)

1,630 

(4,496)

(1,621)

(6,117)

 

 

 

 

 

 

Accumulated other comprehensive income (loss), before income tax impact

- 

- 

- 

(224)

(224)

Income tax impact

- 

- 

- 

85 

85 

Accumulated other comprehensive income (loss), after income tax impact

- 

- 

- 

(139)

(139)

 

 

 

 

 

 

Accumulated other comprehensive income (loss), after income tax impact, March 31, 2009

$

(6,126)

1,630 

(4,496)

(1,760)

(6,256)

 

 

 

 

 

 

 

 

45

 

 

 

 

 

RestrictedStock. On February 19, 2008, our Board of Directors adopted, subject toshareholder approval, the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan,which provides for the grant of stock awards to our employees, officers, anddirectors. The shareholders approved the plan on April 15, 2008. A total of250,000 shares of common stock have been reserved for issuance pursuant toawards under the plan, subject to its anti-dilution provisions. The firstawards were granted in January 2009.  See Part I – Financial Information, Item1. Financial Statements, Note 12 contained herein for additional discussionregarding our restricted stock plan.

 

Regulatory Capital Requirements. Under regulatoryrequirements, reported accumulated other comprehensive income  (loss) amountsdo not increase or reduce regulatory capital and are not included in thecalculation of risk-based capital and leverage ratios. The Company and the Bankare required to meet regulatory capital requirements that currently includeseveral measures of capital.  At March 31, 2009, the Company and the Bank werecategorized as well capitalized under the regulatory framework based on themost recent notification from federal banking agencies.  Since March 31, 2009, noconditions or events have occurred that have resulted in a material change inthe Company's or the Bank's category.  See Part I- Financial Information,Item 1. Financial Statements, Note 17 contained herein for discussion regardingthe Company's and the Bank's regulatory capital requirements and results.

 

Dividends. Thefollowing table summarizes key dividend information at and for the periods indicated (dollars in thousands, except percommon share data).

 

 

 

 

**At and for the three month**

 

 

 

 

 

**periods ended March 31,**

 

 

 

 

 

**2009**

 

**2008**

 

 

Cash dividends per common share

$

0.06 

 

0.20 

 

 

Cash dividends declared and paid

389 

 

1,287 

 

 

Dividend payout ratio

19.51 

%

35.30 

 

 

 

Historically, dividendshave been paid on a quarterly basis. On March 17, 2009, our Board of Directorsdeclared a cash dividend of six cents per share of common stock.  The firstquarter dividends were declared and payable March 31, 2009 to stockholders ofrecord on March 17, 2009.  The Board of Directors believes that areduction in the dividend was prudent to preserve our capital and allow us tomanage our balance sheet during these uncertain times. Our Board of Directorswill continue to evaluate dividend payment opportunities on a quarterly basis.There can be no assurance as to future dividends because they are dependent onour financial condition, results of operations, and / or cash flows, as well ascapital and dividend regulations. See Part II - Other Information, Item 1a.Risk Factors for further discussionregarding the risk of a further reduction or suspension of dividend payments.

 

***Guarantees, Commitments, and Contingencies***

*** ***

See Part I – Financial Information, Item 1. FinancialStatements, Note 14 contained herein for discussion regarding guarantees,commitments, and contingencies.

*** ***

***Freestanding Derivative Financial Instruments andHedging Activities***

*** ***

See Part I – Financial Information, Item 1. FinancialStatements, Note 15 contained herein for discussion regarding derivativefinancial instruments and hedging activities.  

*** ***

46

 

 

***Income Review ***
Overview
 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Income**

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

**periods ended March 31,**

 

 
			 
 
			 
 

 

 

 

 

 

**2009**

 

**2008**

 

 

**Dollar**

**variance**

 

**Percent**

**variance**

 

Interest income

 

 

 

 

 

 

 

 

 

 

Interest earned on cash and cash equivalents

$

6 

 

42 

 

 

(36)

 

(85.7)

%

 

Dividends paid on FHLB stock

- 

 

57 

 

 

(57)

 

(100.0)

 

 

Interest earned on investment securities available for sale

1,533 

 

1,090 

 

 

443 

 

40.6 

 

 

Interest and fees earned on loans

16,048 

 

19,051 

 

 

(3,003)

 

(15.8)

 

 

 

 

Total interest income

17,587 

 

20,240 

 

 

(2,653)

 

(13.1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

Interest paid on deposits

4,712 

 

7,116 

 

 

(2,404)

 

(33.8)

 

 

Interest paid on retail repurchase agreements

13 

 

112 

 

 

(99)

 

(88.4)

 

 

Interest paid on commercial paper

15 

 

144 

 

 

(129)

 

(89.6)

 

 

Interest paid on other short-term borrowings

77 

 

251 

 

 

(174)

 

(69.3)

 

 

Interest paid on long-term borrowings

371 

 

68 

 

 

303 

 

445.6 

 

 

 

 

Total interest expense

5,188 

 

7,691 

 

 

(2,503)

 

(32.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,399 

 

12,549 

 

 

(150)

 

(1.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

2,175 

 

488 

 

 

1,687 

 

345.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

10,224 

 

12,061 

 

 

(1,837)

 

(15.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

   

Service charges on deposit accounts, net

1,884 

 

2,167 

 

 

(283)

 

(13.1)

 

 

Fees for trust and investment management and brokerage services

534 

 

756 

 

 

(222)

 

(29.4)

 

 

Mortgage-banking income

865 

 

469 

 

 

396 

 

84.4 

 

 

Investment securities gains

2 

 

- 

 

 

2 

 

100.0 

 

 

Other

1,146 

 

1,513 

 

 

(367)

 

(24.3)

 

 

 

 

Total noninterest income

4,431 

 

4,905 

 

 

(474)

 

(9.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

Salaries and other personnel

5,862 

 

6,195 

 

 

(333)

 

(5.4)

 

 

Occupancy

916 

 

805 

 

 

111 

 

13.8 

 

 

Furniture and equipment

883 

 

944 

 

 

(61)

 

(6.5)

 

 

Loss on disposition of premises, furniture, and equipment

55 

 

- 

 

 

55 

 

100.0 

 

 

Marketing

297 

 

332 

 

 

(35)

 

(10.5)

 

 

Amortization of core deposit intangibles

11 

 

11 

 

 

- 

 

- 

 

 

Other

3,514 

 

3,096 

 

 

418 

 

13.5 

 

 

 

 

Total noninterest expense

11,538 

 

11,383 

 

 

155 

 

1.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

3,117 

 

5,583 

 

 

(2,466)

 

(44.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

1,123 

 

1,937 

 

 

(814)

 

(42.0)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

1,994 

 

3,646 

 

 

(1,652)

 

(45.3)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common and per share data

 

 

 

 

 

 

 

 

 

 

Net income - basic

$

0.31 

 

0.57 

 

 

(0.26)

 

(45.6)

%

 

Net income - diluted

0.31 

 

0.56 

 

 

(0.25)

 

(44.6)

 

 

Cash dividends

0.06 

 

0.20 

 

 

(0.14)

 

(70.0)

 

 

Book value

18.12 

 

17.54 

 

 

0.58 

 

3.3 

 

 

   

   

   

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,448,668 

 

6,431,172 

 

 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,529,972 

 

6,519,127 

 

 

 

 

 

 

 

Net interestincome totaled $12.4 million for thequarter ended March 31, 2009 as compared to $12.5 million for the same periodof 2008. This decrease in net interest income for the period is due to adecrease of 40 basis points in the net interest margin somewhat offset by a10.0% increase in the average balances of interest-earning assets, combinedwith a similar increase in interest-bearing liabilities as well as the impactof loans placed on nonaccrual during the period. The net interest margindecreased from 4.22% during the three month period ended March 31, 2008 to3.82% during the same period of 2009.  

 

Income resulted in areturn on average shareholders’ equity of 6.86% and 13.01% for the three monthperiods ended March 31, 2009 and 2008, respectively.  Return on average assetswas 0.58% and 1.16% for the same periods.

 
Net Interest Income General.  Net interest income totaled $12.4 million for the quarterended March 31, 2009 as compared to $12.5 million for the same period of 2008.This decrease in net interest income for the period was due to a decrease of 40basis points in the net interest margin somewhat offset by a 10.0% increase inthe average balances of interest-earning assets, combined with a similarincrease in interest-bearing liabilities as well as the impact of loans placedon nonaccrual during the period. The net interest margin decreased from 4.22%during the three month period ended March 31, 2008 to 3.82% during the sameperiod of 2009.  
 

47

 

 

 

During the second half of 2007 andcontinuing through the first quarter of 2009, the financial markets experiencedsignificant volatility resulting from the continued fallout of subprime lendingand the global liquidity crises.  A multitude of governmentinitiatives along with rate cuts by the Federal Reserve have been designed toimprove liquidity for the distressed financial markets and stabilize thebanking system. The relationship between declining interest-earning assetsyields and more slowly declining interest-bearing liability costs has caused,and may continue to cause, net interest margin compression.  
 
Average Balance Sheets and Net Interest Income / MarginAnalysis. The following table summarizes the average balance sheets and netinterest income / margin analysis for the periods indicated (dollars inthousands).  The following table does not include a tax-equivalent adjustmentto net interest income for interest-earning assets earning tax-exempt income toa comparable yield on a taxable basis.

 

 

 

 

 

For the three month periods ended March 31,		

 

 

 

 

2009

 

2008

** **

 

 

 

 

Average 

Income/ 

Yield/ 

 

Average 

Income/ 

Yield/ 

** **

 

 

 

 

balance

expense

rate

 

balance

expense

rate

** **

Assets

 

 

 

 

 

 

 

 

Interest-earnings assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 $

20,450  

 $

6  

         0.12		

%

 $

22,798  

 $

42  

         0.74		

%

 

FHLB stock

7,143  

-    

            -  		

 

3,340  

57  

         6.86		

 

 

Investment securities  available for sale, taxable (1)

72,872  

1,104  

         6.14		

 

49,631  

631  

         5.11		

 

 

Investment securities  available for sale, nontaxable (1)

50,639  

429  

         3.44		

 

52,571  

459  

         3.51		

 

 

Loans (2)

1,164,661  

16,048  

         5.59		

 

1,067,468  

19,051  

         7.18		

 

 

 

Total interest-earning  assets

1,315,765  

17,587  

         5.42		

 

1,195,808  

20,240  

         6.81		

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-earning assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

26,234  

 

 

 

16,605  

 

 

 

 

Allowance for loan losses

(11,298)

 

 

 

(7,434)

 

 

 

 

Premises and equipment, net

27,214  

 

 

 

25,570  

 

 

 

 

Premises held for sale

1,376  

 

 

 

-    

 

 

 

 

Goodwill, net

3,688  

 

 

 

3,688  

 

 

 

 

Core deposit intangibles,  net

22  

 

 

 

74  

 

 

 

 

Accrued interest receivable

5,320  

 

 

 

6,383  

 

 

 

 

Other 

19,028  

 

 

 

19,832  

 

 

 

 

 

Total noninterest-earning  assets

71,584  

 

 

 

64,718  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 $

1,387,349  

 

 

 

 $

1,260,526  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and  Shareholders' Equity

 

 

 

 

 

 

 

 

Liabilities  

 

 

 

 

 

 

 

 

Interest-bearing  liabilities

 

 

 

 

 

 

 

 

 

Transaction deposit accounts

 $

354,384  

 $

245  

         0.28		

%

 $

389,925  

 $

2,029  

         2.09		

%

 

Money market deposit  accounts

94,413  

168  

         0.72		

 

114,327  

776  

         2.73		

 

 

Savings deposit accounts

38,176  

31  

         0.33		

 

36,011  

30  

         0.34		

 

 

Time deposit accounts

489,683  

4,268  

         3.53		

 

381,005  

4,281  

         4.52		

 

 

 

Total interest-bearing  deposits

976,656  

4,712  

         1.96		

 

921,268  

7,116  

         3.11		

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase  agreements

21,692  

13  

         0.24		

 

18,582  

112  

         2.42		

 

 

Commercial paper (Master  notes)

24,409  

15  

         0.25		

 

26,761  

144  

         2.16		

 

 

Other short-term borrowings

54,437  

77  

         0.57		

 

28,217  

251  

         3.58		

 

 

Long-term borrowings

52,000  

371  

         2.89		

 

9,615  

68  

         2.84		

 

 

 

Total interest-bearing  liabilities

1,129,194  

5,188  

         1.86		

 

1,004,443  

7,691  

         3.08		

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing  liabilities

 

 

 

 

 

 

 

 

 

Noninterest-bearing  deposits

130,252  

 

 

 

132,313  

 

 

 

 

Accrued interest payable

2,052  

 

 

 

2,576  

 

 

 

 

Other 

7,957  

 

 

 

8,480  

 

 

 

 

 

Total noninterest-bearing  liabilities

140,261  

 

 

 

143,369  

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

Total liabilities

1,269,455  

 

 

 

1,147,812  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

117,894  

 

 

 

112,714  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and  shareholders' equity

 $

1,387,349  

 

 

 

 $

1,260,526  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INTEREST INCOME / NET  YIELD ON

 

 

 

 

 

 

 

 

 

INTEREST-EARNING ASSETS 

 

 $

12,399  

         3.82		

%

 

 $

12,549  

         4.22		

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

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

 

 

(2)

Calculated including  mortgage loans held for sale, excluding the allowance for loan losses.   Nonaccrual loans are included in average balances for

 

 

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

 

 

and deposits are domestic.

 

 

 

 

 

 

 

 
	 
48

 

 

 

 

 

Rate / Volume Analysis. As summarized in the precedingtable, net interest income decreased $150 thousand, or 1.2%, during the threemonth period ended March 31, 2009 over the same period of 2008.  The followingrate / volume analysis 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 periods indicated (inthousands).  The impact of the combination of rate and volume change has beendivided proportionately between the rate change and volume change.  Thecomparison between the periods includes an additional change factor thatsummarizes the impact of the difference in the number of days within eachperiod.

 

 

 

 

**Change due to**

**volume**

 

**Change due to		rate**

**Change due		to difference		in number of days**

**Total		change**

Assets

 

 

 

 

 

 

 

 

Interest-earnings assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

(4)

 

(31)

 

(1)

 

(36)

 

FHLB Stock

(463)

 

406 

 

- 

 

(57)

 

Investment securities available for sale (1)

248 

 

207 

 

(12)

 

443 

 

Loans (2)

2,003 

 

(4,871)

 

(135)

 

(3,003)

 

 

Total interest income

$

1,784 

 

(4,289)

 

(148)

 

(2,653)

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

Transaction deposit accounts

$

(170)

 

(1,612)

 

(2)

 

(1,784)

 

Money market deposit accounts

(116)

 

(491)

 

(1)

 

(608)

 

Savings deposit accounts

2 

 

(1)

 

- 

 

1 

 

Time deposit accounts

97 

 

(74)

 

(36)

 

(13)

 

 

 

(187)

 

(2,178)

 

(39)

 

(2,404)

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

23 

 

(122)

 

- 

 

(99)

 

Commercial paper (Master notes)

(12)

 

(117)

 

- 

 

(129)

 

Other short-term borrowings

(1,843)

 

1,669 

 

- 

 

(174)

 

Long-term borrowings

305 

 

1 

 

(3)

 

303 

 

 

Total interest expense

$

(1,714)

 

(747)

 

(42)

 

		(2,503)

 

 

 

 

 

 

 

 

 

 

 

 

     Net interest income

$

3,498 

 

(3,542)

 

(106)

 

(150)

 

 

 

 

 

 

 

 

 

 

(1)

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

(2)

Calculated including mortgage loans held for sale, excluding the allowance for loan losses. Nonaccrual loans are included in average balances for yield computations.  The impact of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis.

* *

Federal Reserve Rate Influences. The Federal Reserve influences the general market rates ofinterest earned on interest-earning assets and paid on interest-bearingliabilities.  The following table summarizes the actions taken by theFederal Reserve with regard to the prime interest rate and the federal fundsinterest rate from December 31, 2007 through March 31, 2009.

49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Prime rate**

 

**Federal funds rate**

 

 

 

**Change**

**Balance**

 

**Change**

**Balance**

Rate, at December 31, 2007

 

7.25 

%

 

4.25 

 

 

 

 

 

 

 

 

Changes in rate

 

 

 

 

 

 

January 22, 2008

(0.75)

 

 

(0.75)

 

 

January 30, 2008

(0.50)

 

 

(0.50)

 

 

March 18, 2008

(0.75)

 

 

(0.75)

 

 

 

Total changes in rate

 

(2.00)

 

 

(2.00)

Rate, at March 31, 2008

 

5.25 

 

 

2.25 

 

 

 

 

 

 

 

 

Changes in rate

 

 

 

 

 

 

April 30, 2008

(0.25)

 

 

(0.25)

 

 

October 8, 2008

(0.50)

 

 

(0.50)

 

 

October 29, 2008

(0.50)

 

 

(0.50)

 

 

December 16, 2008

(0.75-1.00)

 

 

(0.75-1.00)

 

 

 

Total changes in rate

 

(2.00-2.25)

 

 

(2.00-2.25)

 

 

 

 

 

 

 

 

Rate, at December 31, 2008

 

3.00-3.25 

 

 

0.00-0.25

 

 

 

 

 

 

 

 

Changes in rate

 

- 

 

 

- 

 

 

 

 

 

 

 

 

Rate, at March 31, 2009

 

3.00-3.25 

%

 

0.00-0.25

 

*Provision for Loan Losses*

 

Provision for loan lossesincreased from $488 thousand during the first three months of 2008 to $2.2million for the same period of 2009. Our decision to increase the provision forloan losses was prompted by a number of factors primarily driven by currenteconomic conditions, as well as our methodology for determining the level ofallowance for losses and regulatory guidelines regarding impaired assets. Webelieve that continuing to strengthen loan loss reserves is the prudent actiondue to increases in nonaccrual loans collateralized by real estate,specifically, construction and land development and nonfarm residential loans,which have been negatively impacted by the economic turmoil.  SeeFinancial Condition – Lending Activities, included elsewhere in this item, for further discussion of the factors impactingthe adequacy of the allowance for loan losses and, therefore, theprovision for loan losses.

 
Noninterest Income
 

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

 

 

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2009**

**2008**

Service charges on deposit accounts, net

$

1,884 

2,167 

Fees for trust and investment management and brokerage services

534 

756 

Mortgage-banking income

865 

469 

Investment securities gains

2 

- 

Other

1,146 

1,513 

 

Total noninterest income

$

4,431 

4,905 

 

Service Charges on Deposit Accounts, Net.  Service chargeson deposit accounts, net comprise a significant component of noninterest incomeand totaled 1.6% of average transaction deposit accounts for the three monthperiod ended March 31, 2009 and 1.7% of average transaction deposit accounts forthe three month period ended March 31, 2008.  

 

In response to decreasing deposit levels, institutions inthe financial services industry have increasingly been providing services forfree in an effort to lure deposits away from competitors and retain existingbalances.  Services that were initially developed as fee income opportunities,such as Internet banking and bill payment service, are now provided tocustomers free of charge. Consequently, opportunities to earn additional incomefrom service charges for such services have been more limited; however, servicecharges for nonsufficient funds and overdraft activity have partially offsetthe declining fees from such services charges.  

 

50

 

Fees for Trust and Investment Management and BrokerageServices. The following table summarizes the composition of fees for trustand investment management and brokerage services for the periods indicated (inthousands).

 

		     

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2009**

**2008**

Fees for trust and investment management services

$

407 

592 

Fees for brokerage services

127 

164 

 

Total fees for trust and investment management and brokerage services

$

534 

756 

 

Due to the substantial decline in the S&P 500 primarilywithin the last three quarters, fees for trust and investment management andbrokerage services for the three month period ended March 31, 2009 decreased $185thousand, or 31.3% to $407 thousand from $592 thousand for the three monthperiod ended March 31, 2008.  The decline in fees for trust and investmentmanagement services over these periods was consistent with the changes inmarket valuation over the same periods, which reduced the base on which feesare earned.   

 

The following table summarizes trust and investmentmanagement and brokerage assets under management at the dates indicated (inthousands).

 

 

 

**March 31,**

 

 

**2009**

**2008**

Trust and investment management assets

$

209,061 

308,665 

Brokerage assets

159,934 

201,699 

 

Total trust and investment management  and brokerage assets

$

368,995 

510,364 

 

 

 

 

 

Mortgage-Banking Income.   Mortgagebanking income increased during the three month period ended March 31, 2009over the same period of 2008 primarily because we capitalized on refinancingopportunities resulting from historically low interest rates.  

 

Most of the residential mortgage loans that we originate aresold in the secondary market.  Often we retain servicing rights.  Mortgageloans serviced for the benefit of others amounted to $396.5 million and $377.3million at March 31, 2009 and December 31, 2008, respectively. 

 

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

 

 

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2009**

 

**2008**

Mortgage-servicing fees

$

240 

 

216 

Gain on sale of mortgage loans held for sale

522 

 

189 

Other mortgage-banking income

103 

 

64 

 

Total mortgage-banking income

$

865 

 

469 

 

 

 

 

 

Mortgage-servicing fees as a percentage of mortgage loans serviced for the benefit of others at period end

0.25 

%

0.23 

 

Other.  Other noninterestincome decreased $367 thousand, or 24.3%, for the three month period endedMarch 31, 2009 over the same period of 2008 as the result of a nonrecurring2008 transaction that added $226 thousand in other noninterest income and adecrease in interest earned on balances with the Bank’s third party servicer ofofficial checks.  

 

Included within other noninterestincome for the three month period March 31, 2008 was a pretax gain ofapproximately $226 thousand resulting from the mandatory redemption of ourClass B Visa, Inc. shares as part of Visa’s initial public offering.  Wecontinue to own shares of Visa Class B shares that are convertible into Class Ashares. The amount of Class A shares we could realize upon conversion of ourremaining Class B shares may change depending upon whether additional amountsof money need to be reserved by Visa to settle outstanding litigation. TheClass B shares carry a three-year lock-up provision and may not be converted orredeemed during that period. We obtained our ownership of Visa shares, and the resultingproportionate share of the Visa litigation settlement, by being a long-timeVisa member. Our ownership proportion is based upon our percentage of totalfees paid to Visa over this period.

 

 

 

51

 

 

 

Also impacting this decline wasa decrease in interest earned on balances from a third party servicer ofofficial checks.  During the three month period ended March 31, 2008, we earned$75 thousand on such balances compared with none during the same period of2009.  

 

*Noninterest Expense*

 

General.  We continue to be disciplined about ourefforts to manage expenses.  The following tablesummarizes the components of noninterest expense for the periods indicated (inthousands).

 

 

 

 

 

 

 

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2009**

**2008**

Salaries and other personnel

$

5,862 

6,195 

Occupancy

916 

805 

Furniture and equipment

883 

944 

Loss on disposition of premises, furniture, and equipment

55 

- 

Marketing

297 

332 

Amortization of core deposit intangibles

11 

11 

Other

3,514 

3,096 

 

Total noninterest expense

$

11,538 

11,383 

 

 

 

 

 

Salaries and Other Personnel.Comprising 50.8% of noninterest expense during the three month period endedMarch 31, 2009 and 54.4% of noninterest expense during the three month periodended March 31, 2008, salaries and other personnel expense decreased by $333thousand over the periods.  This decline was primarily as a result of adecrease in expense associated with our officer incentive plan caused, in part,by an overaccrual at December 31, 2008 being used during the first quarter of2009 as well as a decline in the reserve allocated for 2009 incentive paymentsbased on anticipated payments less than those budgeted.

 

Occupancy. Occupancyexpense increased $111 thousand, or 13.8%, for the three month period endedMarch 31, 2009 over the same period of 2008 primarily as a result of the impactof the new corporate headquarters.  Occupancy expense for the three month periodended March 31, 2009 includes a partial month’s payment under the leaseagreement for the new headquarters.  This increase was offset by the impact ofexpenses associated with banking offices consolidated during 2008 no longerbeing recorded within occupancy expense but rather being recorded as a branchclosure expense within other noninterest expense.

 

Loss on Disposition of Premises, Furniture, and Equipment. We recognized $55 thousand in losses with regard to the writeoff of premises,furniture, and equipment in conjunction with the move to the new corporateheadquarters in March 2009.  See Part I- Financial Information, Item 1.Financial Statements, Note 5 contained herein for discussion regarding thisloss.

 

Other.  Other noninterestexpense increased by $418 thousand, or 13.5%, to $3.5 million during the threemonth period ended March 31, 2009 from $3.1 million during the three monthperiod ended March 31, 2008. 

The following table summarizes significant fluctuationswithin other noninterest expense for the periods indicated (in thousands).

 

 

**For the three month**

 

**periods ended March 31,**

 

**2009**

**2008**

FDIC assessment

$

454 

165 

Mortgage-servicing rights amoritzation expense

414 

216 

Real estate acquired in settlement of loans writedowns

29 

360 

Professional expenses

235 

139 

Branch closure expense

88 

- 

 

$

1,220 

880 

 

FDIC insurance premiumsincreased $289 thousand over the periods presented due to higher than budgeteddeposits during the three month period ended March 31, 2009 and higherassessment rates over the three month period ended March 31, 2008.  During thethree month period ended March 31, 2008, we fully utilized one-time assessmentcredits from 2006.  

 

52

 

 

 

 

 

Due to the recent failure of several unaffiliatedFDIC-insured depository institutions, and the FDIC’s new liquidity guaranteeprogram, the deposit insurance premium assessments paid by all banks willincrease.  The FDIC has proposed imposing a 20-basis point special emergencyassessment payable September 30, 2009, with authorization of the FDIC board toimplement an additional 10 basis-point premium in any quarter.  As aresult, we anticipate our future insurance costs to be substantially higherthan in previous periods.

 

Amortization ofmortgage-servicing rights increased $198 thousand over the periods presented.Since December 31, 2007, the Federal Reserve has decreased rates by 400 to 425basis points. This decline in interest rates has resulted in an increase inloan prepayments and, therefore, has increased amortization within themortgage-servicing rights portfolio.

 

Professional expenses increased$96 thousand over the periods presented due, in part, to costs associated with ourmove to the new corporate headquarters. 

 

Branch closure expensesincreased $88 thousand over the periods presented due to expenses associatedwith banking offices consolidated during 2008 that have not yet been subleasedor sold.

 

Offsetting these increases toother noninterest expense was a decrease in real estate acquired in settlementof loans writedown expense of $331 thousand.  This decrease was primarily dueto expense required during the first quarter of 2008 related to a commercialreal estate property within the portfolio with respect to which we own aparticipation interest. The lead bank is managing the operations of theproperty and is currently working with an external firm to market the property. We were a 20% participant in the loan relationship and are now a 20% owner ofthe collateral property. Therefore, we must cover 20% of the costs related tothe property.  Although this property remains in our real estate acquired insettlement of loans portfolio at March 31, 2009, no such costs on this propertywere determined to be necessary during the first quarter of 2009.

 
Provision for Income Taxes
 

Incometax expense totaled $1.1 million for the three month period ended March 31,2009, compared with $1.9 million for the three month period ended March 31,2008.  The Company’s effective tax rate was 36.0% and 34.7% over the sameperiods. 

 

***Recently Issued / Adopted Accounting Pronouncements*****

 

See Part I – FinancialInformation, Item 1. Financial Statements, Note 1 contained herein fordiscussion regarding recently issuedand recently adopted accounting pronouncements and their expected impact on ourbusiness, financial condition, results of operations, or cash flows.  

 

Item 3.  Quantitativeand Qualitative Disclosures about Market Risk 

 

As of March 31, 2009, the following table summarizes the forecastedimpact on net interest income using a base case scenario given upward anddownward movement in interest rates of 100 basis points and 200 basis pointsbased on forecasted assumptions of nominal interest rates, balance sheet growthrates (derived from targeted budget projections), and deposit and loanrepricing rates (based upon past interest rate cycles).  Estimates are based onhistorical interest rate cycles, current targeted budget projections, and otherfactors deemed to be relevant. However, underlying assumptions may be impactedin future periods which were not known to management at the time of theissuance of the Consolidated Interim Financial Statements.  Therefore,management’s assumptions may or may not prove valid.  No assurance can be giventhat changing economic conditions and other relevant factors impacting our netinterest income will not cause actual occurrences to differ from underlyingassumptions. 

 

 

53

 

 

 

 

 

 

 

 

 

 

 

 

 

**Interest rate scenario (1)**

**Percentage**

**change in net**

**interest**

**income from**

**base**

 

 

 

 

Up 200 basis points

(4.66)

%

 

 

Up 100 basis points

(2.11)

 

 

 

 

Down 100 basis points

(0.27)

 

 

 

 

Down 200 basis points

(0.06)

 

 

 

 

 

 

 

 

 

 

 

(1) The rising 100 and 200 basis points and falling 100and 200 basis point interest rate scenarios assume an immediate and parallelchange in interest rates along the entire yield curve.

 

Thereare material limitations with the model presented above, which include, but arenot limited to:
-  It presents the balance sheet in astatic position.  When assets and liabilities mature or reprice, they do notnecessarily keep the same characteristics.
-  The computation of prospectiveimpacts of hypothetical interest rate changes are based on numerous assumptionsand should not be relied upon as indicative of actual results.
-  The computations do notcontemplate any additional actions we could undertake in response to changes ininterest rates.

 
Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls andProcedures
 

An evaluation of ourdisclosure controls and procedures (as defined in Sections 13(a)-15(e) and15(d)-15(e) of the Securities Exchange Act of 1934) was carried out under thesupervision and with the participation of the Chief Executive Officer, thePresident and Chief Operating Officer (Principal Financial Officer) and several other members of senior managementas of March 31, 2009, the last day of the period covered by this Quarterly Report. The Chief Executive Officer and the Presidentand Chief Operating Officer (Principal Financial Officer) concluded that our disclosure controls andprocedures were effective as of March 31, 2009 in ensuring that the informationrequired to be disclosed in the reports we file or submit under the SecuritiesExchange Act of 1934 is (i) accumulated and communicated to management(including the Chief Executive Officer and the President and Chief OperatingOfficer (PrincipalFinancial Officer)) in a timelymanner, and (ii) recorded, processed, summarized, and reported within the timeperiods specified in the SEC’s rules and forms. 

 
First Quarter Internal Control Changes
 

During the first quarter of 2009, we did not make any changes in ourinternal controls over financial reporting that have materially affected or arereasonably likely to materially affect those controls.

 

54

 

 

 

 

 

PART II – OTHERINFORMATION

                                                                             

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

 

See Part I – Financial Information, Item 1. Financial Statements, Note 14contained herein for a discussion of the information required by thisitem.  

 

**Item 1a. Risk Factors**

 

For a discussion of certain risk factors that could cause ourfinancial results and condition to vary materially from period to period orcause actual results to differ from expectations for future financial andbusiness performance, refer to Item 1A. of our Annual Reporton Form 10-K for the year ended December 31, 2008.  The following summary provides additional clarification torisk identified in our Annual Report on Form 10-K for the year ended December31, 2008 and provides additional risk factors identified since that time as aresult of recent developments.  

 

*We May Further Reduce or Suspend Dividend Payments*

 

The holders of our common stock are entitled to receivedividends, when and if declared by the Board of Directors, out of funds legallyavailable for such dividends. Palmetto Bancshares is a legal entity separateand distinct from the Bank and depends on the payment of dividends from theBank. Palmetto Bancshares and the Bank are subject to regulatory policies andrequirements relating to the payment of dividends, including requirements tomaintain adequate capital above regulatory minimums. Federal regulatoryauthorities are authorized to determine under certain circumstances that thepayment of dividends by a bank holding company or a bank would be an unsafe orunsound practice and to prohibit payment of those dividends. Federal regulatoryauthorities have indicated that banking organizations should generally paydividends only out of current income. In addition, as a South Carolinachartered bank, the Bank is subject to limitations on the amount of dividendsthat it is permitted to pay. 

 

In an effort to retain and build capital during thisperiod of economic uncertainty, the Board of Directors approved a reduction inthe Company's quarterly common stock dividend from $0.20 per share during thefourth quarter of 2008 to $0.06 per share during the first quarter of 2009.There can be no assurances regarding the level at which we will pay futuredividends because our ability to pay such dividends is dependent on a varietyof factors, including, but not limited to, our financial condition, results ofoperations, cash flow, and capital requirements.

 

*We Have Experienced a Decline in Asset Quality Resultingin Increased Potential Losses within Our Loan Portfolio and May SeeFurther Asset Deterioration and Higher Potential Losses*

* *

Our ability to generateearnings is significantly impacted by our ability to properly originate,underwrite, and service loans. We have experienced a decline in asset qualityand have identified increased potential losses within our loan portfolio primarilybecause borrowers, guarantors, or related parties have been unable to performin accordance with the terms of their loans. Asset quality deterioration couldcause our interest income and net interest margin to decrease, which couldadversely impact our business, financial condition, and results of operations.We have identified deficiencies with respect to certain loans in our loanportfolio which are primarily related to the downturn in the economy. Propertyvalues for real estate collateral have declined substantially.  Weincreased our allowance for loan losses to $12.6 million at March 31, 2009to address the risks inherent within our loan portfolio. During the secondquarter of 2009, we plan to engage a third party firm to perform an evaluationof our identified impaired loans and allowance for loan losses process.  Additionally,during the second and third quarters of 2009, we plan to engage a third party firmto augment our loan review process. Regardless of the underwriting criteria wehave utilized, the third party evaluation of our loan portfolio may identifypotential  losses as a result of various factors beyond our control, including:
-  Cost overruns;
-  Declining property values;
-  Mismanaged construction;
-  Inferior or improper     construction techniques;
-  Economic changes or     downturns during construction;
-  Rising interest rates that     may prevent sale of the property; and
-  Failure to sell completed     projects or units in a timely manner.

 

55

 

 

 

 

 

The results of our continued internalevaluations and these external evaluationsof our loan portfolio and allowance for loan losses model may cause management to adjust its opinion of the levelof asset quality in our loan portfolio. Such a determination may lead toincreases in our nonperforming assets and impaired loans, and, therefore,additions to our allowance and provision for loan losses, which could alsoadversely impact our business, financial condition, and results of operations.

 

**Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

None

 

**Item3. Defaults Upon Senior Securities**

** **

None

 

**Item4. Submission of Matters to a Vote of Security Holders**

** **

None

 

**Item5. Other Information**

** **

None

** **

**Item6. 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, and32 have been filed with the SEC in conjunction with this Quarterly Report onForm 10-Q. Copies of these exhibits are available upon written requestto Lauren S. Greer, The Palmetto Bank, 306 East North Street, Greenville, SouthCarolina 29601.

 

56

 

 

 

 

 

 

                                                                                                                                               

 

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 

 

PALMETTOBANCSHARES, INC.

 

 

 

By:

 

 

/s/ L. Leon Patterson                   

L.Leon Patterson

Chairmanand Chief Executive Officer

PalmettoBancshares, Inc.

 

 

/s/ Paul W. Stringer

PaulW. Stringer

Presidentand Chief Operating Officer, 

ChiefAccounting Officer

PalmettoBancshares, Inc.

 

 

Date:May 11, 2009

 

57

 

 

 

 

 

**EXHIBITINDEX**

 

 

Exhibit No.        Description

 

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                        CertificationsPursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

* *

 

58

 

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